Complexities in designating life-insurance beneficiaries

by Leo Almazora22 May 2019

For those who own a life insurance policy, the ability to leave behind a death benefit opens the door to several estate-planning advantages. But maximizing those advantages requires a deep understanding of the rules governing life insurance, not least of which are the ones concerning the designation of beneficiaries.

This is evident in a new note explaining how Ontarians can use assets such as life insurance and registered savings in succession planning. “In Canada, the receipt of a life insurance death benefit on a policy owned by an individual owner is not subject to income tax as it is considered a receipt of capital,” O’Sullivan Estate Lawyers LLP said. Life insurance benefits designated as payable to a beneficiary aside from the insured’s estate, the note added, generally do not form part of the value of the value of the estate used in calculating Ontario Estate Administration Tax, which amounts to around 1.5% of an estate’s value.

The Ontario Insurance Act also provides an opportunity to shield life insurance proceeds from the insured person’s creditors. If the proceeds are designated as payable to any beneficiary irrevocably or to the insured’s spouse, child, grandchild, or parent, the insured’s creditors will have no access to any amount payable under an insurance contract so long as the insured is alive.

“Following the death of the insured person, where a beneficiary other than the insured person's estate is designated as beneficiary of a death benefit, the death benefit remains out of reach of the insured person's creditors,” the note said.

That’s in stark contrast to cases where a corporation is designated as the beneficiary. In such situations, the death of the insured would generally result in the benefit going to the corporation’s capital dividend account, from which a capital dividend free of income tax can be paid to the corporation’s Canadian resident shareholders. But in general, the life insurance proceeds payable to a corporation would be exposed to its shareholders’ creditor claims before funds could be paid out to the shareholders.

The Ontario Insurance Act also allows beneficiaries of a life insurance policy to be designated either in the contract or through a declaration, which could be contained in a will or another document.  “Insurance declarations are frequently completed in conjunction with estate planning documents,” the note said. “In the case of a jointly owned joint and last to die life insurance policy, a declaration is generally completed jointly by the insured owners in a separate, jointly executed insurance declaration.”

While designating a beneficiary within an insurance contract ensures that the intended beneficiary will receive the payment of the death benefit, using a declaration in a will allows for more flexible trust provisions. Those include the appointment of trustees to hold the insurance proceeds, the provision of contingent beneficiaries, and other terms and conditions that can parallel provisions of the plan for the estate.

“The designation provision in an insurance contract offers very limited options and can create problems, particularly if there are minor beneficiaries,” the note said. In particular, many insurance contracts have no provisions to appoint a trustee to receive insurance proceeds on a minor’s behalf; those that do are very limited in their terms, often requiring payment to the beneficiary upon the age of majority — which is not necessarily an indicator of financial maturity.