The Intersection of Separation Agreements and Life Insurance

1. The Intersection of Separation Agreements and Life Insurance Robin Goodman, B.A., LL.B, TEP AVP Tax & Estate Planning

2. Important Information This presentation is intended for professional education. Do not reproduce or distribute this presentation without the permission of Manulife Financial.

3. Separation Agreements and Life Insurance • Most agreements require insurance for a period of time • Proceeds can be used to • Replace support • Provide separate obligation to create or maintain wealth • Buy-out interest in corporation or trust • Must ask series of questions to ensure structure best suited to both parties

4. What to Consider? • What’s the purpose of the insurance • How much insurance do we need • For how long? • Who should own the policy • Who should be the beneficiary of policy • How do we ensure that the premiums are paid up • Should we use an irrevocable beneficiary designation • Pros and cons • Should we use an Insurance trust • Can we? • Should we use irrevocable beneficiary designation • Will the policy be creditor protected • How do we deal with corporate ownership of insurance • Do we need new insurance or use existing insurance • How do we change beneficiary back after obligation ceases

5. General rules of Insurance Act (Ontario) • Owner rights • Make or change beneficiary • Transfer or assign policy • Withdraw funds • Change coverage amount • Pay premium or not pay premium • Limitation on owner rights • Irrevocable beneficiary designation • Incapacity • Power of attorney • Assignment • Joint ownership

6. Many Ways to Structure….What’s the Purpose of the insurance??? • Guarantee support or • Independent obligation or • Guarantee of estate distribution or • Guarantee of purchase of interest in corporation

7. Court’s Right to interpret Purpose Turner v. DiDonato et al. 2009, 95 O.R. (3d) 147 (On.C.A.) • Separation agreement required support payable till age 65 • Agreement required $100,000 life insurance policy maintained till age 65 • Support payor died 9 years before support obligation terminated • Ex-wife argued entitlement to full $100,000 • New wife argued entitlement to $43,000 only • Argued that his “intention” was likely not to create windfall • Court: • Was life insurance policy required by separation agreement security for diminishing support or was it an independent obligation? • Ont. C.A. - if the parties intended insurance policy to merely be security for support payments and nothing more should have addressed it in agreement • Insurance policy was separate obligation and not security for support • Full $100,000 payable • No argument of mistake

8. Purpose prevents another designation Schorlemer Estate v. Schorlemer(2006) Canlii 42364 (Ont S.C.) • Father had obligation in separation agreement to maintain insurance for daughter’s benefit while child of marriage • Weeks before death, dad changed beneficiary to second wife • Daughter was 22 and in last year of university • Second wife claimed she was dependent • Court confirmed that obligation under agreement prevents another designation • Imposed a trust over death benefit • Court has discretion to alter terms of agreement to ensure adequate support of all dependents • Court imposed trust over full amount of proceeds • Found no windfall to daughter - remedy specified in contract • No mention of diminishing obligation • Found wife adequately provided for elsewhere

9. Or… Purpose permits another designation Roberge v. Roberge, 2007 SKQB 310 • Separation Agreement required 4 children irrevocably designated as beneficiaries • 2 children already adults at time of agreement • Argued material change in circumstances • All children now adults • Father remarried • Can court vary terms of agreement to effectively “undesignate”? • Must look to intentions of parties at time of agreement • Intention to provide maintenance v. distribution of husband’s estate • Court found that intention was to provide maintenance • Under heading of Child Support • Allowed court to undesignate without consent of irrevocable beneficiary

10. Practical drafting suggestions • Clear indication of purpose of insurance • Timeframe for maintaining insurance • Ability to reduce benefits payable as support NPV reduces • Insurance may be valuable (existing or new) • Reduce coverage • Reduce amount payable • Mechanism to obtain consent if irrevocable beneficiary • Executed consent in escrow – acceptable to insurer? • Staledated • Merged companies • Alternative to irrevocable designation is third party trustee holding policy • Trust terms reduce payment of proceeds over time or return policy

11. Practical drafting suggestions • File agreement with insurer • Instrument that can contain Declaration • Avoids neglect to change beneficiary on payor’s part • Avoids need to change beneficiary annually to reduce payment • Indicates intention

12. Ownership of policy • Personal is customary • PROS: • Easiest to secure and underwrite • Simple method of paying premiums • CONS: • Rights of ownership leaves recipient spouse vulnerable • Alternatives?

