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Life Insurance Trust Declarations are often overlooked as an extremely valuable estate planning tool. In this article, which is based on a presentation by author Barbara Lawrie to the CALU Associate Members Forum, she reviews the advantages of using a life insurance trust declaration and provides a checklist to assist in ensuring that the declaration will be effective.
Table of Contents
This article will discuss the advantages of having one or more trusts designated to receive life insurance proceeds, and the characteristics of a well-drafted life insurance trust declaration. The trust(s) may be established under a Will, or in other documents, but it is always desirable for the trust(s) to qualify as "testamentary" trusts for income tax purposes. Every person with minor children should consider making at least a secondary beneficiary designation to make life insurance proceeds payable to trustees who would hold the proceeds in trust for the children. Beneficiaries who are adults can also benefit from tax savings if life insurance proceeds are held in a trust.
The most common reasons for providing for a trust to receive life insurance proceeds are:
These objectives, and the legal and tax considerations relating to them, are explored in detail, below.It is trite to say that estate planning must be as individual as the client; although life insurance trusts are useful for many people and many purposes, every client's needs must be examined on a case-by-case basis, and recommendations and provisions must be tailored to the client's particular situation.
Life insurance products have always had the advantage that life insurance proceeds payable to a named beneficiary do not form part of the estate of a deceased insured and, as such, are not subject to the claims of the insured's creditors and are not required to be included in the value of the estate for the purpose of calculating probate fees. It is typical, however, for a policyholder to name his or her spouse as primary beneficiary under the policy, and not to make any secondary beneficiary designation, although it is intended that the insurance would benefit children if the spouse does not survive. In the event that the spouse does not survive, the life insurance proceeds would, by default, fall into and form part of the policyholder's estate. As a result, those proceeds would be subject to the claims of creditors and probate fees would be payable in respect of the value of the life insurance proceeds. This result can be avoided if a secondary beneficiary designation is made. If the children are minors, the insurance proceeds cannot be paid directly to them as named beneficiaries (the insurance company would pay the proceeds into court if minor children are named beneficiaries). Instead, the secondary beneficiary designation should specify that the life insurance proceeds are to be paid to named individuals as trustees, to hold on certain trusts for the children. The trust terms can either be spelled out in detail in the declaration, or, if there is a Will which sets out trust terms for estate funds that are to be held in trust for children, the declaration can incorporate those terms by reference. It is generally desirable to ensure that the trust(s) in respect of the life insurance proceeds will be separate from the trusts under the estate, to preserve the advantages of creditor protection and non-payment of probate fees, and for tax savings (as discussed below).
The case of Re Brown3 demonstrated that it must be clear from the life insurance declaration that the policyholder does not simply intend for the life insurance proceeds be paid to the estate executors to be dealt with as part of the estate. In Re Brown, the insured made a declaration of change of beneficiary in his Will, by which he directed that the proceeds be paid to his Trustees (defined to be his executors), to be held in trust and paid to the insured's wife and children in certain proportions, as outright distributions. The Judge held that the wife and children were not the "named beneficiaries" because they were not entitled to receive payment of the proceeds from the insurance company. The Judge further concluded that the essence of the "named beneficiary" exemption is that the proceeds are payable to persons other than the estate executors. The Judge based his decision on his interpretation of the policyholder's intention, as evidenced in the declaration. He was very influenced by the fact that the declaration was contained in a clause which came after the provision in the Will under which the testator gave and devised all of his property to his executors on trust, as well as the fact that there were other policies in respect of which designations were made in favour of the wife and children directly.
A contrary decision was made in an earlier case at the Saskatchewan Queen's Bench, Harry v. Harry Estate4 . In that case, life insurance money was payable to the estate executors in trust for children equally "on the same trusts, terms and conditions as if such proceeds had formed part of the residue" of the estate. It was held that the insurance proceeds did not form part of the estate and were not subject to probate fees. It appears that the use of the words "as if" was quite important; the judge commented that "the words 'as if' require the reader to treat as real, certain imaginary circumstances - in this case that the proceeds of insurance form part of the residue of the estate."
