TAX, RETIREMENT & ESTATE PLANNING SERVICES An advisor s guide to insurance trusts
Insurance Trust AN EFFECTIVE TOOL IN PLANNING YOUR CLIENT S ESTATE An insurance trust can be an effective tool to help you plan your client s estate. The best way to create the insurance trust depends on the situation and the ultimate goal of the person settling (settlor) the trust. A variety of methods are available, each with benefits and considerations. Regardless of the method you choose, the wording you use must be drafted carefully to ensure that the insurance trust accomplishes its goal. The following pages contain different methods for setting up an insurance trust, the potential benefits and considerations of each method and draft clauses to use. Keep in mind that the clauses are suggestions only. They should not be included verbatim in a legal document or relied on as legal advice. You will need to consult a lawyer with extensive experience in Will and Estate Planning when implementing an Estate Plan and drafting a Will. Note: Using an insurance trust may be permissible in Quebec. Due to the complexity of structure, it is recommended that the assistance of a professional with expertise on how to structure the trust be obtained. 2
Methods for setting up an Insurance Trust DECLARATION WITHIN A WILL How to make the designation Declaration in a Will: See attached Schedule A and file Will with carrier Beneficiary designation in the insurance contract (where declaration is in the Will): Although not necessary, one may wish to indicate the following on the contract: The Trustee of the Insurance Trust created in the Last Will and Testament dated [insert date] of the Life Insured. Or the date of the Will does not need to be included as reliance will be made on the words Last Will and Testament. Note: Lawyers acting for clients who have implemented an insurance trust may only wish to file the Will with the declaration contained in it and not the form. The declaration within a Will stands on its own as a designation. While it is not necessary to file a copy of the Will, it is strongly suggested so as to provide notice to the insurance carrier of the existence of the declaration and the name of the trustee. It is possible to also make a designation in the contract. The contractual designation will revoke the declaration in the Will, and the proceeds will be paid to the trustee to be administered by the trustee in accordance with the insurance trust provision in the Will. Where a policy is jointly owned, the beneficiary designation form must be completed and signed by each owner in accordance with the insurance contract and provincial legislation requirements. BENEFITS Will is a familiar vehicle Flexible can mirror residue clauses in Will Designation contained all in one document Canada Revenue Agency (CRA) will treat as a testamentary trust * If Will invalid, declaration can still stand Note: With the above method, the trust is the beneficiary and not the owner, or premium payer, of the policy. * Under current law, a trust can be considered a testamentary trust if there is no settlement of property, even for a nominal amount, in the trust (technical Interpretation #9605575). A trust can be established during lifetime of the settlor but not settled. The trust arises as a result of the consequence of death of the settlor. Note: There are changes to the taxation of testamentary trusts that will apply January 1, 2016. The most significant change is the elimination of the graduated rates that currently apply to testamentary trusts other than the Graduated Rate Estate (GRE) and Qualified Disability Trust (QDT). A separate insurance trust will not qualify as a GRE but may qualify as a QDT. CONSIDERATIONS An insurance trust must clearly identify the beneficiaries as well as the trustee, and should also state that the insurance proceeds are not intended to form part of the estate. Otherwise, the insurance proceeds may fall into the estate and be subject to probate and creditors of the estate. There are specific issues to be considered when drafting an insurance trust. See Schedule A on page 8 for more details. The settlor s lawyer should be informed of all documents containing designations, to avoid the revocation of one designation over the other and a conflict in documentation. The Will must be signed before suggested wording in the contract is made. The interim options until the Will is signed are as follows: a) Another beneficiary designation in the interim, which will be changed later; b) In the absence of designation, the insurance company will make payment to the owner or the owner s estate; c) Once the Will has been signed, send copy to the insurance company to change designation; d) Send letter advising of change in designation. Risks: Insurance Act indicates insurance company is entitled to actual instrument (in this case, the Will). Company may have difficulty determining proper party to pay, which could cause delays and extra costs. The insurance company should be informed of designation changes in Will. Insurance trust should be distinct from the rest of the dispositive clauses in order to distinguish assets of estate. Will should be provided to the insurance company, and upon death, a notarial copy will be required for claims over a certain amount. Loss of confidentiality when the Will is provided to the insurance company. If trustee powers not set out, trustee is limited by provincial legislation. The intention is to create a separate insurance trust so that the insurance proceeds do not form part of the residue (as part of the residuary of the estate) of the estate and be subject to tax. 3