13. Ownership of policy • Joint Ownership • PROS: • Protects recipient spouse • Signature required for beneficiary changes • Signature required for assignment or transfer • Right to information • Put provision in agreement allowing recipient to make payments if necessary • CONS: • Personal info of payor spouse available to recipient • How to guarantee transfer of policy after obligation terminates • Transfer of ownership form in escrow – acceptable to insurer? • Potential tax consequences to recipient spouse on transfer • Incapacity of one owner • May not permit designation of testamentary insurance trust • Not created by THE person who’s death gave rise to the trust

14. Ownership of policy • Third party (trustee) owner • PROS: • Payor continues responsibility for premium payment • Trustee has notice of potential lapse and can advise recipient • Put provision in agreement allowing trustee to make payments if necessary • Trust terms avoid change of beneficiary or assignment of policy • Incapacity not an issue • Beneficiaries = recipient (proceeds) • Beneficiary = payor (insurance) • S. 107(2) rollout • CONS: • Finding that third party • Proceeds payable to trust (not testamentary)

15. Ownership of policy vs. irrevocable beneficiary • Alternative to complex ownership structure • Irrevocable beneficiary = removal of policy from hands of owner • Not subject to creditors • Can’t change beneficiary designation without consent • Can’t transfer or assign • Entitled to information re: lapse from insurer • Must be filed with insurer to be effective • Reasonable solution for spousal support obligation

16. Ownership of policy vs. irrevocable beneficiary • Need mechanism to obtain consent to change beneficiary • After cessation of obligation • If reducing obligation • Pre-signed consent form? • Acceptable to insurer • Question of later incapacity • Put consent in Separation Agreement • File with insurer • Additional evidence of intention

17. Insurance for benefit of children – INSURANCE TRUST • Trust created to hold life insurance proceeds • Created outside Will • Retains testamentary status • Need 3 Certainties • Flexible trust terms • Created as a result of beneficiary designation

18. Insurance for benefit of children – INSURANCE TRUST • Child can’t give receipt to insurer • Permits control over proceeds • Terms can require proceeds held till children attain stipulated age • Proper trust terms rather than bare trust • Ensure distribution date • Ensure gift over (avoid Saunders v. Vautier) • Generates testamentary tax treatment over proceeds • Single life policy/personal owner • Joint ownership treatment is questionable • Trust ownership treatment = inter vivos trust • No one else can contribute to trust • DOES NOT extend creditor protection over proceeds

19. Insurance for benefit of children – INSURANCE TRUST • If need single life/personally held policy • Control over beneficiary designation? • Irrevocably designate trustee • How do we do this if trust doesn’t yet exist? • Is right to consent “property” • Have we created inter vivos trust instead • If testamentary trust • How does trustee consent to change of beneficiary • Now or in future • Trust doesn’t exist

20. Insurance for benefit of children – INSURANCE TRUST • Accept that not testamentary trust • Obtain pre-signed consent form from trustee • What if trustee not same person at time of cessation of obligation • Draft so that children are beneficiaries • Appoint trustee on their behalf • Subtle difference, but… • may retain testamentary trust treatment • May give extra creditor protection • Remaining problem – obtaining consent to cessation of obligation

21. Insurance for benefit of children – INSURANCE TRUST • Where is trust declaration contained? • In Will • Can’t make irrevocable designation in will • In Separation Agreement • Signed by both parties • Testamentary trust? • On Contract • Append trust terms when filing

22. Other issues to discuss • 3 types of life insurance • Term (Temporary) • Perm (Permanent) • Group

23. Term Insurance • For temporary insurance needs • Relatively inexpensive in early years, cost increases as insured ages • Coverage expires at certain age (typically 75) • Appropriate where need is for a specific period and cash value not required

24. Permanent Insurance • Coverage for life • Level cost or quick pay • Tax advantaged

25. Type of Insurance Term vs Perm = If vs When • Short term need - Term Insurance • e.g. child support • Long term need – Permanent Insurance • Other estate planning needs • May start out as one and end up as another

26. Interaction of marriage contract, Will and beneficiary designation • Elton Estate v. Elton, 2010 NLCA (CanLII) • Marriage contract limited amount of insurance payable to wife to specified amount ($450,000) • Subsequent Will provided for insurance proceeds naming wife as beneficiary and any addition insurance monies necessary to provide her with $450,000 • Court found this to be the beneficiary designation that governed • Is it clear? • Does it limit amount to $450,000 or does it mean she gets all proceeds she is designated to receive under policies?