In order to avoid the result in Re Brown, I recommend the following with respect to drafting a life insurance declaration in a Will:
All of these measures will support the argument that it is the insured's intention that the life insurance proceeds will fall outside of the estate, as being paid to named beneficiaries (who happen to be subject to an obligation to hold the proceeds in trust). It is my view that if the foregoing recommendations are followed, there is a good basis to conclude that the insured did have the intention that the insurance proceeds would pass outside of the estate to named beneficiaries, and a lawyer can comfortably have his or her client swear an affidavit of estate value that excludes the life insurance proceeds. The issue would never come before a court in jurisdictions such as Ontario, where it is not necessary to submit a list of assets to the Court when applying for letters probate.6Since clients seem to be very interested in avoiding probate fees whenever possible, I will digress somewhat from the specific topic of life insurance declarations to discuss some recent developments regarding when it is necessary to obtain letters probate, and what estate value must be disclosed for the purpose of calculating the probate fees.
There is an exception to the requirement to pay probate fees in respect of the entire value of the estate for limited grants (i.e., grants limited to part of the estate only). The Court would not issue a grant limited only to certain assets in the estate for which probate is needed. However, limited grants have been routinely used in situations where individuals own assets in different jurisdictions. For example, it would be desirable for a client who owns assets in South Africa to have a separate Will for the those assets, because of currency controls and other limitations which restrict the ability, particularly for foreign executors, to deal with such assets. Such a client would be advised to also do a Will dealing with his assets everywhere in the world other than South Africa. In the event of the client's death, the South African Will would be probated in South Africa, without reference to the Canadian estate, and if the individual died while resident in Ontario, the Ontario Court would be asked to probate the Will dealing with all of the assets outside South Africa. It has always been accepted that in such a case, the value of the South African assets would not be required to be included in the estate value disclosed in the application for the Ontario grant because it would be limited to dealing with those assets outside of South Africa. This technique of using multiple Wills and obtaining limited grants has long been accepted practice for dealing with assets in foreign jurisdictions.
The concept of using multiple Wills has been extended in the past several years to dealing with assets in the same jurisdiction, but for which letters probate is arguably not required. In particular, multiple Wills have been used for clients who own shares of private corporations and receivables from private corporations. Generally, it is expected that it will not be necessary to have letters probate to deal with the private corporation shares (which, of course, can be very valuable) because it is not usually anticipated that it will be necessary to provide a probated Will as evidence of the authority of estate trustees to deal with the shares. This is founded on the legal principle that the authority of the estate trustees is derived from their appointment under the Will itself, and the grant of letters probate only functions as evidence of this pre-existing authority.
In the case of Granovsky Estate v. Ontario7 , Mr. Granovsky had died leaving two Wills. His Primary Will dealt with all of his assets other than his shares of a private corporation, and his Secondary Will dealt with his shares of the private corporation. The application for letters probate for the Primary Will disclosed the fact that the assets to be administered under the Primary Will had a value of $3 million, while the assets to be administered under the Secondary Will (which was not being submitted for probate) had a value of $25 million. The applicants asked for a limited grant, i.e., they requested that only the Primary Will be submitted for probate and that the probate fee be based only the $3 million in assets that would be administered under the Primary Will. After reviewing other ways in which individuals may validly arrange their affairs to minimize probate fees (e.g., through the use of joint ownership of property, and naming beneficiaries under life insurance policies), Madam Justice Greer concluded that it was acceptable to minimize probate fees by use of multiple wills, and she gave the estate trustees a limited grant of probate with respect to the assets under the Primary Will only. She commented that it was an important consideration that each of the Primary Will and Secondary Will could stand on its own, without reference to the other.
There has been some indication from counsel for the Attorney-General of Ontario that their department considers multiple Wills are not effective to avoid payment of the "probate fee" tax under the new Estate Administration Tax Act, 1998. However, it is difficult to see on what basis they hold this view because the Estate Administration Tax Act, 1998 expressly states that "Where the application or grant is limited to part only of the property of the deceased, it is sufficient to set forth in the statement of value only the property and value thereof intended to be affected by such application or grant". This is even clearer than under the former provision in the Estates Act8 .
