It's good to know that governments all over the world are now educating people on how to protect against acts of terrorism. Take New York City, for example.
On July 10, the city released its new 16-page preparedness manual titled "Ready New York," which contains such advice as: If you encounter radiation, go outside (if you're inside a building), or go inside (if you're outside a building). The manual goes on to advise "do not accept packages from strangers," and if you find yourself holding a mysterious substance, "put it down."
If I could add some financial advice to the list, I'd suggest buying life insurance -- and consider a trust for that life insurance to boot. You see, there are several situations where an insurance trust can make sense. Let me explain.
Life insurance can be used to accomplish many things, and if you're going to insure your life, there are at least two questions to answer: "Who should own the insurance?" and "who should be the beneficiary of the policy?" This is where a trust could make sense.
You see, there are two type of trusts: Inter vivos (trusts created during your lifetime), and testamentary (trusts created after your death by your will). Let me say that most Canadians will find testamentary insurance trusts to be useful in more situations than inter vivos insurance trusts, so I'll focus today on the testamentary version of these trusts. To clarify, you'll purchase insurance on your life, with the proceeds paid to a trust for your intended beneficiaries upon your death, rather than being paid directly to your beneficiaries.
There are four situations where you might benefit from an insurance trust set up at the time of your death.
1. Trust for minors. If you die while your beneficiaries are still minors, you'll have a problem leaving the insurance proceeds directly to them. In Ontario, for example, the insurance law requires the insurer to pay insurance proceeds into court where a minor has been named beneficiary. A parent or guardian will then have to apply to the court for permission to make interim payments out of the funds, with the child taking full possession of the cash at the age of majority. Bad idea. Having the proceeds paid into a trust created upon your death, where the cash can be controlled by the trustee, makes more sense.
2. Special needs trust. If you're looking after someone with a disability, you may want to leave insurance to provide for him or her. It generally makes sense to leave the insurance to a properly structured testamentary trust so that any government benefits received by the dependent will not be jeopardized.
Also, consider spendthrift beneficiaries.
If your kids have trouble handling their money, you may want to control access to the funds after you're gone by leaving the insurance money to a trust, and providing the trustee with guidance or discretion to determine when and for what purposes your child gets the cash.
Finally, we all know some who have made weddings a habit. If you're concerned that any insurance dollars you leave behind could be pursued by the ex-spouse of your beneficiaries, a trust can protect those dollars.
3. Spousal trust. Rather than leaving insurance proceeds directly to your spouse, consider establishing a trust upon your death to receive those proceeds.
Your spouse can be the sole beneficiary. The benefit? Tax savings! Any income earned on the insurance money can now face tax, at graduated tax rates, in the hands of the trust, rather than being taxed directly in the hands of your surviving spouse where he or she will likely pay much more in tax.
This is just smart income splitting.
4. Support payments trust. Picture this. You owe $2,000 monthly in child support until your child reaches age 23. So, you've purchased $250,000 of life insurance to provide that support if you die. Two months before your child's 23rd birthday, you die.
The $250,000 of insurance proceeds goes to your ex-spouse.
Your last two months of support, totalling $4,000, comes out of those proceeds, and your spouse keeps $246,000 as a windfall. Maybe this is okay with you, but many won't find it palatable. An insurance trust can ensure those dollars are used only for your children.
Keep in mind that these trusts often work by making an insurance declaration in your will.
You'll want the insurance to fall outside of your estate to avoid probate fees, which can be accomplished by a proper declaration that makes reference to your provincial Insurance Act.
Check out the "tax tools" (see "other tools") on my Web site at http://www.timcestnick.com for sample wording.
Tim Cestnick, FCA, CFP, TEP is author of The Tax Freedom Zone and Winning the Tax Game 2003. He is managing director, National Tax Services, at AIC Ltd.
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