One of the ways that you can control the distribution of your assets upon your death is through the purchase of a life insurance policy. By controlling the insurance payout— technically called the “proceeds”—you can influence how it is distributed and received by the beneficiaries.
Just as you control some conditions of the distribution of your assets under your Will, you may want to retain some control around the payout of the proceeds. Here are a few of the options are available to you.
1) Bypass your Estate
The most basic way to control the proceeds is to name a specific beneficiary in the life insurance policy itself. The named beneficiary becomes directly entitled to the payout, so the proceeds do not form part of your estate.
This option lets you distribute the proceeds of insurance in a way that diﬀers from how you divide the rest of your estate. For example, you could divide the estate among three children, but give the life insurance proceeds to just one of them.
Apart from the control, bypassing the estate oﬀers a tax advantage: the proceeds avoid incurring probate tax. That, in itself, is a savings. But you have other choices, too . . .
2) Incorporate the Proceeds into Your Estate
A second way to control the proceeds is to include it in the valuation of your estate. By naming your estate as the beneficiary on the policy, upon your death the proceeds are added to your asset valuation and dealt with according to your Will.
This method is recommended when your desired division of the life insurance proceeds matches exactly the division of the rest of your estate. When the estate is the named beneficiary, you don’t have to update the insurance policy every time you make a change to your Will.
The downside to this approach is that the proceeds are subject to probate tax. That tax may or may not be a significant sum, depending on the size of the payout.
3) Creating an Insurance Trust
In a case where the probate tax on the payout is significant and you have reasons for not directly designating a specific beneficiary under the policy, you have a third option: an insurance trust.
An insurance trust acts as a bank account operating outside of your estate. By designating the insurance trust as the beneficiary of the policy, you can both avoid probate tax and avoid direct payment to an individual.
This option is the most costly of the three, due to the up-front costs of setting up the trust. The advantage is that it gives you the most flexibility: not only can the distribution of the funds under the trust be completely diﬀerent from the distribution of the assets under the Will, but in addition, a trust can operate on a much more sophisticated level. Instead of a single payout, for example, you can designate multiple payouts over an extended period of time.
The Recipient’s Tax Obligation
Whether the proceeds will be taxable in the hands of the recipient is an important but separate question. The answer is determined by the components of the policy and the financial situation of the recipient.
You will need to do some number crunching with a professional before you can know which alternative has the most favourable tax consequences.
Get Some Advice
This is a great time of year to review your estate planning and insurance needs. Contact your lawyer and schedule an appointment if it’s been a while since you last your will and estate plan, or you don’t have one at all.
Rob Lewis, B.A., LL.B.-JD, MBA
Robert A. Lewis Law Office
Unit 40, 2450 Lancaster Road