An insurance trust is a trust created by a policy owner (settlor) to ensure proceeds are distributed to the beneficiaries of the trust in a way that meets the settlor’s goals.
There are three parties to an insurance trust.
- The settlor (who is also the policy owner) is the person who creates the trust in writing and names the beneficiaries who will receive the insurance proceeds. The settlor names a trustee and provides powers to that trustee about what can be done with the proceeds and how they are to be distributed.
- The trustee manages the assets in the trust according to the terms of the trust agreement. There can be more than one trustee appointed to a trust.
- The beneficiary is the person who will receive the insurance policy proceeds in accordance with the trust terms.
There are three main ways to set up an insurance trust.
1. Through a will
An insurance trust can be created right within a will. The trust information should:
- specifically state that it’s an insurance trust
- identify the insurance policy by number and insurance carrier to clarify which policies the insurance trust applies to
- name the trustee or trustees –there can be more than one trustee, and they do not need to be the same trustee(s) as the executor of the will
- grant powers to that trustee(s)
- explain how the proceeds of the trust should be distributed and to whom.
Since the insurance proceeds flow into the insurance trust by way of an insurance declaration, they are separate from the other assets of the estate and are not subject to probate or creditors’ claims. This applies even if the insurance declaration creating the insurance trust is written in a will.
2. By Trust agreement
An insurance trust can be set up in a separate agreement. The trust agreement will:
- specifically state that it’s an insurance trust
- identify the insurance policy by number and insurance carrier to clarify which policies the insurance trust applies to
- name the trustee or trustees –there can be more than one trustee, and they do not need to be the same trustee(s) as the executor of the will
- grant powers to that trustee(s)
- explain how the proceeds of the trust should be distributed and to whom.
Because the insurance declaration containing the trust is a standalone document, the insurance proceeds do not flow through the estate and are not subject to probate or creditors’ claims.
3. A hybrid method using the settlor’s existing will
This method is probably the easiest way to create an insurance trust because the beneficiary
designation form can be used to create the trust. A will must exist in order to use the hybrid method.
When the policy owner completes the beneficiary designation form for the life insurance, they name a trustee and reference the trust created by an existing will. The trustee will follow the provisions of the will to distribute the insurance proceeds.
A lawyer who practises in the area of estates should draft the provisions of the trust.
It’s important to note that insurance trusts cannot be used in Quebec because of how trusts are set up under the Quebec Civil Code.
Insurance trusts offer many advantages
In a nutshell, insurance trusts give a person a way to ensure that the proceeds from an insurance policy reach the intended beneficiaries in a controlled and efficient manner.
Insurance trusts also:
- Let the settlor control the distribution of proceeds to beneficiaries.
- Pay the trustee proceeds on behalf of a minor child eliminating the need for a court-appointed guardian of property that can receive insurance proceeds.
- Pay a child proceeds in accordance with the trust distribution. This means the trust proceeds might not be automatically paid when the child reaches the age of majority.
- Offer creditor protection because the proceeds do not form part of the estate of the settlor (that is the policy owner who has died).
- Avoid probate fees, since the trust is separate from the deceased policy owner’s estate, which may be probated.
- Help maintain privacy in cases where a separate insurance trust or the hybrid method are used. Where privacy is important, a will may not be the best place to create an insurance trust because if the will is probated, it will become public record (unless a court orders otherwise) and that means privacy is lost.
- Can be used in a divorce or separation situation where having a trustee disburse the insurance proceeds may be better than having an ex-spouse do that work.
- Provide for a mentally incapacitated person who might not be able to manage their own finances.
- Help ensure that a beneficiary who is eligible to receive provincial government benefits in provinces that offer these programs, will be able to keep those government benefits AND receive trust funds. This is achieved using a specific type of discretionary trust called a Henson trust.
- May qualify as a Qualified Disability Trust (QDT) for income tax purposes. A QDT is a type of testamentary trust that is taxed more favourably. If the beneficiary meets the eligibility requirements each year under the Income Tax Act, the trust income will be taxed at graduated tax rates instead of at the top tax rate.
Final thoughts
An insurance trust provides the settlor – that is the policy owner – options for making sure insurance proceeds are distributed to the right beneficiaries and in the way the policyholder wishes.
There are different methods for setting up an insurance trust. They give the settlor flexibility to pick the method that best suits their needs.
An insurance trust gives the trustee investment powers and allows distributions out of the trust that might not otherwise be permitted if the trustee were governed by provincial trustee legislation.
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