Testamentary Trusts vs. Living Trusts – A Complete Guide by a Montreal CPA Firm Near You

Introduction

Trusts are among the most powerful tools in Canadian tax and estate planning. But not all trusts are the same. The two main categories—testamentary trusts (created at death through a will) and living trusts (created during a person’s lifetime)—serve different purposes, follow different tax rules, and offer different advantages. Understanding the distinction is critical for anyone planning their estate, protecting assets, managing family wealth, or seeking tax efficiency. This guide explains how both trust types work, how they are taxed, and when each one is appropriate.

Legal and Regulatory Framework

Trusts in Canada are governed by provincial trust law and federal tax rules under the Income Tax Act. A testamentary trust is created upon the death of an individual, typically through a will. An inter vivos trust (living trust) is created during a person’s lifetime by transferring assets to a trustee for the benefit of beneficiaries. All trusts (except certain exemptions) must file annual T3 Trust Income Tax and Information Returns. Living trusts are generally taxed at the top marginal rate, while testamentary trusts may qualify as a Graduated Rate Estate (GRE) for up to 36 months, granting access to low marginal tax rates during that period.

Key Court Decisions

In Garron Family Trust v. Canada, the Supreme Court emphasized the importance of identifying where true management and control of a trust lies for residency and tax purposes. In Antle v. Canada, the court struck down a trust that lacked genuine trust intention and compliance with trust formalities. In Neuman v. The Queen, CRA successfully challenged income splitting through trusts where documentation was inadequate. These decisions highlight that trusts must have proper structure, control, documentation, and adherence to legislation to receive favourable tax treatment.

What Is a Testamentary Trust?

A testamentary trust is created as a direct result of a person’s death. It is established through the deceased’s will or estate documents and only comes into existence after death. Testamentary trusts are commonly used to: manage inheritances for minors, support spouses, protect disabled beneficiaries, control long-term distribution of assets, provide asset protection, and hold investments or business shares post-death. For the first 36 months, a testamentary trust may qualify as a Graduated Rate Estate, giving it access to lower individual tax rates.

What Is a Living Trust (Inter Vivos Trust)?

A living trust is set up during a person's lifetime. Assets are transferred to a trustee, who manages them for the beneficiaries. Examples include: family trusts for business planning, alter ego trusts for probate avoidance, joint partner trusts for married couples, bare trusts for real estate holding, and Henson trusts for protecting disabled beneficiaries. Living trusts are taxed at the highest marginal tax rate, unless income is paid to beneficiaries and taxed in their hands.

Testamentary Trusts vs. Living Trusts: Key Differences

1. Timing of Creation

Testamentary: Created at death through a will.
Living: Created while the person is alive.

2. Tax Rates

Testamentary: Eligible for GRE status (graduated rates for 36 months).
Living: Taxed at top marginal rate (unless income allocated to beneficiaries).

3. Probate Planning

Testamentary: Assets pass through probate unless a trust arises automatically through the will.
Living: Can avoid probate by transferring assets before death (alter ego or joint partner trusts).

4. Control and Flexibility

Testamentary: Terms are fixed once the individual dies.
Living: Can be customized extensively while the settlor is alive.

5. Reporting Requirements

Both types must file T3 returns, but new trust reporting rules require additional disclosure for living trusts, including bare trusts.

6. Use Cases

Testamentary: Protect minors, disabled heirs, or a surviving spouse.
Living: Business planning, income splitting (with restrictions), probate avoidance, asset protection.

When Should You Use a Testamentary Trust?

Testamentary trusts are ideal when: you want to control how children receive inheritances; you want to support a spouse but protect assets from remarriage or creditors; you have disabled dependents who require long-term care; or your estate will have significant assets requiring professional management. GRE rules allow reduced tax rates for three years, making testamentary trusts tax-efficient during early estate administration.

When Should You Use a Living Trust?

Living trusts are powerful tools when: you want to avoid probate; you want to control assets during your lifetime; you want to simplify the transfer of assets at death; you own property in multiple provinces; you want immediate asset protection; or you are implementing a business freeze or family trust for succession planning. Alter ego and joint partner trusts offer particular advantages for seniors aged 65+.

New Reporting Rules Affect Both Types

Recent trust reporting changes require both testamentary and living trusts—especially bare trusts—to file T3 returns and disclose all trustees, beneficiaries, settlors, and controlling individuals. Trustees must maintain detailed documentation and comply with CRA’s enhanced transparency requirements.

Mackisen Strategy

At Mackisen CPA Montreal, we help clients design, structure, and maintain both testamentary and living trusts. We coordinate with estate lawyers to draft trust deeds, prepare annual T3 tax filings, manage allocations to beneficiaries, ensure compliance with the new reporting rules, assist executors with trust administration after death, and develop long-term family tax and succession plans. Our goal is to ensure your trust achieves its legal and tax objectives while minimizing audit risk.

Real Client Experience

A Montreal family created a testamentary trust for a minor child, benefiting from GRE tax rates; we handled all T3 filings and distributions. A business owner used a family trust to hold corporate shares and split capital gains; we ensured compliance and maximized tax savings. A couple used an alter ego trust to avoid probate and maintain privacy; we structured the trust and coordinated valuation and transfers. A family using a bare trust for real estate required new reporting under updated rules—we prepared filings and prevented penalties.

Common Questions

Do living trusts reduce taxes? Not directly—most are taxed at top rates unless income is shifted to beneficiaries. Do testamentary trusts last forever? Usually up to 21 years, unless distributing property earlier. Can I change a trust after it’s created? Living trusts may be adjusted; testamentary trusts are fixed after death. Do trusts avoid probate? Only living trusts designed properly (e.g., alter ego trusts).

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps families, business owners, and executors use trusts effectively for tax planning, inheritance management, and asset protection. Whether setting up a living trust or administering a testamentary trust, our guidance ensures compliance, efficiency, and peace of mind.