4th Annual Dollars & Sense Survey: Turning up the heat

Using a life insurance testamentary trust to receive the proceeds of a life insurance policy has many advantages for estate planning, including control and management of the distribution of the funds; tax advantages from the graduated rates; and the avoidance of probate fees.

Once a decision is made to create a trust, it becomes the lawyer’s job to ensure the provisions are carefully drafted so all the tax, management and personal goals of the testator are met. Say, for example, the beneficiary designation appearing in the will fails to make it clear that the insurance proceeds don’t form part of the estate. In such a case, the proceeds could be subject to estate administration taxes (probate) and also placed at the mercy of any creditors.

Bear in mind the declaration in a will takes effect from the date of execution rather than upon the testator’s death. Clients must be aware of this and ensure appropriate beneficiary designations be made on policies acquired after the date of the execution, as the designation only applies to contracts in force at the time of execution. Special rules also impact contracts issued before July 1, 1962 for which a preferred beneficiary was designated.

It’s a good idea to select persons other than the executors of the will to be the trustees. Doing this helps clearly establish the trust is in no way intended to form part of the estate. The insurance trustee should then be designated all the powers granted to the estate trustee. Administration of a trust is a long-term obligation, so an advisor should get the client to name one or more contingent trustees in the event his or her first choice is unable to follow through.

There should also be a provision in the will identifying the policies to which the declaration refers. Recent case law suggests wording such as “all my policies” may be specific enough, and the use of a general declaration ensures it won’t be deemed ineffective in the event there is an error in identifying the correct policies. The provision should state all previous beneficiary designations are revoked and that the declaration is separate under the relevant provincial insurance legislation. It should state the proceeds are being paid to the trustees as named beneficiaries and are being held as a separate insurance trust fund.

Although it’s most common to use a will declaration to create a testamentary insurance trust, it can also be done using a separate legal instrument. Such an approach can be appropriate when a client makes frequent changes to the will or anticipates life events may affect the trust and its provisions. For example, a single parent who re-marries but wants to ensure his children receive an inheritance.

Advantages to this approach include the ability to keep proceeds completely separate, rather than risk having them mixed with other assets. The separate testamentary insurance trust declaration also won’t be revoked in the event the will is challenged. The insurance company can be provided with a copy of any relevant documents for further certainty. These advantages might be slightly offset by the additional cost and complication of requiring a separate document and some duplication of the terms of the will. But if there is concern about protecting assets or ensuring their separation from other parts of the estate, it’s the right way to go.

No matter how you set up the declaration, don’t go it alone. Trust and insurance law is complex, so it’s important to recruit qualified legal, tax and insurance professionals to help clients through the process.

Using a life insurance testamentary trust to receive the proceeds of a life insurance policy has many advantages for estate planning, including control and management of the distribution of the funds; tax advantages from the graduated rates; and the avoidance of probate fees.

Once a decision is made to create a trust, it becomes the lawyer’s job to ensure the provisions are carefully drafted so all the tax, management and personal goals of the testator are met. Say, for example, the beneficiary designation appearing in the will fails to make it clear that the insurance proceeds don’t form part of the estate. In such a case, the proceeds could be subject to estate administration taxes (probate) and also placed at the mercy of any creditors.

Bear in mind the declaration in a will takes effect from the date of execution rather than upon the testator’s death. Clients must be aware of this and ensure appropriate beneficiary designations be made on policies acquired after the date of the execution, as the designation only applies to contracts in force at the time of execution. Special rules also impact contracts issued before July 1, 1962 for which a preferred beneficiary was designated.

It’s a good idea to select persons other than the executors of the will to be the trustees. Doing this helps clearly establish the trust is in no way intended to form part of the estate. The insurance trustee should then be designated all the powers granted to the estate trustee. Administration of a trust is a long-term obligation, so an advisor should get the client to name one or more contingent trustees in the event his or her first choice is unable to follow through.

There should also be a provision in the will identifying the policies to which the declaration refers. Recent case law suggests wording such as “all my policies” may be specific enough, and the use of a general declaration ensures it won’t be deemed ineffective in the event there is an error in identifying the correct policies. The provision should state all previous beneficiary designations are revoked and that the declaration is separate under the relevant provincial insurance legislation. It should state the proceeds are being paid to the trustees as named beneficiaries and are being held as a separate insurance trust fund.

Although it’s most common to use a will declaration to create a testamentary insurance trust, it can also be done using a separate legal instrument. Such an approach can be appropriate when a client makes frequent changes to the will or anticipates life events may affect the trust and its provisions. For example, a single parent who re-marries but wants to ensure his children receive an inheritance.

Advantages to this approach include the ability to keep proceeds completely separate, rather than risk having them mixed with other assets. The separate testamentary insurance trust declaration also won’t be revoked in the event the will is challenged. The insurance company can be provided with a copy of any relevant documents for further certainty. These advantages might be slightly offset by the additional cost and complication of requiring a separate document and some duplication of the terms of the will. But if there is concern about protecting assets or ensuring their separation from other parts of the estate, it’s the right way to go.

No matter how you set up the declaration, don’t go it alone. Trust and insurance law is complex, so it’s important to recruit qualified legal, tax and insurance professionals to help clients through the process.