To keep life insurance proceeds out of the estate you need to keep the beneficiary updated, transfer the ownership of the policy, or put the policy into a trust. The most suitable method depends on whether you are the insured and how much control you want to maintain over the policy.
Keep reading to understand what goes into the estate and why it is important to keep life insurance proceeds out of the estate. From here you can dive into the processes for keeping proceeds from going into the estate.
The estate is made up of assets and liabilities, including:
Accounts with listed beneficiaries can avoid going into the estate, and they do not contribute to its value.
To determine the worth of the estate you need to determine the value of the assets, subtract the sales tax imposed by the Canada Revenue Agency, and subtract the amount of any liabilities.
In almost every case it is better to keep the life insurance out of the estate. When the payout of the death benefit of a policy goes through the estate it:
If there is nowhere else for the policy to go then going through the estate is preferred, but the benefits beyond that situation are preferred.
When a life insurance policy is paid to the estate, it raises the value by the amount paid out. Life insurance policies can be a small amount, such as $50,000, but in most cases, life insurance companies have a lower threshold set at $100,000.
When you consider that many policies can be worth millions of dollars you understand how a policy can change the value of the estate drastically. In certain cases, this can lead to higher tax rates put on the estate than would be without the value of the insurance policy.
Life insurance policies are set up so that the payout to the beneficiary is not taxable. This minimizes the taxes taken at the time of death and provides a larger sum for the financial benefit of your heirs.
When a life insurance policy is paid to the estate instead of a beneficiary then the policy contributes to the taxable amount of the estate. While the policy is still eventually distributed by the executor, the net amount that it contributes is far less than it would be paid out directly.
Life insurance policies are a contract that requires the insurance company to pay the death benefit to the beneficiaries when the insured dies. They are not designed to go through the estate and get stuck in the probate process and instead can provide immediate funds for the family to use during that time.
When the policy goes through the estate it gets stuck in probate along with every other asset. This process cannot be set to a specific timeline, and the assets are not released until the process finishes and the executor gets the go-ahead from the CRA to distribute the estate.
During this time the funds could have been used to cover funeral expenses, allow spouses more time off work, or prevent the sale of assets to cover other costs.
Once you realize why it is important to keep life insurance proceeds out of the estate you should start looking for ways to prevent them from entering the estate.
Luckily, policies are designed to avoid the estate when used correctly. In most cases, you can keep the beneficiary updated to prevent them from entering the estate. If you are holding a policy that insures another person, but you want to keep the value out of your estate, then you will need to look into other options.
In this case, you can designate a contingent owner. You can also transfer the ownership of the policy or put it into a trust, but these require a bit more insight.
If you have an insurance policy listing yourself as the insured then you need to make sure you are naming a beneficiary and keeping this designation updated. The beneficiary of a life insurance policy cannot be influenced outside of the policy, so updating your will is not sufficient regarding the beneficiary assignment.
This applies to any other financial accounts you have. Make sure you go through every few years and reevaluate who is the beneficiary on your account. You should also consider updating your beneficiary when you marry, divorce, have a new child, or have a death in the family.
Transferring ownership of the policy and designating a contingent owner can keep it out of your estate if you own a policy with another person as the insured. The policy remains intact as long as the insured is still alive at the time of your death.
To transfer your ownership of the policy you choose another competent adult to act as the owner of the policy. This person can also be the beneficiary, but they will be responsible for paying the premiums on the policy.
At this point, you give up any rights that you have to make changes to the policy, and the transfer cannot be revoked.
You can transfer ownership at any point to remove the policy as an asset, but if you die within three years of transferring the policy it will still be considered part of your estate. Designating a contingent owner allows the active policy to transfer without sending it through your estate.
Many prefer putting the policy into an Irrevocable Life Insurance Trust (ILIT) because they still maintain some control over the policy without assuming ownership in a way that puts it through their estate.
This is commonly used for removing a policy from the worldwide value of an estate for United States tax purposes. You appoint a trustee to administer the policy and designate trust beneficiaries, and these should be Canadian citizens to avoid more complex tax situations.
You can transfer a policy into a trust, but you can also start a policy here to grow. By starting in an ILIT you avoid the three-year ownership rule that can land the life insurance proceeds in your estate.
Keeping life insurance proceeds out of your estate is essential to maintaining their full value and benefits. Contact Sim Gakhar to learn how you can keep your life insurance policy far from your estate and keep it ready for your intended uses.
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