The Intersection of Separation Agreements and Life Insurance

Robin Goodman, B.A., LL.B, TEP

AVP Tax & Estate Planning

Important Information

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Financial.

Separation Agreements and Life Insurance

Most agreements require insurance for a period of time

Proceeds can be used to Replace support

Provide separate obligation to create or maintain wealth

Buy-out interest in corporation or trust

Must ask series of questions to ensure structure best suited to both parties

What to Consider?

What’s the purpose of the insurance How much insurance do we need For how long? Who should own the policy Who should be the beneficiary of policy How do we ensure that the premiums are paid up Should we use an irrevocable beneficiary designation

— Pros and cons Should we use an Insurance trust

— Can we?— Should we use irrevocable beneficiary designation

Will the policy be creditor protected How do we deal with corporate ownership of insurance Do we need new insurance or use existing insurance How do we change beneficiary back after obligation ceases

General rules of Insurance Act (Ontario)

Owner rights Make or change beneficiary Transfer or assign policy Withdraw funds Change coverage amount Pay premium or not pay premium

Limitation on owner rights Irrevocable beneficiary designation Incapacity Power of attorney Assignment Joint ownership

Many Ways to Structure….What’s the Purpose of the insurance???

Guarantee support

or

Independent obligation

or

Guarantee of estate distribution

or

Guarantee of purchase of interest in corporation

Court’s Right to interpret Purpose

Turner v. DiDonato et al. 2009, 95 O.R. (3d) 147 (On.C.A.)

Separation agreement required support payable till age 65— Agreement required $100,000 life insurance policy maintained till age 65

Support payor died 9 years before support obligation terminated Ex-wife argued entitlement to full $100,000 New wife argued entitlement to $43,000 only

— Argued that his “intention” was likely not to create windfall Court:

— Was life insurance policy required by separation agreement security for diminishing support or was it an independent obligation?

Ont. C.A. - if the parties intended insurance policy to merely be security for support payments and nothing more should have addressed it in agreement

Insurance policy was separate obligation and not security for support— Full $100,000 payable— No argument of mistake

Purpose prevents another designation

Schorlemer Estate v. Schorlemer (2006) Canlii 42364 (Ont S.C.)

Father had obligation in separation agreement to maintain insurance for daughter’s benefit while child of marriage

Weeks before death, dad changed beneficiary to second wife— Daughter was 22 and in last year of university— Second wife claimed she was dependent

Court confirmed that obligation under agreement prevents another designation— Imposed a trust over death benefit— Court has discretion to alter terms of agreement to ensure adequate support of

all dependents Court imposed trust over full amount of proceeds

— Found no windfall to daughter - remedy specified in contract No mention of diminishing obligation

— Found wife adequately provided for elsewhere

Or… Purpose permits another designation

Roberge v. Roberge, 2007 SKQB 310

Separation Agreement required 4 children irrevocably designated as beneficiaries

— 2 children already adults at time of agreement Argued material change in circumstances

— All children now adults — Father remarried

Can court vary terms of agreement to effectively “undesignate”? Must look to intentions of parties at time of agreement

— Intention to provide maintenance v. distribution of husband’s estate Court found that intention was to provide maintenance

— Under heading of Child Support Allowed court to undesignate without consent of irrevocable beneficiary

Practical drafting suggestions

Clear indication of purpose of insurance

Timeframe for maintaining insurance

Ability to reduce benefits payable as support NPV reduces Insurance may be valuable (existing or new)

— Reduce coverage

— Reduce amount payable

Mechanism to obtain consent if irrevocable beneficiary— Executed consent in escrow – acceptable to insurer?

Staledated

Merged companies

Alternative to irrevocable designation is third party trustee holding policy

— Trust terms reduce payment of proceeds over time or return policy

Practical drafting suggestions

File agreement with insurer Instrument that can contain Declaration

— Avoids neglect to change beneficiary on payor’s part

— Avoids need to change beneficiary annually to reduce payment

— Indicates intention

Ownership of policy

Personal is customary PROS:

— Easiest to secure and underwrite

— Simple method of paying premiums

CONS: — Rights of ownership leaves recipient spouse vulnerable

Alternatives?