Declaration outside of a Will (e.g. an insurance declaration containing trust provisions) How to make the designation Declaration in a trust document: See attached Schedule B Beneficiary designation in insurance contract: John Doe, trustee, or any successor trustee of the Name of trust Date: OR Send in the trust document OR Send in letter Note: The declaration within a trust document stands on its own as a designation where written in the contract. A new designation is created that incorporates by reference the trust document. (See risk entry below under considerations.) BENEFITS Flexible All in one document CRA will treat as a testamentary trust * see note on page 3 Is not included with other assets of estate Note: With the above method the trust is the beneficiary and not the owner, or premium payer, of the policy. CONSIDERATIONS Any notice sent to insurance company which makes reference to the trust document should be specific so that the company is certain no other trust exists. It is advisable to send in document. Risk: A letter regarding the designation sent into the company is not regarded as actual notice as required under the Insurance Act. The company may have difficulty determining proper party to pay, causing delays and extra costs. It is necessary to provide some particulars, meaning there is loss of confidentiality on a limited basis. Insurance company needs to be informed of designation changes in subsequent Will, or amendments to trust document. If funded, even for a nominal amount, it becomes an inter vivos trust and is then subject to the top marginal tax rates. If trustee powers are not set out, then trustee is limited by provincial legislation. Later designation in another document (i.e. Will or insurance contract) revokes designation in trust document. If the trust document is revocable and does become revoked, and the designation is contained in the contract and makes reference to the trust document, the designation in the contract will have no proper reference mechanism. 4
Hybrid method insurance contract references Will How to make the designation Made in insurance contract and includes references to provisions in testator s Will: John Doe, in trust, to hold the proceeds for the benefit of my residuary beneficiaries upon the same trusts and subject to the same terms as are set out in the residuary provisions contained at paragraph [insert numbers] within my Last Will and Testament dated [insert date]. (Manulife s preference is to provide the date see item marked with * in the column below). BENEFITS Flexible can mirror provisions in Will Simple to draft CRA will treat as a testamentary trust * see note on page 3 If Will invalid, declaration can still stand Note: With the above method, the trust is the beneficiary and not the owner, or premium payer, of the policy. CONSIDERATIONS Concern where initial Will has been revoked or changed. If revoked or changed, declaration within Will may not stand alone. * There is uncertainty whether Will should be referenced by date because the designation should reflect most recent version of Will. It is better to include date of Will and to update the designation as necessary when Will is updated. It is advisable to provide the insurance company with new designation each time. If new Will or designation is not provided there is a risk the payout could be made to the wrong party. If no trustee provisions exist, the trustee is limited to powers set out in provincial legislation. If no valid residual clause exists, this could create an intestacy causing insurance company uncertainty as to what will happen at the time of payout. When Will is invalid, payment may be made into court. However, if enough evidence exists, insurance company may pay to named trustee in designation contained in the contract. Arguments can be made for both sides as to payout, making it unclear what will happen to proceeds. Proceeds could be paid to those entitled on intestacy or to previous beneficiary designation. This results in delays and costs at claim time. Insurance company must be informed of any change to Will affecting designation. The intention is to create a separate insurance trust so that the insurance proceeds do not form part of the residue of the estate and be subject to tax, as part of the residuary of the estate. 5
Alternative methods to set up an Insurance Trust IN CONTRACT PAYABLE TO THE ESTATE How to make the designation Designation in contract: Proceeds payable to estate of John Doe BENEFITS Simple Insurance company has certainty as to where payment goes Note: In this alternative, the proceeds are paid to the estate via the beneficiary designation. CONSIDERATIONS Flows into estate and is therefore subject to probate fees. Subject to creditors of estate. No ability to create a separate testamentary trust allowing for more favourable tax treatment (see changes to the tax treatment of testamentary trusts that will apply January 1, 2016, discussed on page 3). 6
