A Word about Beneficiaries

29 September, 2014

The discussion about beneficiary designations comes up when we are setting up life insurance policies. A husband and wife usually indicate each other as "primary" beneficiaries on their policies. I then ask them who they would like to receive the proceeds of both the insurance policies if the both die at the same time. We refer to this designation as the "contingent" beneficiary. The answer is universally the same..."We want our kids to get the money."

Let's say the parents each take out a policy for $1 million each. If they both die at the same time, the amount to be left to the children would be $2 million. But if they have two children, say, age 6 and 8 years old, it's not just a simple check mark that allows the parents to leave the kids $2 million from the insurance policy. After all, the two children are minors and cannot be responsible for handling that sum of money at that age.

So...what is a parent to do?
I usually give them two suggestions. The first one is the most tax efficient. Namely, that they indicate on the insurance form that they wish to leave the monies in "trust" to kids, with the guardian as the trustee. Let's call the guardian "Aunt Betty" for the purpose of this example. I explain that this method is the most tax efficient in that the insurance proceeds bi-pass the estate and are not subject to probate fees (approximately $15 on every $1000 in Ontario). So, on $2 million dollars of insurance proceeds, this would amount to $30,000 in tax (ouch). As well, if the life insurance policy becomes part of the estate (which it is not in this case), the executor can charge a fee of 3 to 5 % to manage the monies. So, there's another $60 to $100 thousand saved by designating the guardian (Aunt Betty) as the trustee on the life insurance policy.

Ok - so that's the good news!
By leaving the monies to the kids in trust with Aunt Betty on the insurance application, you do avoid having the proceeds as being part of the estate. But here is the bad news. As a result of this designation, the children must receive the monies at the age of 18 regardless of whether or not they are incredibly responsible human beings or little hell raisers. Yes...show me the child at 18 and I'll give you the man at 25. I have a lot of issues with giving an 18 year old the monies outright as they may not have the maturity to deal with the windfall. A pretty girl might catch your son's fancy and voila....there goes the education fund and everything with it while he tries to wine and dine her with the insurance proceeds, with the brand new Porsche humming in the background. As well, there is nothing stopping Aunt Betty from spending all the money and turning to the kids at age 18 and telling them there is nothing left. The optics are horrible. Both you and your spouse are dead. The kids are now forced to sue their one trusted surviving relative! Yuck!

So.....I propose a better way that allows a parent to rule from the grave. Why not make the contingent beneficiary the "Estate" of the last parent to die. Yes, it is subject to probate tax and executor fees. And you need to set up a will and that represents another cost.

However, you can put in all sorts of rules that can make the money last and last. Let's say you have $1 million of proceeds in the estate. You can tell Aunt Betty that she can spend $1,000,000 of it to raise the kids. That leaves a cool million for the kids to split at some point. Ok, you can write in the will that the kids are to receive $50,000 each at the age of 18, and then another $100,000 when they turn 21 and the remainder when they turn 25 (or graduate from medical school - if you feel they are so inclined).

The bottom line is that you can put in rules that stop silly wasting of monies at immature stages of life.

I very often encourage clients who wish to pursue the contingent beneficiary as the Estate to purchase a few more dollars of insurance to cover the probate fees and executor fees. Therefore, a $1 million dollar policy becomes a $1,050,000 policy to account for additional fees.

There are other options such setting up an insurance trust. But the contingent beneficiary as the "estate" is a reasonable program for parents to consider for minor children.

This article was written by John Klotz and can be reached at 416-783-PLAN (7526) or email at john@northwoodmortgagelife.com.

Insurance Products are offered through IPC Estate Services Inc.