Ownership of policy

Joint Ownership PROS:

— Protects recipient spouse Signature required for beneficiary changes Signature required for assignment or transfer

— Right to information Put provision in agreement allowing recipient to make payments if necessary

CONS:— Personal info of payor spouse available to recipient— How to guarantee transfer of policy after obligation terminates

Transfer of ownership form in escrow – acceptable to insurer? Potential tax consequences to recipient spouse on transfer

— Incapacity of one owner— May not permit designation of testamentary insurance trust

Not created by THE person who’s death gave rise to the trust

Ownership of policy

Third party (trustee) owner PROS:

— Payor continues responsibility for premium payment Trustee has notice of potential lapse and can advise recipient

Put provision in agreement allowing trustee to make payments if necessary

— Trust terms avoid change of beneficiary or assignment of policy

— Incapacity not an issue

— Beneficiaries = recipient (proceeds)

— Beneficiary = payor (insurance) S. 107(2) rollout

CONS:— Finding that third party

— Proceeds payable to trust (not testamentary)

Ownership of policy vs. irrevocable beneficiary

Alternative to complex ownership structure Irrevocable beneficiary = removal of policy from hands of

owner— Not subject to creditors— Can’t change beneficiary designation without consent— Can’t transfer or assign — Entitled to information re: lapse from insurer

Must be filed with insurer to be effective Reasonable solution for spousal support obligation

Ownership of policy vs. irrevocable beneficiary

Need mechanism to obtain consent to change beneficiary

— After cessation of obligation— If reducing obligation

Pre-signed consent form? — Acceptable to insurer— Question of later incapacity

Put consent in Separation Agreement— File with insurer— Additional evidence of intention

Insurance for benefit of children – INSURANCE TRUST

Trust created to hold life insurance proceeds

Created outside Will

Retains testamentary status

Need 3 Certainties Flexible trust terms

Created as a result of beneficiary designation

Insurance for benefit of children – INSURANCE TRUST

Child can’t give receipt to insurer

Permits control over proceeds Terms can require proceeds held till children attain stipulated age

— Proper trust terms rather than bare trust

Ensure distribution date

Ensure gift over (avoid Saunders v. Vautier)

Generates testamentary tax treatment over proceeds Single life policy/personal owner

— Joint ownership treatment is questionable

— Trust ownership treatment = inter vivos trust

No one else can contribute to trust

DOES NOT extend creditor protection over proceeds

Insurance for benefit of children – INSURANCE TRUST

If need single life/personally held policy Control over beneficiary designation?

Irrevocably designate trustee How do we do this if trust doesn’t yet exist?

Is right to consent “property”— Have we created inter vivos trust instead

If testamentary trust How does trustee consent to change of beneficiary

— Now or in future

— Trust doesn’t exist

Insurance for benefit of children – INSURANCE TRUST

Accept that not testamentary trust Obtain pre-signed consent form from trustee

— What if trustee not same person at time of cessation of obligation

Draft so that children are beneficiaries Appoint trustee on their behalf

Subtle difference, but… may retain testamentary trust treatment

May give extra creditor protection

Remaining problem – obtaining consent to cessation of obligation

Insurance for benefit of children – INSURANCE TRUST

Where is trust declaration contained?

In Will— Can’t make irrevocable designation in will

In Separation Agreement— Signed by both parties

— Testamentary trust?

On Contract— Append trust terms when filing

Other issues to discuss

3 types of life insuranceTerm (Temporary)

Perm (Permanent)

Group

Term Insurance

For temporary insurance needs

Relatively inexpensive in early years, cost increases as insured ages

Coverage expires at certain age (typically 75)

Appropriate where need is for a specific period and cash value not required

Permanent Insurance

Coverage for life

Level cost or quick pay

Tax advantaged

Type of Insurance

Term vs Perm = If vs WhenShort term need - Term Insurance

e.g. child support

Long term need – Permanent Insurance Other estate planning needs

May start out as one and end up as another

Interaction of marriage contract, Will and beneficiary designation Elton Estate v. Elton, 2010 NLCA (CanLII)

Marriage contract limited amount of insurance payable to wife to specified amount ($450,000)

Subsequent Will provided for insurance proceeds naming wife as beneficiary and any addition insurance monies necessary to provide her with $450,000

Court found this to be the beneficiary designation that governed

— Is it clear?

— Does it limit amount to $450,000 or does it mean she gets all proceeds she is designated to receive under policies?

