will-estate-planning

From an estate planning perspective, segregated funds are often seen as useful for minimizing potential estate administration fees (probate). Since a seg fund is an insurance product, where a beneficiary is named on the plan contract, the proceeds normally pass outside of the estate and probate is avoided. It’s important, however, to be aware of potential pitfalls when using seg funds as a planning tool.

Creditor protection

Though not necessarily an estate-planning purpose, creditor protection is an additional benefit of a seg fund. But this protection may be lost in certain circumstances. For instance:

  • If the seg fund was purchased when the investor was experiencing financial difficulties, or knew he or she would face such difficulties, creditor protection may be challenged.
  • Seg funds may not provide creditor protection from CRA if income tax liabilities are outstanding in a non-bankruptcy situation.
  • Seg funds may not provide protection from claims arising under family law to provide for a dependant.
  • Creditor protection is typically available only when a family class beneficiary (e.g., spouse, child, grandchild or parent) is named on the plan contract.

The above list isn’t exhaustive. The important thing is that you counsel caution if a client’s motivation in purchasing seg funds is creditor protection.

Read: 3 fixes for clients’ trust woes

Fees

A seg fund usually has a higher MER than a mutual fund, partly to cover the fund’s insurance features.

When a client’s buying seg fund solely to minimize probate, she needs to consider whether the fund’s additional annual cost is more or less than the probate savings that will eventually be realized. In Ontario, the probate fee associated with a $1-million estate is $14,500; in British Columbia, it’s $13,250; in Nova Scotia it’s about $14,186.

Probate is a one-time fee paid after a person dies; seg fund MERs, by contrast, are paid annually. For comparison purposes, a 1% difference in MER on $1 million would equate to an annual fee of $10,000. If the fund was held for ten years the increased MER would equate to a fee of $100,000.

Read: What happens when an RRSP annuitant dies

Estate planning

It’s important for advisors to be aware of standard beneficiary designation language used in wills, and to review any seg funds clients may have. The reason is that it’s possible to inadvertently change the beneficiary designation in a will or seg fund contract, which can defeat the client’s estate-planning goals.

Consider the case of Orpin v. Littlejohn (2009). Shortly before his death, Littlejohn designated his two sons as beneficiaries of an insurance contract held within his RRSP. Even though the account was structured as an RRSP, the investment product held within the policy was a seg fund.

Subsequent to this designation, Littlejohn created a new will that contained the following clause:

I HEREBY DESIGNATE my spouse, LOUISE CLARE ORPIN as the sole beneficiary of all moneys that I may have at the date of my death in any registered retirement savings plan, registered retirement income fund, registered pension plan, registered investment fund or any other similar device. I DIRECT my Trustees to make all necessary arrangements to transfer such funds to my spouse as soon as is reasonably practicable following the date of my death.

The question before the court was whether the seg fund should pass to the sons (per the designation in the policy) or to the widow (per the direction in the will). At first blush, it could be argued that Littlejohn was only attempting to change the beneficiary designation for his registered plans, but not on any insurance contacts (including the seg fund) he held. After all, insurance is never mentioned in the clause; plus, he had changed the beneficiary designation of the seg fund shortly before creating the will.

Further, although a beneficiary designation may be made or revoked by a declaration—including in a will—in order to be effective, a declaration must identify the contract or describe the insurance or insurance fund. There was no such language in Littlejohn’s will.

 

The court held that while the will did not specifically refer to an insurance policy, the words used were sufficient to constitute a declaration for purposes of the Insurance Act. In short, the court held that in using broad language, including the words, “or any other similar device,” Littlejohn had changed the seg fund’s beneficiary designation.

Read: Don’t let courts choose who gets dead clients’ RRIFs

Conclusion

Seg funds have attractive benefits, including probate minimization and creditor protection. However, when used as a planning tool, it’s important to consider fees and to have a nuanced awareness of the contents of clients’ estate documentation.

Keith Masterman, LLB, TEP is vice-president, Tax, Retirement and Estate Planning at CI Investments. He can be reached at kmasterm@ci.com.
Originally published on Advisor.ca
See all commentsRecent Comments

BATCHISON

The guarantees on seg funds can be useful, but the cost of securing that guarantee can outweigh the benefit. The maturity guarantee that you are referring to usually guarantees that the client has 75% of the original deposit amount when the contract matures on the 10th anniversary of the original purchase. That one day only. Any redemptions from the plan reduce the guarantee, either proportionally or dollar for dollar, so if the client has a RRIF account, the guarantee is eroded very quickly. I have seen it work in the client’s favour in the event of a death during market downturn. I have also seen clients be essentially forced to hang on to underperforming assets for the full 10 years just to get their principal back. It is also important to note that if the non-registered investment is below the guarantee on the maturity date and the fund/insurance company tops up the investment to bring it to the guarantee value, the amount of that top up is taxed as a capital gain.

Friday, April 8 @ 1:58 pm //////

KENT.WOOTTON.7

Exactly, and it could not have been stated any clearer, those guarantees are invaluable

Wednesday, April 6 @ 12:08 pm //////

MICHAEL.GENTILE.8

I would have to believe that Mr Masterman is well aware that the fund company he represents has a lot of their product on the shelves of insurance companies in a seg fund format.Of interest to note he does not make reference to the added value of the downside protection such as 75% and 100% guarantees paid for through the 1% higher MER.In the event of a major market turn down at precisely the wrong time for somebody about to retire do you think that that person would really be concerned about the 1% extra they paid to protect their retirement income over the long term????

Saturday, April 2 @ 12:41 pm //////

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