A couple of recent cases have explored some of the implications of dealing with an estate (or part thereof) in which letters probate have not been granted. In Re Silver Estate9, the issue was whether the Court had jurisdiction to pass the accounts of an estate trustee under the Secondary Will, which had not been submitted for probate. No objections were filed by either the Children's Lawyer or the Public Guardian and Trustee. Madam Justice Hailey stated the legal principle noted above that any requirement to obtain letters probate is only as a means of providing evidence of an executor's right to deal with an estate; it is not necessary in order for the executor to have the entitlement to deal with the estate, which arises from the Will at death. She concluded that the Court did have jurisdiction to supervise and audit the accounts of the estate trustee even where a grant of letters probate had not been made. She did, however, suggest that if the validity of a Will was challenged at a later date, then the Court might insist upon probate as a precondition to passing accounts of the estate trustees.
In the case of Re Carmichael10, beneficiaries sought to remove two estate trustees under a Will. The question before the Court was whether the Superior Court of Justice has the jurisdiction to remove executors and trustees who have taken steps to administer the estate but who have not obtained letters probate of the Will from the Court. Madam Justice Haley concluded that a beneficiary is free to bring an application for removal of estate trustees, whether or not those estate trustees have obtained letters probate of the Will. To find otherwise would place an impediment in the path of the beneficiary, and she believed that it would not be logical to require a beneficiary who seeks the removal of an executor for cause to first have to take steps to have the executor's status validated by the Court through a grant of probate.
These cases are comforting because they confirm that where multiple Wills are used, it should be possible to administer the respective "Primary Estate" and "Secondary Estate" in accordance with normal principles applicable to estates.
The case of Rozon v. TransAmerica Life Insurance Company of Canada11 dealt with the question of whether or not a life insurance company is justified in requiring that letters probate be provided before making payment of life insurance proceeds to estate trustees named in a Will. More than $2 million of life insurance proceeds was payable to the estate of Mr. Rozon after his death; about $1.5 million was payable by Canada Life and the balance by TransAmerica Life. The executors submitted their claims for the life insurance proceeds, and the insurance companies followed what was normal industry practice in stating that they would require a probated Will in order to release the proceeds. Probating the Will would have resulted in payment of a probate fee of close to $80,000, so the executors went to Court to compel the insurers to pay the proceeds without having the Will probated. Canada Life eventually paid its claim based on the unprobated Will, but TransAmerica refused and the matter went to the Ontario Court (General Division) and subsequently to the Ontario Court of Appeal.
The insurance company argued that it was entitled to require a probated Will because of section 203(c) of the Insurance Act, which states that an insurer is required to pay insurance money "where an insurer receives sufficient evidence of the right of the claimant to receive payment" (emphasis added). Counsel for the executors argued that section 207 of the Insurance Act would protect the insurer. That section states that "until an insurer receives...an instrument or an order of the Court affecting the right to receive insurance money...it may make payment of the insurance money and shall be as fully discharged to the extent of the amount paid as if there were no such instrument or order." The insurers admitted that they had not received notice of any competing claims.
In an unreported decision, Mr. Justice Charbonneau of the Ontario Court (General Division) held that there was nothing in the Insurance Act which should lead the Court to interpret "sufficient evidence" to mean necessarily a probated Will. He felt that the evidence supplied (an unprobated Will) was sufficient evidence, and he ordered TransAmerica to pay the insurance proceeds. In his handwritten endorsement on the record, he stated that he was of the view that the insurer was protected under section 207 should a subsequent claimant come forward, as long as the insurer had no notice of any competing claim at the time of payment. He also awarded the executors their costs, although it was a novel issue, because he thought that it should be obvious to the insurance company that it could pay the proceeds without a probated Will. The matter was appealed to the Court of Appeal. In a two-sentence decision, the three Court of Appeal judges agreed with Mr. Justice Charbonneau that there is nothing in the Insurance Act that should lead the Court to interpret "sufficient evidence" in section 203 of the Insurance Act to mean necessarily a probated Will, and TransAmerica was required to pay the insurance proceeds on the basis of the unprobated Will.