Changing Beneficiary Designations…after death

Richardson v Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403

Touched on Issues of:

When can a Constructive Trust can be imposed over life insurance proceeds

When could a rectification argument succeed

The effect of a general release clause in a separation agreement

The Beneficiary Designation as a testamentary disposition— Impact on the ability to use powers of attorneys

Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403

Michael was married to Stephanie (1965-1992) Michael was then married to Anne (1992-2007) Michael became incapacitated and Anne took over his finances

Paid for out of joint account and once depleted, out of her funds

Michael died (2007) holding $100,000 life insurance AND THE BENEFICIARY WAS

Supposed to be Stephanie until 2005 (court ordered) Anne thought it was only a “temporary” designation Michael never changed the designation

Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 Stephanie’s Argument:

Money should be paid to her outright

Insurance Act: moneys payable to Beneficiary

— Stephanie was named in contract

— Designation is unassailable

Anne’s argument:

Money should be held on constructive trust for her because:

Michael inadvertently forgot to change the designation

— Windfall to Stephanie

Stephanie was unjustly enriched by receiving proceeds

— Anne was correspondingly deprived by paying premiums

General release clause in separation agreement should have had effect of “undesignating”

Had she known she would have used power of attorney to amend designation

Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 The Court found:

BENEFICIARY DESIGNATION IS AKIN TO A TESTAMENTARY DISPOSITION— Power of attorney?— Good discussion of elevation of duties where diminished capacity

Testamentary disposition?

No evidence that Michael intended to change beneficiary designation = NO RECTIFICATION— Rectification requires evidence of significant mistake— His inaction is the best evidence of his intention

Proper beneficiary designation with no mistake = juristic reason to receive proceeds — ie. Stephanie’s entitlement is supported by law— Juristic reason = NO CONSTRUCTIVE TRUST ARGUMENT

SEPARATION AGREEMENT: general release clause is different than life insurance designation clause

— General language used in waivers and releases is NOT A DECLARATION within the meaning of the Insurance Act.

Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 Drafting ideas?

Execute change of beneficiary form at time of Separation Agreement

— Hold in escrow

Change beneficiary to estate— Probate

— Can change again

— Distributed through terms of Will (intestacy)

Third party trustee holds policy— No concerns of incapacity

— Control over policy while obligation exists

Corporate Context

Life insurance in corporation Maintained to redeem shares from spouse or trust at death

Ribeiro (Estate) v. Braun Nursery Ltd. 2009 CanLII 1149 (OSC)

Redemption of deceased’s shares pursuant to shareholders agreement

Life insurance for key person protection used for redemption

CDA retained by corporation

Shareholders agreement did not address use of CDA

Estate not entitled to capital dividend

Corporate Context - Life Insurance Shares

• Ms A owner/manager of private corporation (Opco) held through Holdco

• Adult children not involved in Opco

• Wants Holdco to fund an insurance policy on Ms A’s life

• Ms A wants to take advantage of spousal rollover (testamentary spouse trust)

• Wants insurance proceeds to go to kids

Life Insurance Shares

Shares designed to give holder right to insurance proceeds No other corporate value

Way to stream insurance proceeds to (non-shareholding) heirs

Valuation issues addressed by CRA

ATTRIBUTES•Shares have nominal value during lifetime •Share terms defer payment (if redeemed during lifetime) till after death

• Can’t force collapse of insurance policy•After death, redemption = insurance proceeds

2 SCENARIOS (at death)• common shares reflect CSV, insurance shares have nominal value• insurance shares reflect CSV, common shares not increased

Life Insurance Shares: 2005 – APFF CRA Roundtable

Planning for Ms. A

Holdco

Mr A

100 %commonshares

•On death of Ms A, the entire corporate value is attributable to the common shares (including the cash surrender value). •The common shares are rolled to Mr. A •The life insurance shares are gifted to adult children and insurance

proceeds distributed tax-free to children through CDA.

Life insuranceshares

Ms. A Adult Children

6. Trust As Owner of Insurance

Keeps policy out of corporation(s) No disposition at death of individual owner

Good alternative where intention is to benefit a non-shareholder Eg. Inter-generational transfer alternative

Control over distribution of proceeds Can roll policy out to capital beneficiaries

CRA says: Although life insurance is not capital property for tax purposes, it is trust capital for trust law purposes.

— 107(2) applies rather than 148(7)

Not subject to 21 year rule because not capital property No rollover into trust Need to fund premiums

Trust

Thank you