Spendthrift Trusts in Canada — Protecting an Inheritance From the Beneficiary

A 68-year-old Hamilton widower has three adult children. Two are settled professionals; the third has struggled with gambling for fifteen years and has filed for bankruptcy twice. The father wants to leave each child an equal share of his $1.8 million estate but knows that an outright bequest to the third child will be gone within months — and most likely to the same casinos and online sportsbooks that produced the bankruptcies. He also wants to avoid disinheriting the child, which would damage the family relationship and leave the child with nothing to fall back on in later life.

The standard Canadian solution is a discretionary testamentary trust for the third child's share. The trustee — typically one of the other siblings, paired with a professional co-trustee — holds the share, invests it, and makes distributions for the child's housing, healthcare, basic living expenses, and other purposes the testator has indicated in a non-binding letter of wishes. The child has no automatic entitlement to any specific amount and no power to demand a lump sum. Creditors who eventually pursue the child (a gambling debt collector, a bankruptcy trustee) cannot attach the trust's assets because the child has no fixed interest in them. The structure achieves what a US estate planner would call a spendthrift trust, using Canadian common-law mechanics. For the broader picture of how trusts fit into the estate plan, see our pillar on estate planning in Canada and our companion guide on trusts in Canada.

The terminology difference #

US estate planning has a well-developed concept called a "spendthrift trust" — a trust containing an explicit anti-alienation clause that bars the beneficiary from assigning or pledging their interest, and that bars creditors from attaching trust assets in satisfaction of the beneficiary's debts. The protection is provided by statute in most US states.

Canadian common-law provinces do not have an equivalent statutory anti-alienation regime. A clause in a Canadian trust deed that says "the beneficiary's interest cannot be assigned and cannot be attached by creditors" is not, on its own, enforceable against a creditor with a properly perfected claim against a fixed beneficial interest.

The Canadian work-around is structural. Instead of trying to protect a fixed interest by labelling it un-attachable, the Canadian protective trust avoids creating a fixed interest in the first place. A genuinely discretionary trust gives the beneficiary nothing more than a right to be considered for distributions in the trustee's discretion — and a contingent right of that nature is not a "property" interest that a creditor can attach.^[1]

The result, for practical purposes, is similar to a US spendthrift trust. The mechanic is different.

The three structural elements #

A Canadian discretionary protective trust typically combines three drafting elements.

Pure discretion over income and capital. The trustee has absolute discretion to pay, or not pay, any amount of income or capital to the beneficiary or to any other beneficiary in a defined class. The trust deed avoids language that would create a fixed entitlement — phrases like "the trustee shall pay" or "the beneficiary is entitled to the income" are typically replaced with "the trustee may pay" and "the trustee may, in their absolute discretion, consider the needs of."

A class of beneficiaries. The protected beneficiary is generally one of several potential recipients — for example, "my child X and the issue of my child X" or "my child X, my child X's spouse, and my child X's issue." This broadens the trustee's discretion to direct distributions to family members other than the at-risk beneficiary when appropriate (paying a child's tuition directly to a school rather than handing money to the at-risk parent, for instance).

A guidance document, not binding. A letter of wishes (sometimes called a memorandum of wishes) explains the testator's intent to the trustee — what the trust is for, how the testator hoped the trustee would exercise discretion, particular concerns about the beneficiary's risks. The letter is not legally binding, but it gives the trustee a defensible record of the testator's intent if distributions are later challenged.

Creditor and bankruptcy protection #

The key claim — that creditors cannot reach trust assets — depends on the trust being genuinely discretionary. Two patterns can break the protection:

1. A purported discretionary trust that operates as a de facto entitlement. If the trustee, in practice, distributes the same fixed amount to the beneficiary every month for years, a court reviewing the structure on a creditor's claim may find that the trust has effectively created an entitlement, and the entitlement can be attached. Trustees of protective trusts should vary distribution patterns over time, document their reasoning, and avoid creating an apparent contractual arrangement with the beneficiary.

2. Self-settled trusts. If the beneficiary is also the settlor — that is, the beneficiary put their own assets into the trust to protect them from their own creditors — Canadian courts and bankruptcy law generally see through the structure. The Bankruptcy and Insolvency Act includes provisions that can void self-settled protections. Testamentary trusts (settled by a deceased testator for the benefit of someone else) do not face this issue because the beneficiary did not settle the trust.

Tax mechanics #

A testamentary trust is a separate taxpayer for Canadian income tax purposes.^[1] Three tax-rate regimes can apply:

• Graduated Rate Estate (GRE) rates. During the first 36 months of estate administration, an estate is taxed at the same graduated rates that apply to an individual. Trusts that arise on death and qualify as the GRE benefit from these lower rates during that period.
• Qualified Disability Trust (QDT) rates. A testamentary trust with a beneficiary who is eligible for the disability tax credit can elect QDT status and use graduated rates indefinitely.^[2]
• Top marginal rate. Most other testamentary trusts (including discretionary protective trusts without a disability-credit-eligible beneficiary) are taxed on retained income at the top federal-plus-provincial marginal rate. This is the post-2016 default for testamentary trusts.

The standard response is to allocate income out of the trust to the beneficiary each year — even if the cash itself is not paid out — so the income is taxed in the beneficiary's hands at the beneficiary's lower rate. The trust deed must permit this; the trustee must exercise the discretion; and the beneficiary must report the income. For a beneficiary with addiction or financial mismanagement issues, the trustee may legitimately decide that distributing cash to the beneficiary is unwise, even though the tax allocation has been made — the trustee can pay the beneficiary's expenses directly (rent, healthcare, food) and account for those payments as the income allocation.

The 21-year rule #

Every 21 years from the trust's creation, the Income Tax Act treats the trust as if it had disposed of all its capital property at fair market value, triggering tax on accumulated gains.^[1] For a protective trust intended to last a beneficiary's lifetime, the 21-year mark requires planning — typically, distributing or rolling over assets shortly before the anniversary to manage the tax hit.

The rule applies to all personal trusts, not just protective trusts. The planning is the same — but the protective trust's purpose may complicate the response, because rolling assets out to the at-risk beneficiary defeats the protective purpose. Some trusts roll assets to a second, freshly-settled trust (a "21-year roll") to reset the clock; others accept the tax hit and continue.

When the protective trust is not the right answer #

Two situations where a different structure works better:

• The beneficiary has a disability that qualifies for the disability tax credit. A Henson trust or a Qualified Disability Trust often produces better outcomes. A Henson trust is typically an absolute discretionary trust under which the beneficiary cannot compel distributions or unilaterally control the trust property; whether that interest is counted as an asset for eligibility purposes depends on the wording and structure of the particular benefits program, such as ODSP in Ontario. Our companion guide on the Henson trust walks the disability case.
• The beneficiary's issues are transient. A young adult who is currently financially unstable but expected to mature is sometimes better served by a "staged distribution" structure (one-third at 25, one-third at 30, one-third at 35) than by a lifetime discretionary trust. The staged approach achieves some protection without committing the family to multi-decade trustee involvement.

What we focus on at It's Simple Will #

A discretionary protective trust drafted into a Canadian will requires careful legal drafting — the trust deed language, the trustee selection, the class of beneficiaries, and the letter of wishes all need to fit the family's specific situation. The Will Creator handles the structurally common patterns of estate planning; for clients who need a protective trust for an at-risk beneficiary, the tool flags the issue and recommends professional legal drafting. The Life Discovery Kit captures the trustee's contact information and notes for the executor about the protective trust's purpose. Our companion guide on testamentary trusts in Canadian wills walks the broader testamentary-trust category.