Managing life insurance benefits with a trust
In some cases, it can be beneficial to put life insurance payouts into a trust, giving the insured more control over how the benefit is distributed. Typically, a life insurance benefit is paid as a tax-free lump sum directly to a beneficiary when the insured dies. Instead, many insured parents put their benefits into a trust until their children can manage the funds themselves.
Your life insurance payout directly goes to your beneficiaries in most cases. However, there are situations that warrant placing your life insurance payout in a trust. This can include when your beneficiary is a minor or you don’t want them receiving the benefit as a lump sum or other cases where you want more control over the disbursement of the policy’s death benefit.
This article explains what a trust is, the benefits of issuing your death benefit via trust, and how to set it up.
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What is a trust?
A trust is a way for someone to own something. The property’s legal title is given to a “trustee” who manages and distributes the property to the “beneficiary” who holds a beneficial title to the property. It’s the trustee’s responsibility to manage the property per the trust’s terms and conditions and with the beneficiary’s best interest in mind.
In the context of life insurance, a trust can receive your death benefit tax-free. The trustee receives the legal title of the death benefit, and the beneficiary receives the beneficial title. The trustee then manages the proceeds of your life insurance benefit per the trust document and for the benefit of the beneficiary.
Trustees are usually a close friend or family member, a lawyer or accountant, or a company in the business of acting as trustees. Most people can act as a trustee, and a single trust can have more than one trustee. The most important aspect is that this is someone you trust and who can competently carry out the trustee duties. Those who can’t legally act as trustees include minors, those with a history of insolvency and bankruptcy, or those deemed mentally incapable.
The trustee can have broad discretion or specific abilities to make decisions regarding the property, including how it’s invested. Although a trustee must follow the terms set out by the trust, a court may invalidate certain terms because they’re impossible to perform, illegal, or go against public policy.
The types of trusts
There are two main categories of trusts:
- Testamentary Trust: a trust created upon the death of a person. It’s usually established by a will or by court order.
- Inter Vivos Trust: a trust set up during one’s lifetime — effectively, anything that’s not a testamentary trust.
A life insurance trust is one where the trust property is the life insurance benefit. Because the benefit requires a person’s death, a life insurance trust is most often testamentary.
Benefits of a life insurance trust
Managing the distribution of your death benefit and making sure a minor beneficiary is correctly receiving the payout are the two main benefits of a life insurance trust.
Providing your death benefit to a minor
In many provinces, a child under 18 can’t control the money left over from a life insurance policy. Thus, a trust is set up in the minor’s name to hold the funds until they reach a certain age, usually 18. Suppose you don’t set up a trust, and the life insurance beneficiary is under 18. In that case, the insurer will likely pay the proceeds to the court. The court then distributes the funds to a public trustee to hold on behalf of the under-aged beneficiary until they reach the age of majority.
Managing distribution of your payout
You may not want your beneficiary to receive a lump sum because you feel they are unable to manage their finances, or there’s a fear they’ll deplete a large-sum payout by buying unnecessary goods, through gambling, or a host of other pursuits you didn’t intend to support or encourage.
A trust can turn the lump sum payment into a regular allowance. The trustee would be responsible for managing the total capital, so the beneficiary doesn’t have to worry about investing it properly. The trust document would further dictate how to pay out the money. However, there are certain cases and ways a beneficiary can end a trust and receive whatever capital is left. This often involves applying to court or there may even be a predetermined end date fot the trust at which point the beneficiary could receive the remaining proceeds.
How to set up a life insurance trust
You can usually set up a life insurance trust in one of two ways: within a will or as a separate document
Within a will
People commonly create a testamentary trust within their will because they both contemplate how a trustee or executor will distribute your assets after death. The trust usually forms through a clause in the will, which addresses the insurance benefit’s payout scheme (in this case, through a trust). The death benefit can mirror the distribution of other assets if you’ve also placed said assets into the trust or you can create an entirely different distribution scheme for the death benefit.
It’s essential to consult a lawyer when creating a will, especially with the complexity of having a trust within a will. If the terms of the trust are unclear, it could result in a failed trust, in which the insurance payout may go to your estate and be subjected to probate fees and creditors.
Read our Guide To How Wills Work In Canada to learn more.
Separate trust agreement
Depending on your circumstance, you may choose to create a trust agreement separate from your will. In this instance, you should label the trust as testamentary. Further, it isn’t ideal to place other properties in the trust before your death. Doing so could result in the trust being deemed an inter vivos trust, which creates different and possibly unfavourable tax considerations depending on your situation.
A trust is a powerful tool for managing your life insurance benefit. How a trust is structured and created is bespoke to your circumstances and commonly requires a lawyer and accountant. Our expert advisors can help you begin the journey by discussing your life insurance needs. You’ll also receive a no-obligation, custom quote for the life insurance you’re seeking. Reach out below!
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- A trust is an estate planning tool which allows you another party (the trustee) to manage financial assets for a beneficiary until a pre-determined time or when they reach the age where they can legally manage their own funds.
- Many parents use a trust to ensure their minor children are taken care of financially at a stage where they cannot manage their own finances.
- You can create a trust as part of your will or a separate trust agreement.