If things go very badly financially, it would be nice to have some assets that provide a basis for starting over. Assets that cannot be seized by creditors provide a base to restart. Life insurance is such an asset if it is designed properly.
How does that work?
In the common-law provinces, insurance legislation provides that if beneficiaries of a life insurance policy are of the protected class – spouse, children, grandchildren and parents, the insurance policy is immune from seizure by creditors. That could be in respect of the death benefit and the cash value. You should check the rules in your own jurisdiction.
Where it becomes more interesting is in respect to Registered Retirement Savings Plans. (RRSP)
It is generally true that an RRSP is protected from seizure by a creditor in a bankruptcy, but an RRSP that is held within a deferred annuity is exempt from seizure at any time. It is a form of life insurance product and the insurance laws apply.
Deferred annuities are “segregated funds” of an insurer and behave in ways similar to mutual funds. Protection from seizure while not a bankrupt provides considerable negotiating advantage.
Segregated funds can be held outside an RRSP too. Just as with an RRSP they avoid creditors, are generally not subject to probate, and have some form of guarantee of capital at death.
Outside an RRSP, a segregated fund can allocate losses to a unit owner in the year they incurred, whereas a mutual fund must store them into the future.
On the downside, segregated funds have somewhat higher expense ratios.
The law provides some limits to the creditor protected setup.
- The transfer of seizable assets into an insurance product will be reversed if it is done in contemplation of bankruptcy. Certainly within 12 months and sometimes longer.
- Does not protect from duties imposed by Family Law
- The government occasionally challenges the protection when taxes are a significant liability. They have mixed results on that.
An interesting question arises in respect to irrevocable beneficiaries. They qualify as part of the preferred class and so situations where there are no preferred connections to the owner/insured may become qualified by creating an irrevocable beneficiary. To my knowledge there are no cases on this point.
While defeating one’s creditors should not be the reason to own life insurance or its variants, it is comforting to know that assets held through that kind of plan could be “Phoenix Money.” That which allows you to rise from the financial ashes of a failed business adventure.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.
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