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Integrating Life Insurance in The Estate Plan: The Need for an Holistic Approach

One of the interesting changes in our modern age when it comes to succession on death is that for many people, most of what they pass to their family and others will not be through their will, but instead by a “will substitute” such as life insurance. Many persons have term policies with a death benefit far greater than the assets accumulated during their life.

But with the use of such will substitutes comes the need to ensure integration with the will and overall estate plan. Unfortunately, the forms available to name beneficiaries provided by many life insurance companies lead to a lack of harmony with the will plan because they are too simple. It is ironic that a lot of time and effort can be spent in designing a complicated and comprehensive will plan which deals with assets of far less value than insurance proceeds passing by way of a too simple beneficiary designation.

Life insurance is often used to provide for dependents and create an estate. Insurance on the life of a primary breadwinner can help a family maintain its standard of living, or even avoid financial ruin. It can be an essential source of income for families with limited savings and assets, particularly those with minor children or special needs dependents.

In addition to creating an estate, life insurance can offer many benefits as part of an estate plan. For larger estates, life insurance can be used to avoid depleting or liquidating assets by providing a ready cash resource. Insurance proceeds can pay debts of the deceased, estate expenses such as funeral costs and legal fees and tax liabilities such as estate administration, land transfer, and capital gains taxes. Life insurance proceeds can also be used to pay the high tax bill on a family cottage intended to be given to a beneficiary and avoid a “forced sale” of the cottage to pay taxes. If an estate consists primarily of a family business that is being given to a particular beneficiary, insurance proceeds can create equalizing gifts for other beneficiaries.

Life insurance can also be a tax-efficient way to transfer wealth, as a beneficiary will receive the death benefit tax-free. In Ontario, life insurance proceeds can in many cases pass to designated beneficiaries without the need to pay estate administration tax, which is charged at a rate of approximately 1.5% on the total value of an estate.

Because a will and life insurance play different roles in estate planning and are sometimes not considered in conjunction with each other, there is a failure to seek legal advice to optimize planning for it.

Many clients will use beneficiary designation forms provided by insurance companies. While these forms may be appropriate in relatively straightforward situations (e.g. where a spouse is the only beneficiary), they often do not include provisions for designating trustees or contingent beneficiaries, and when they do they are often too simplistic. This can be a problem where a minor or incapable person is the beneficiary of insurance proceeds, since a failure to name a trustee with proper trust terms can result in the insurance proceeds being paid into court or the need to appoint a guardian of property (regardless of whether the minor has parents still living).

With proper legal advice, an insurance declaration in a will can be prepared to include trust provisions for minor children, special needs beneficiaries, contingent beneficiaries and adult children, which can parallel the trust provisions in the will to ensure an integrated approach. Also, beneficiary designations can be updated as part of will planning to avoid possible legal disputes in the event of separation or divorce. This is important because, for example, insurance proceeds can be subject to support claims, even if a beneficiary designation is made outside a will.

Life insurance can offer many advantages as a key part of estate planning for families and individuals. Beneficiary designation forms are easy to use, but this convenience can be illusory if it leads to unintended consequences or a failure to meet each person’s individual estate planning objectives.

The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.