Because the Re Rozon decision was unanimously affirmed at the Court of Appeal, it will be a very important precedent in Ontario. It will also carry significant weight in other provinces, as standing for the proposition that where life insurance proceeds are payable to an estate, if probate of the Will is not required for any other reason, the estate trustees are entitled to receive payment of the life insurance proceeds without obtaining letters probate. I understand, however, that there is reluctance on the part of insurance companies to change their practice of requiring letters probate, so we may see more case law on this issue in the future. It also has implications with respect to payment of claims under RRSPs and similar plans, which are payable to an estate.
Income tax savings can be achieved by having income, which would otherwise be subject to tax at high rates, be allocated to low rate taxpayers. Under the revised tax rates applicable after the October 2000 "mini-budget," the rates of tax on individuals in Ontario will be approximately 22% on the first $31,000 of ordinary income, then 32% on income up to $50,000, then 42% on income up to $100,000 and 46.8% on income over $100,000. Suppose a spouse receives life insurance proceeds and invests it to produce income. If that spouse already has income from other sources, the investment income from the life insurance proceeds will be taxed at the marginal rate of the spouse, which is likely to be one of the two top rates. However, if the income can be taxed in the hands of minor children, it is likely to be taxed at the lowest rate (or, in the case of dividends, a substantial amount can be received tax free because of the dividend tax credit). Income splitting with low rate individuals is one of the fundamental goals of estate planning, but attribution rules which apply to inter vivos transfers and loans effectively limit legal income splitting with minors to capital gains.
The attribution rules do not apply after the individual who transfers property has died. Accordingly, a trust which is established under a Will for a minor child is not subject to the attribution rules, and if a child receives income from such a testamentary trust, that income will be taxed in the child's hands at his or her low rates, rather than at the (likely higher) tax rate of the deceased's spouse. This is also the case if a trust is established under a Will for an adult child and his or her (low rate) issue. Testamentary trusts have the added advantage of having the same progressive tax rates, as noted above, that apply to individuals, unlike inter vivos trusts (ones established during the settlor's lifetime), which are always subject to tax on income at the top rate. Therefore, if a testamentary trust is established for a child, the trust itself is also a low rate taxpayer, which can report some of the income and pay tax at low rates. The more testamentary trusts that can be effectively created, the more low rate taxpayers there are, and the greater potential for tax savings through income splitting with those low rate taxpayers.
The Income Tax Act12 contains an anti-avoidance rule in section 104(2) allowing the Minister of the Canada Customs and Revenue Agency (the "CCRA", formerly Revenue Canada) to designate that several trusts which have the same beneficiaries may be taxed as one trust. However, if trusts are created with different beneficiaries, this designation power cannot be applied. For example, suppose an individual leaves a spouse and three children, and life insurance in addition to other estate assets. The Will could provide for a testamentary trust for the spouse and one for each child, to accomplish income splitting with respect to estate funds. It would be possible to create additional, different trusts, for the life insurance proceeds along the following lines: Trust 1 could have the spouse and child 1 (and his or her issue) as discretionary beneficiaries; Trust 2 could have the spouse and child 2 (and his or her issue) as discretionary beneficiaries; Trust 3 could have the spouse and child 3 (and his or her issue) as discretionary beneficiaries; and Trust 4 could have all of the spouse, the three children, and their issue, as discretionary beneficiaries. The trusts would not be subject to the Minister's designation power because they have different beneficiaries. Of course, whether or not such planning is desirable for any particular client depends on the amount of assets available, the amount of income required by the spouse, and whether or not the complexity of multiple trusts (and the tax returns required for them) is warranted by the potential savings.
A critical element in maximizing the tax savings is that the trust(s) established must be "testamentary" as defined in the Act. In order for a trust to be a "testamentary trust" as defined in subsection 108(1) of the Act, it must have arisen as a consequence of the death of an individual, and no property may have been contributed to the trust other than by the deceased and as a consequence of the death. Technical interpretation letters from the CCRA have confirmed, among other things, that:
It is therefore important to ensure that, if a beneficiary designation in favour of trustees is set out in a document other than a Will, no property is transferred to the trustees to establish the trust, until the life insurance proceeds are paid to the trustees. Otherwise, the trust will be taxed as an inter vivos trust at the top marginal rate.