IN CONTRACT PAYABLE TO THE TRUSTEE How to make the designation Designation in contract: Mary Doe, proceeds payable to John Doe as trustee (see item marked with * in the column below) OR Mary Doe. During the minority of Mary Doe, ** proceeds payable to John Doe as trustee. BENEFITS Simple to draft Potential for CRA to treat as a testamentary trust, but no formal evidence of a trust (see changes to the tax treatment of testamentary trusts that will apply January 1, 2016, discussed on page 3) Note: With the above method, the trust is the beneficiary and not the owner, or premium payer, of the policy. CONSIDERATIONS No trustee powers set out so subject to limitations in provincial legislation. Trustee obligations and purpose of trust are absent: a) Was there an intention to create a trust? b) How long does the trust last? c) When does the trust terminate? * If beneficiary initiates claim to collect at age of majority, payment will not be made to beneficiary but rather to trustee, unless specifically stipulated. ** Indicates trust has been established during beneficiary s minority and therefore payout to beneficiary can occur once age of majority is attained. If insurance company is uncertain, payment will be made into court or the Public Guardian and Trustee, or signed releases from the beneficiary and trustee may be required before payment is made. Insurance company may be unsure whether to deal with trustee or beneficiary, which may cause confidentiality problems. Settling cheque made out to in trust for may cause issues at the bank. The bank may question whether there is a trust or trust agreement. 7
Schedule A PROPOSED CLAUSES TO CREATE AN INSURANCE TRUST WITHIN A WILL (DISTRIBUTION TO MIRROR WILL PROVISIONS) By this declaration I name [name specific beneficiaries of trust or class] as beneficiary(ies) of Policy No. [insert policy number] issued by The Manufacturers Life Insurance Company no matter to whom the same presently may be payable in connection with the terms thereof or of any declaration prior in date hereto. I appoint (insert name of trustee) ( Insurance Trustee ) as Trustee for my aforesaid beneficiaries to hold the proceeds in a separate insurance trust for their benefit. If my named Insurance Trustee shall also be named as the executor of my Will, each respective role shall be separate and distinct from one another. The insurance proceeds shall not form part of my estate. The insurance trustee shall receive the life insurance proceeds and such proceeds shall be administered by my named Insurance Trustee, for the benefit of the aforesaid minor beneficiaries. The proceeds shall be held in a separate insurance trust in the same manner and in accordance with the residual clauses contained in my Will at paragraphs[insert numbers]. This declaration shall be a declaration within the meaning of the Insurance Act, [insert Province]. Subject to the foregoing, my Insurance Trustees shall have the same powers, rights, protections, obligations and duties in connection with the administration of this insurance trust fund as they have for the administration of my residuary estate. Note: A separate distribution scheme may be set up that does not mirror the residuary provisions in the Will. Caution should be taken to ensure that the residuary clauses referenced do, in fact, exist within the Will. With a separate distribution scheme, Canada Revenue Agency (CRA) will be less likely to treat the proceeds as part of the other testamentary trust provisions (see changes to the tax treatment of testamentary trusts that will apply January 1, 2016, discussed on page 3). The provision above can also be modified in terms of the powers, rights and obligations of the Insurance Trustee. Lawyers drafting insurance trust provisions in a Will should be aware of two cases. The decision in Joyce Carlisle Deceased, 2007 SKQB 435, indicated that an insurance trust created within a Will can only be exempt from the application of probate fees in limited circumstances. The Carlisle decision indicated that the trustee of the insurance trust must be someone other than the executor of the estate, and the distributive clauses should not be reflective of those found within the Will. In the later decision of Sun Life Assurance Co. of Canada v. Taylor 2008 SKQB 403, the court indicated that drafters of Wills who include an insurance declaration in the Will can name the same individual as both executor and insurance trustee so long as there is a clear intention that the individual is acting in more than one capacity. The Taylor case also indicates that the declaration should name the beneficiaries and then address the role of the trustee. 8
Schedule B This is a specimen trust document. This specimen contemplates a distribution of proceeds to the Declarant s children at specified times, and in the event of death of any of the Declarant s children, to the children of that child living or failing any such children, a division amongst the Declarant s children then living. This is one example of distribution, but other scenarios could be used with modifications to this text. INSURANCE DECLARATION I, [Declarant s name], declare that the proceeds of my insurance policy number [insert policy number] issued by Manulife, no matter to whom the same presently may be payable in connection with the terms thereof or any declaration prior in date hereto, shall be paid to [insert name of trustee] (the Insurance Trustee ) as a separate Insurance Trust Fund. The Insurance Trust Fund shall be divided by the Insurance Trustee into as many equal shares as may be required in order that there is one equal share for each of my children, who survives me and I direct my Insurance Trustees to hold the Insurance Proceeds for the benefit of those children on the following trusts: a. To invest the Insurance Proceeds invested, and so much of the income and capital thereof as my Insurance Trustee in his or her discretion considers advisable for the benefit of my children until each attains the