27. Changing Beneficiary Designations…after death • Richardson v Mew(2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 • Touched on Issues of: • When can a Constructive Trust can be imposed over life insurance proceeds • When could a rectification argument succeed • The effect of a general release clause in a separation agreement • The Beneficiary Designation as a testamentary disposition • Impact on the ability to use powers of attorneys

28. Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 • Michael was married to Stephanie (1965-1992) • Michael was then married to Anne (1992-2007) • Michael became incapacitated and Anne took over his finances • Paid for out of joint account and once depleted, out of her funds • Michael died (2007) holding $100,000 life insurance • AND THE BENEFICIARY WAS • Supposed to be Stephanie until 2005 (court ordered) • Anne thought it was only a “temporary” designation • Michael never changed the designation

29. Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 • Stephanie’s Argument: • Money should be paid to her outright • Insurance Act: moneys payable to Beneficiary • Stephanie was named in contract • Designation is unassailable • Anne’s argument: • Money should be held on constructive trust for her because: • Michael inadvertently forgot to change the designation • Windfall to Stephanie • Stephanie was unjustly enriched by receiving proceeds • Anne was correspondingly deprived by paying premiums • General release clause in separation agreement should have had effect of “undesignating” • Had she known she would have used power of attorney to amend designation

30. Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 • The Court found: • BENEFICIARY DESIGNATION IS AKIN TO A TESTAMENTARY DISPOSITION • Power of attorney? • Good discussion of elevation of duties where diminished capacity • Testamentary disposition? • No evidence that Michael intended to change beneficiary designation = NO RECTIFICATION • Rectification requires evidence of significant mistake • His inaction is the best evidence of his intention • Proper beneficiary designation with no mistake = juristic reason to receive proceeds • ie. Stephanie’s entitlement is supported by law • Juristic reason = NO CONSTRUCTIVE TRUST ARGUMENT • SEPARATION AGREEMENT: general release clause is different than life insurance designation clause • General language used in waivers and releases is NOT A DECLARATION within the meaning of the Insurance Act.

31. Richardson v. Mew (2008), 300 D.L.R. (4th) 503, 93 O.R. (3d) 537 (S.C.J.), affd 2009 ONCA 403 • Drafting ideas? • Execute change of beneficiary form at time of Separation Agreement • Hold in escrow • Change beneficiary to estate • Probate • Can change again • Distributed through terms of Will (intestacy) • Third party trustee holds policy • No concerns of incapacity • Control over policy while obligation exists

32. Corporate Context • Life insurance in corporation • Maintained to redeem shares from spouse or trust at death Ribeiro (Estate) v. Braun Nursery Ltd. 2009 CanLII 1149 (OSC) • Redemption of deceased’s shares pursuant to shareholders agreement • Life insurance for key person protection used for redemption • CDA retained by corporation • Shareholders agreement did not address use of CDA • Estate not entitled to capital dividend

33. Corporate Context - Life Insurance Shares • Ms A owner/manager of private corporation (Opco) held through Holdco • Adult children not involved in Opco • Wants Holdco to fund an insurance policy on Ms A’s life • Ms A wants to take advantage of spousal rollover (testamentary spouse trust) • Wants insurance proceeds to go to kids

34. Life Insurance Shares • Shares designed to give holder right to insurance proceeds • No other corporate value • Way to stream insurance proceeds to (non-shareholding) heirs • Valuation issues addressed by CRA

35. Life Insurance Shares: 2005 – APFF CRA Roundtable • ATTRIBUTES • Shares have nominal value during lifetime • Share terms defer payment (if redeemed during lifetime) till after death • Can’t force collapse of insurance policy • After death, redemption = insurance proceeds • 2 SCENARIOS (at death) • common shares reflect CSV, insurance shares have nominal value • insurance shares reflect CSV, common shares not increased

36. Planning for Ms. A Ms. A Mr A Adult Children 100 % common shares Life insuranceshares Holdco • On death of Ms A, the entire corporate value is attributable to the common shares (including the cash surrender value). • The common shares are rolled to Mr. A • The life insurance shares are gifted to adult children and insurance proceeds distributed tax-free to children through CDA.

37. 6. Trust As Owner of Insurance • Keeps policy out of corporation(s) • No disposition at death of individual owner • Good alternative where intention is to benefit a non-shareholder • Eg. Inter-generational transfer alternative • Control over distribution of proceeds • Can roll policy out to capital beneficiaries • CRA says: Although life insurance is not capital property for tax purposes, it is trust capital for trust law purposes. • 107(2) applies rather than 148(7) • Not subject to 21 year rule because not capital property • No rollover into trust • Need to fund premiums Trust

38. Thank you