The most common reason for providing for a trust to receive life insurance proceeds is that the beneficiaries (perhaps secondary beneficiaries) are minors, so adult trustees must be appointed to manage the funds on their behalf. In that case, it is common for the declaration to be included in the Will, in which case the declaration may state that the separate insurance trust fund is to be held in trust for the beneficiaries on the same terms and conditions as if the life insurance proceeds formed part of the residue of the estate. It should also be expressly provided that, in administering the separate insurance trust fund, the Insurance Fund Trustees are to have all of the powers conferred on the estate trustees for the administration of the general estate. This is an efficient way of incorporating by reference detailed trust terms and conditions, as well as extensive administrative provisions which should be included in the Will. Although there have been significant changes to the Trustee Act of Ontario to permit investments in accordance with a "prudent person" test, and to authorize investments in mutual funds, it is generally still desirable to have detailed provisions giving added investment authority to the Trustees, for example, to enter into agreements for discretionary investment management with investment advisers. Other administrative powers, e.g., with respect to payments to or for minors, and executors compensation are also desirable and can be easily incorporated by reference in a Will. If a declaration is made outside a Will, it is necessary to either make specific reference to the Will to incorporate its terms, or to set out all the trust terms and conditions, and the trustee powers, in the declaration (which will be lengthy, so it will have to be set out in a Schedule to the form).
If a beneficiary is disabled, it will be desirable for trustees to manage assets for him or her (whether those assets are estate assets or life insurance proceeds) subject to trust terms and conditions which maximize the beneficiary's rights to any government benefits. The case of Minister of Community and Social Services v. Henson,13 confirmed that, when an application is made for government benefits for a disabled person, it is not necessary to disclose as assets belonging to the disabled person, the value of assets which are held in a discretionary trust under which the disabled person has no legal right to require the payment of income or capital to him or her. Therefore, trusts for disabled persons typically give the trustees complete discretion to determine whether any amounts of income and/or capital should be paid to or for the benefit of the disabled person, and may also include other potential beneficiaries who could receive property from the trust. Such trusts also usually contain language designed to remind the trustees that they are to exercise their discretion in a manner that will maximize the benefits available from other sources.
Trusts are sometimes used for asset protection. For example, parents may be concerned that their adult daughter is married to a person who is engaged in a business which exposes them to creditors' claims. Such parents often seek to ensure that their estate assets and life insurance proceeds will not become subject to those creditors' claims. To accomplish this, it is common to provide that such assets would be held in trust by trustees, who would exercise discretion to pay income and/or capital to or for the benefit of the daughter and her family. Or, it may be the business person who wishes to provide a trust for life insurance proceeds so that they will not form part of their estate and be subject to the claims of creditors. Specialized advice should be sought to ensure that the asset protection planning is valid and effective. If a transaction is characterized as being intended to hinder or delay creditors, the transaction could be set aside as being a fraudulent conveyance. This concept was recently applied in a surprising fashion in the case of Stone v. Stone14. A husband transferred significant business assets to his children a couple of months before his death. The evidence made it clear that the actions were made with the intent of defeating the wife's right to receive an equalization payment after death under the Family Law Act, and the Court held that the Fraudulent Conveyances Act could be used to set aside the transfers.
Sometimes a trust is used for privacy. An individual may wish to leave assets to a person or persons without this becoming public knowledge. A life insurance declaration may be made in favour of trustees as named beneficiaries, and the trustees can be instructed only to disclose the terms of the trust to the intended beneficiaries, without this becoming a matter of public record. Trust law includes the concept of a "half secret trust," with respect to which a declaration might state that the trustee is to hold the funds in trust on the terms and conditions previously communicated to him, as well as the concept of a "wholly secret trust," where there is no written reference to the fact the recipient is to hold as trustee rather than beneficial owner, although those terms would have been previously communicated to the trustee.