age of [insert age] years when [indicated amount of proceeds] of the capital thereof shall be paid to him or her and the remaining balance shall be paid to him or her upon attaining the age of [insert age], and the remaining balance will be for his or her own use absolutely. Any income not so paid or applied in any year is to be added to the capital and dealt with as part thereof; b. If any of my children should die before receiving the entire benefit of the Insurance Proceeds, the Insurance Proceeds or the amount thereof remaining shall be paid or transferred to his or her children alive at the date of his or her death in equal shares, or if there is no such children of him or her then alive, then the Insurance Proceeds or the amount thereof remaining shall be divided in equal shares amongst my children then living and invested in accordance with paragraph (a) above. **THIS DECLARATION is a declaration within the meaning of the Insurance Act [insert province] and the Insurance Trustees shall have the same powers, rights and obligations in connection with the administration of this Insurance Trust Fund as the Estate Trustees have for the administration of the residuary estate pursuant to the terms of the Will of [enter name] dated that same date as set out below and whether or not such Will is later revoked. DATED at [insert city and province] this day of, [insert year]. WITNESS DECLARANT **This declaration can stand alone but makes reference to a Will drafted and dated the same date as the declaration in relation to the powers, rights and duties of the Trustee. If the Declarant wishes to set out powers that differ from those of the trustee under the Declarant s Will, the terms of those powers must be inserted in the above text. 9
Professional Advisor Checklist This is a checklist of items that an insurance advisor may consider when discussing the implementation of an insurance trust with a client s professional advisor. The checklist highlights possible issues that should be reviewed. Because an insurance trust depends not only on the facts of each case but also the implementation document chosen, this checklist provides a tool to determine how best to approach and obtain information from the client when considering whether an insurance trust is appropriate. What type of documents exist that may contain a valid beneficiary designation within the meaning of the Insurance Act? Declaration by Will Declaration by other written document (e.g. trust document) Designation in insurance contract When, and in which document, was the last designation made? Are there any questionable issues / ambiguous points in the current designation? If the insurance trust is to mirror the residual clause contained within the Will, does the corresponding residual clause in the Will actually exist? If in Will, and insurance trust mirrors residual distribution, is a separate insurance trust created so as not to be treated as one testamentary trust? (Note: Changes to the taxation of testamentary trusts will apply January 1, 2016. See page 3 and 6 herein for additional information. These changes should be considered in client discussions.) If no trust document exists, but insurance contract makes proceeds payable to trustee, is there direction as to payout where beneficiary is a minor? If trust document exists, has there been any settlement of property into the trust (even nominal amounts) prior to the death of the settlor? If yes, then inter vivos trust is created. Does Will or trust document properly set out scope of powers for trustee? If there is a trust document, does it include a provision for eventual termination of trust? Is there a testamentary spouse trust desired? If so, no matter where the insurance trust is created (i.e. within the Will or outside the Will) the trust will not qualify as a spouse trust for tax purposes. (This would mean that the trust would have a deemed disposition every 21 years from the date of settlement (i.e. the death of the life insured) 10
What documentation has been provided to the insurance company and the professional advisor? To insurance company To professional advisor If letter sent regarding designation to company, should actual document with designation be sent to provide proper notice to insurance company? Have any recent declarations revoked a prior declaration? If so, was this intended by the client? Are the most recent declarations (if applicable) still appropriate? Tips for the Insurance Advisor If changes should be made to a declaration, assist the professional advisor with material that may be helpful for determining the best method for implementation. Conduct an annual review of existing declaration(s) with client to ensure the client is not considering revoking a previous declaration or inadvertently revokes a prior designation. As part of client review, discuss any potential legal issues of concern that the client needs to discuss with professional advisor (i.e. in insurance contract and payable to trustee no trust document). Suggest the client speak to their professional advisor about the different options available with an insurance trust. For your own future reference, note all types of documents and dates of documents containing insurance trusts. Where the insurance policy is jointly owned and a portion of the proceeds are paid on first death or Joint-last-todie, planning with insurance trusts can be very complex a more in-depth discussion can be found in the Tax Topic Insurance Trusts. 11
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