Amongst the many beneficial qualities that life insurance possesses, special protection against the claims of creditors is one of them. Although this legislation falls under provincial jurisdiction, the legislation is generally consistent across Canada. Even though its intended purpose is to protect the rights of the beneficiaries under the contract, certain conditions and limits do apply. In this article, I’ll explore under what conditions creditor protection is available and where it’s not.
As it applies to life insurance, both the cash values and death benefit proceeds are protected or shielded against a policyowner’s creditors. This is achieved in two ways: (1) when a member within a certain class of family members is designated as a beneficiary or (2) an irrevocable beneficiary designation is made.
Revocable beneficiaries that are family members:
Where certain family members are designated as beneficiaries, the legislation prevents creditors of the owner from seizing and surrendering the contract during the lifetime of the individual whose life is insured. In the common law provinces, the family member must be a spouse, child, grandchild or parent of the life insured under the policy. In Quebec, the class is wider and includes all ascendants and descendants of the owner (Quebec Civil Code, Art. 2457). The definition of spouse may include common-law spouses or same-sex spouses, depending upon provincial legislation. In Quebec, only married and civil union spouses can benefit from creditor protection. Common law partners must be designated irrevocably to get the same benefit.
Any Irrevocable beneficiary:
The legislation states that an irrevocable designation, while in effect, can place a policy beyond the reach of the policyowner’s creditors. An irrevocable beneficiary doesn’t have to be in the “family class” described above for protection to apply. Neither the policyowner nor the policyowner’s estate can qualify as an irrevocable beneficiary. Caution should precede before contemplating this type of designation. While the irrevocable beneficiary is living, the policyowner may not alter or revoke the designation without the consent of the beneficiary or a court order. Other restrictions on the policyowner’s ability to deal with the policy may apply, due to the irrevocable designation.
The law states that once the insured dies and proceeds are paid to a designated beneficiary(s) (excluding the policyowner of the policyowner’s estate), the creditors of the deceased cannot make a claim against the death benefit proceeds. That being said, it doesn’t protect the beneficiary from their very own creditors.
Although creditor protection is available, there are limits to consider. Here’s a list, although not exhaustive:
Corporate-owned insurance: Although there are specific classes of beneficiaries, which protect policies against the creditors of the policyowner, unfortunately, corporate beneficiaries are not one of them. For this reason, corporate-owned policies that designate themselves as the beneficiary can expose both CSV and death benefit proceeds to creditors of that corporation. This problem can be avoided by allowing a holding company to own and be the beneficiary of that policy, assuming of course, that the creditors potentially only reside in the operating company. Provided that the Holdco has not guaranteed the obligations of the Opco, this option should work fine. In theory, you may also consider designating another person or corporation as beneficiary (to protect death benefit only, not the CSV), but this may not be practical due to the taxable benefit situation that it creates (i.e. owner: corporation, beneficiary: spouse of insured).
Dependent’s relief claim: The provincial legislation that speaks to this family law matter gives the courts extensive powers to enforce dependent support obligations (i.e. spousal and child support). The courts can deem certain assets that generally fall outside of the estate to be included back if it’s determined that the deceased provided inadequate support for a dependent. The definition of who qualifies as a dependent may vary between provinces. Fortunately, when deciding on adequate support, the courts will often factor in the life insurance payouts received by these dependents making the claim.
Fraudulent conveyance: This occurs when a debtor transacts on a property(s) with the intent of either delaying, hindering, or defrauding their creditors of what’s rightfully theirs. Considering purchasing a life insurance or changing a beneficiary to a family member in the protected class or designating an irrevocable beneficiary before insolvency or bankruptcy is an example of fraudulent conveyance. The courts will likely set aside these types of transactions. That aside, there is a difference between evading payments to creditors who are entitled to them and planning to protect assets from liabilities that may occur in the future.
Canada Revenue Agency (CRA): CRA has extensive powers to collect tax owing and can be considered a privileged creditor. The federal Income Tax Act (ITA) has provisions allowing the CRA to garnish or seize taxpayer property to collect on amounts owing by a taxpayer. The CRA also has collection rights, as a creditor, under provincial law. This can also extend to life insurance. Since the law is ever evolving when it pertains to CRA powers, concerned individuals need to get proper legal advice.
Although fraudulent conveyance, dependant relief claims, as well as CRA claims are instances where creditor protection may not apply, there continue to be many other instances where life insurance can provide protection. Creditor protection should not be the sole reason for purchasing life insurance. It should, however, be viewed as an added feature of the product, if in the future creditor, issues do arise.
