Considering insurance trusts¹ and the annuity settlement option
Wealth Transfer Strategy 4
It’s important for you to have options when passing on savings to the next generation. If you desire a structured payment stream, an annuity settlement option is available. If a structured payment stream isn’t the right fit, you can consider using a trust for transferring wealth to the next generation. Both options give you avenues to transfer wealth.
We’ll look at each option and provide support material where applicable. We’ll also consider what option may fit best in a certain scenario.1
Annuity settlement option
When certainty is important
The annuity settlement option provides a simple cost-free method of gradually transferring wealth to beneficiaries through prescheduled income payments after death. It’s an alternative to a lump-sum payment.
How is it done?
The annuity settlement option can automatically transfer the proceeds of an insurance contract or policy—including a guaranteed interest account (GIA), segregated fund contract, or life insurance policy—into an annuity on death. The resulting annuity will then make gradual income payments to your beneficiaries, as you specify.
The annuity settlement option replaces a lump-sum death benefit with smaller, scheduled payments while providing estate administration and probate fee savings, increased privacy, and potential creditor protection. There are also other benefits; let’s consider them.
With the annuity settlement option, you choose the specific annuity terms. You can select an annuity that makes payments to your beneficiaries, following your death, for the rest of their lives or for a specific time period. Guarantee options can also be added to make sure a minimum number of payments are made.
Flexibility and simplicity
If you decide to change the beneficiaries or the terms of the annuity, a new annuity settlement option form can be completed at no cost. It’s practically the same as a regular beneficiary change. It really is that simple.
Where there are multiple beneficiaries, the annuity settlement option allows you to differentiate between beneficiaries. Terms that best meet the needs of your particular beneficiaries may be selected for payout.
An alternative to a trust
Where a structured payment stream with no conditions fits best with your planning objectives, this option may be a good choice. It also has some benefits over a trust. Trusts have costs associated with setup and ongoing maintenance. If changes need to be made in the future, there are fees to amend or redraft a trust agreement or will. This isn’t the case with the annuity settlement option.
Beneficiary designations can be complicated and naming a trust can add to that complexity. That’s why it’s important to have the right information when it comes to making sure a beneficiary designation is done correctly. Unlike other investments, annuity products—including segregated fund contracts and registered funds—allow for a beneficiary designation to be made.
It’s always recommended that a formal trust be created to help make sure that the intent of the person settling the trust is clear and that the funds ultimately reach the hands of the intended beneficiary. A trust may be a good alternative when you want certain conditions met before a beneficiary can receive death benefit proceeds and where a structured payment stream isn’t the right fit.
A trust may work better than an annuity settlement option in certain situations. For instance, you may want to have a payment stream delayed; trust provisions will allow a trustee to do just that. As an alternative to an annuity settlement option, a trust may be preferred for tax-planning reasons (as discussed in the “Tax reasons” section below), or to control when and how payments will be made to a beneficiary.
The most common use for a trust is often to benefit a minor. Death benefit proceeds can’t be paid directly to a minor and would, therefore, have to be paid into a court or to the Office of the Public Guardian and Trustee, depending on the jurisdiction. To avoid this, death benefit proceeds are received by the trustee for the benefit of the minor and the terms of the trust permit the trustee to make payments out of the trust that will benefit the child.
When a child reaches the age of majority (18 or 19, depending on the province) and no formal trust provisions exist, that child can request the full payment of the death benefit proceeds as a single lump sum. This may not, however, be a desired outcome. A trust can be created to address this issue by providing appropriate distributions from the trust that may better meet that child’s needs and maturity level.
Trust provisions can also address what funds can be used for and how they may benefit the beneficiary. For instance, funds out of a trust can be used to meet financial needs for education.
A trust may be appropriate where a beneficiary is a spendthrift or unable to manage their own financial affairs. Where a trustee is given discretionary power over distribution payments from the trust to the beneficiary, payments can be timed in such a way that the beneficiary receives the money when they actually need it. Timed payments can also be done so that funds don’t end up in the hands of creditors of the beneficiary or become part of a matrimonial dispute.
In a second marriage situation, a trust is one way to help make sure that family members from a first marriage are taken care of and the new spouse is also considered.
Family members of beneficiaries who are disabled and receiving government benefits want to make sure those benefits remain intact. This may be accomplished by using a discretionary trust.
When a trust is named as beneficiary, the trust can be a testamentary trust. This means that the trust results from the death of the individual who settled the trust (the settlor). Testamentary trusts are now taxed at top personal tax rates, not graduated tax rates.
For disabled beneficiaries, a qualified disability trust (QDT) can be used because it still enjoys the graduated rates. The QDT is treated as a testamentary trust and will be taxed at the graduated rates on income in the trust.2 To be considered testamentary, the trust can’t be settled with any property during the lifetime of the settlor. The trust can be created before death, but it doesn’t come into effect until the death of the settlor occurs and the death benefit proceeds from the contract are settled in the trust.
Income splitting may also be possible using a trust where family members are named as beneficiaries. While income splitting may be somewhat limited from a tax perspective, it can still be used in the overall planning of the individual. Income may be distributed over a period of time if the intended beneficiary is in a lower tax bracket.
Comparing the options
It’s important for you to have options when passing on savings to the next generation.
The chart below looks at some of the comparisons between an annuity settlement option and a trust, and indicates where the fit might be better.
Trust as a successor owner
A trust can also be named as a successor owner of a contract. This helps make sure the contract doesn’t become ownerless on the death of the owner—for example, in a situation where the owner isn’t the annuitant, or there’s a successor annuitant.
Where to go from here
Now you know when to consider a trust and when an annuity settlement option may provide an alternative solution. Additional tips can be found below. If you’re interested in how an insurance trust may be set up, see “An advisors guide to insurance trusts” (log-in required).
- Conduct an annual review of existing designations and declarations to make sure they reflect your intention.
- Review all designations and declarations when life-changing events occur (e.g., birth, death, marriage, separation).
- Work with your professionals to make sure designations are up-to-date and reflect your current situation.
- Where a minor is involved, use the box available in the appropriate form that refers to a trustee for a minor instead of creating a designation that refers to a minor on the form in the primary or secondary beneficiary designation space.
1 This Wealth transfer strategy applies to all provinces other than Quebec. Residents of Quebec should speak to their tax and legal advisors about using insurance trusts. 2 There are certain requirements that must be met to qualify as a QDT. These include the trust being a testamentary trust and residing in Canada, and the beneficiary must be eligible for the disability tax credit. Where the trust no longer qualifies as a QDT, a clawback tax is imposed.
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.
Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.