Whatever the reason for using a trust, the considerations with respect to drafting the life insurance declaration are the same, as set forth below. The specific provisions of the trust, and the appropriate administrative provisions, will depend on the purpose for which the trust is to be established.
The following rules apply to a life insurance declaration made in a Will:
With respect to the latter point, the result is different if a declaration is made outside of a Will, as marriage will not revoke a previous beneficiary declaration that was not in a Will.
Whether or not the declaration is in a Will, it is well-established that a policyholder must have testamentary capacity to make a valid life insurance declaration to designate beneficiaries. The common law test of testamentary capacity as set out in Banks v. Goodfellow15, has recently been quoted with approval by Mr. Justice Cullity as follows, in the case of Banton v. Banton16:
"It is essential to the exercise of such a power [of testation] that a testator shall understand the nature of the act and its effects; shall understand the extent of the property of which he is disposing; shall be able to comprehend and appreciate the claims to which he ought to give effect; and, with a view to the latter object, that no disorder of the mind shall poison his affections, pervert his sense of right, or prevent the exercise of his natural faculties - that no insane delusion shall influence his will in disposing of his property and bring about a disposal of it which, if the mind had been sound, would not have been made."
In several cases where testamentary capacity to make a life insurance declaration was in issue, judges have concluded that the policyholder did indeed have the requisite capacity, eg. Re Rogers,17 Fontana v. Fontana,18 and Stewart v. Nash19. However, there are occasional cases where it has been determined that the testator did not have testamentary capacity, and the declaration was declared void (e.g., Tamblyn v. Leach20). Because of the requirement for testamentary capacity, life insurance companies are understandably loathe to place reliance on a beneficiary declaration signed by someone acting under a power of attorney for the policyholder, unless there is no change in substance with respect to who will receive the proceeds.
The following is a summary of what I consider to be "best practices" concerning life insurance trust declarations:
1. In Ontario, as a consequence of the declaration that the Administration of Justice Act was ultra vires, and the enactment of the Estate Administration Tax Act, 1998, S.O. 1998, c. 34, Sch., the levy which used to be called "probate fees" is now correctly called "estate administration tax." However, in this article the term "probate fees" will be used, because that term is still used in other provinces, and even in Ontario it is a term that most clients and advisors are still comfortable using.
2. See also Glenn M. Davis' article "Probate Minimization Strategies: Tips and Traps," February 2000 issue of the CALU Report.
3. (1993), 97 D.L.R. (4th) 163 (Sask. Q.B.)
4. (1988) 32 C.C.L.I. 223
5. This would include beneficiaries who are under a legal disability, such as being a minor, mental incapacity or bankruptcy.
6. Pursuant to Ontario Regulations 484/94 and 740/94, new terms are used in connection with estate matters. The grant formerly called "letters probate" is now called a "certificate of appointment of estate trustee with a will", and executors are now called "estate trustees". This article will refer to letters probate, since that is still a well- understood term; the terms "executors" and "estate trustees" will both be used, depending on the term applicable in the jurisdiction and the relevant time.
7. (1998), 156 D.L.R. (4th) 557
8. R.S.O. 1990, c.E-2.1
9. (1999), O.J. 5026
10. (2000), 46 O.R. (3rd) 630
11. Unreported Nov 30, 1999, Ont. C.A., dismissing unreported Mar 15, 1999, Ont. Ct. Gen Div. Court file No. 98-CV-8449.
12. RSC 1985, c.1 (5th Supplement), as amended, hereinafter referred to as the "Act." Unless otherwise stated, statutory references in this article are to the Act.
13. (1987) 28 E.T.R. 121; (1989) 36 E.T.R. 192
14. (2000) 49 O.R. (3rd) 31
15. (1870), L.R. 5 Q.B. 549
16. (1998), 164 D.L.R. (4th) 176
17. (1963), 39 D.L.R. (2d) 141
18. (1987), 28 C.C.L.I. 232
19. (1988), 33 C.C.L.I. 34
20. (1981) 10 E.T.R. 178