By Kevin Wark
One of the many positive attributes of a life insurance policy is the ability to designate a beneficiary of the life insurance proceeds. Filling out the name of a person in a box on the insurance application ensures the death benefit is paid directly to the named beneficiary upon proof of death. Designating a beneficiary has the added benefits of avoiding probate (including delays and related expenses) and the seizure of the benefit by creditors of the estate, and maintaining confidentiality as to who is the recipient of the funds. Very neat and simple.
Unfortunately, life is not always that simple. Additional thought and planning may be required to meet more complex and sophisticated client objectives. This article will highlight a number of different planning considerations in structuring an insurance beneficiary designation.
Revocable or Irrevocable, That Is the Question
As a first step, a policyholder must determine whether the designation should be “revocable” or “irrevocable.” In most cases the designation will be revocable, as this provides the policyholder with the flexibility to change the designation at any time prior to death.
However, there may be situations where an irrevocable beneficiary designation is the preferred route. This might be the case where the policyholder has assumed certain legal liabilities, since an irrevocable designation will generally protect the policy from creditors of the policyholder. As well, an irrevocable beneficiary designation may be required by contract (e.g., to repay a loan) or under a court order (e.g., to secure support payments to an ex-spouse). The irrevocable beneficiary designation prevents the policyholder from exercising certain rights under the insurance policy, including changing the beneficiary designation, without the consent of the irrevocable beneficiary.
Dealing with More Complex Arrangements
a. The Beneficiary is Not Capable of Managing the Insurance Gift
A parent or grandparent may want to provide insurance benefits to a family member who may not (at least currently) be capable of managing those benefits. This would include young children, those who suffer from mental incapacity, and beneficiaries who have experienced difficulty managing their financial affairs. In these circumstances, the policyholder could establish an arrangement that provides for a trustee to hold and manage the insurance proceeds on behalf of the beneficiaries. In addition, where a beneficiary qualifies for the disability tax credit, there may be ways to structure the payment of the insurance proceeds to protect against the loss of government social assistance benefits, as well as to obtain other tax benefits.
b. Multiple Beneficiaries
The policyholder may wish the insurance benefit to be split among several family members. The complexity associated with multiple beneficiaries does not lend itself well to using the insurance company form. As well, the policyholder should consider the appointment of contingent beneficiaries that would take effect in the event that one of the designated beneficiaries predeceases the policyholder. Again, the insurance declaration form in the insurance contract will be inadequate for this task.
c. Charitable Bequests
An insurance policy may have been acquired or subsequently repurposed to provide for gifts to several charities. There may be the desire to have a person hold the insurance proceeds and manage the gifts to the various charities, thereby ensuring that selected charities have remained “true to their purpose” after the death of the policyholder. In this case a more formal arrangement will need to be established to manage the charitable wishes of the policyholder.
d. Separation or Divorce
A separation agreement or divorce order may require one party to acquire life insurance on his or her life to secure the payment of support benefits to the other party in the event of death. There may be mutual agreement that the insurance be held in a trust arrangement, to ensure premium payments are paid, and that any death benefit not required to satisfy future support payments can be directed to beneficiaries selected by one or both parties. This of course requires a separate arrangement with the appropriate beneficiary designation.
e. Buy-Sell Arrangements
A buy-sell agreement between shareholders of a private corporation may require each shareholder to purchase the shares of a deceased shareholder. The agreement may also specify that each shareholder must own insurance on the lives of the other shareholders for purposes of funding the buy-out on death. Depending on the number of shareholders, this can become an administrative nightmare in terms of ensuring the policies remain in force, and the insurance proceeds are used for the intended purpose. The establishment of a trusteed arrangement, to administer the payment of premiums and/or the disbursement of insurance benefits, will help to ensure the funding of the buy-sell arrangements.
Kevin Wark, LLB, CLU, TEP, is the author of The Essential Canadian Guide to Estate Planning (2nd Ed.) and The Essential Canadian Guide to Income Splitting. To comment on this article, email firstname.lastname@example.org .