Creditor Protection using Insurance
By Andrew Rogerson LLB (Hons) TEP
Financial and insurance professionals, who have mastered the theory of asset protection, seek knowledge of suitable products to recommend to their clients. This is the purpose of what follows. But firstly, an overview of the law.
The Law relating to Protected Insurance Products
As a general rule, all assets of an individual or entity are security for unpaid debts owing to a creditor. This applies whether or not the individual or entity is bankrupt.
Traditionally, life insurance products have been given special protection against the claims of creditors under provincial legislation. The legislation, which is fairly consistent across Canada, is intended to protect the rights of the beneficiaries under the contracts.
The definition of insurance products in all provinces includes annuity contracts. Most RRSPs and non-registered investments issued by insurance companies take the form of an undertaking to provide an annuity and, as such, fall under the definition of life insurance under provincial legislation.
Creditor protection during the lifetime of the owner can be achieved in two ways; by making an irrevocable beneficiary designation in a life insurance contract, or by designating as beneficiaries, certain family members specified in provincial insurance legislation.
In the latter case, the legislation prevents creditors of the owner from seizing and surrendering the contract during the lifetime of the insured. In most provinces, the family member must be a spouse, child, grandchild, or parent of the life insured, for the policy to provide such creditor protection.
The definition of “spouse” may include common law spouses, or same-sex spouses, depending on provincial legislation.
After the death of the life insured, where an appropriate beneficiary has been designated, the creditors of the deceased are prevented from seizing the policy. The death benefit of the policy is specifically excluded from the estate of the owner. This is because the proceeds flow directly to the beneficiary, and are exempt from the claims of creditors.
Where creditor protection is important, it is advisable to name alternative or contingent beneficiaries within the protected class, since the exemption from seizure can be lost if the designated beneficiary dies.
It should be noted that creditor protection only exists where the policy is owned by an individual. Policies owned by a corporation offer no such creditor protection.
Insurance Products – RRSP Creditor Protection
Products offered for sale by a life insurance company are generally creditor protected. Products fall into two categories; life insurance policies, and deferred annuity contracts. When hearing of “a life insurance contract” most people think of a traditional life insurance policy, where one pays a regular stream of premium payments and a death benefit is paid to a designated beneficiary, upon the insured’s death. However, accumulation and investment products sold by life insurance companies are “deferred annuity contracts” and, as such, also qualify as life insurance policies.
Cash can be accumulated within a traditional life insurance policy subject to certain limits imposed by the Income Tax Act. Within these limits the investment growth is not subject to accrual taxation. This is commonly referred to as an “exempt policy”. Furthermore, in most circumstances, the policy fund or cash value is paid out to the designated beneficiary as a tax free benefit, in addition to the face amount of the policy. This feature makes accumulating and investing funds within an exempt policy, by an individual, an attractive estate planning tool, particularly when combined with the added value of creditor protection.
Deferred annuity products encompass a wide variety of investment choices. The creditor protected investment vehicles offered by life insurance companies include:
Daily interest accounts and money market segregated funds
- GICs – from 6 months to 10 years
- Balanced and Portfolio Accounts
- Index Linked Segregated Funds
- Managed Segregated Funds (like a mutual fund, but with maturity and death benefit guarantees)
- Payout annuities (a guaranteed stream of income for life or a certain duration)
Clients frequently ask about possible additional costs resulting from investing via an insurance product to obtain creditor protection. It is true that packaging any available investment as an insurance product will incur an additional fee. This fee would be virtually non-existent for fixed rate investments and about 5-25 bps for an insurer’s variable products. If a third-party fund is elected as a segregated fund, the additional costs could be as high as 150 bps.
Grateful acknowledgement is made of Bob Glover RHU CFP CHFC TEP, of Calgary, for sharing his vast product and industry knowledge.