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Do you have assets that you want to protect from creditors?
Did you know that insurance products like life insurance, annuities, and segregated funds can provide creditor protection?
In this post, you will learn:
- Why creditor protection is so important for business owners
- How you can shield your assets from creditors using insurance products
And much more.
So if you want to find out how you can use this little-known benefit of life insurance to shield your assets from creditors, this post is for you.
What Is Creditor Protection?
As a rule, all your assets are security for unpaid debts owing to a creditor. This applies whether you are bankrupt or not. Even after death, your assets in your estate are available to satisfy your creditor’s claims.
Creditor protection refers to the ability to shield your assets from the claims of creditors.
For business owners and the self-employed, creditor protection for their assets is very important. Take a look at some events that can lead to a claim from creditors:
- Financial loss of the business
- Downturn in the economy caused by unforeseen events (eg: a pandemic)
- Loss of a major client
- Non-payment by a client
- Lawsuits from customers and clients
- Bankruptcy or conflict with a business partner
- Employee fraud
- Disability and critical illness
- Loss of employment
It’s not just your business assets that are exposed. Your personal assets are at risk too when you personally guarantee a loan.
Besides business owners, creditor protection is also important to those exposed to legal liability through their profession. This includes professionals like lawyers and doctors.
With this in mind, it’s important to have a safe place to park your assets. Somewhere that shields them from the claims of your creditors. That’s where life insurance and other insurance products come in.
Life Insurance Creditor Protection
Before we explain how you can get creditor protection from your life insurance policy, you need to know the parties involved in an insurance policy.
Owner: This is the person or entity who buys, pays for, and controls the policy.
Life insured: This is the person whose life is insured under the policy. When the life insured dies, the insurance company pays out the death benefit. The life insured is often the same person as the owner, but doesn’t have to be.
Beneficiary: This is the person or entity who receives the death benefit after the life insured dies.
How does your life insurance policy provide creditor protection?
As the owner of the policy, you can shield the policy from creditors by ensuring the beneficiary is one of the following:
- The spouse, child, grandchild, or parent of the life insured
- An irrevocable beneficiary
The parties in #1 are known as the specified family members. The definition of spouse includes common-law partners and same-sex partners.
With an irrevocable beneficiary, you can’t access the cash value, change the beneficiary, surrender the policy, assign the policy, and more without the beneficiary’s consent. This differs from a revocable beneficiary where the owner has total control of the policy.
In either case, provincial legislation protects the entire policy – including the death benefit and cash value – from the claims of your creditors during your lifetime and after death.
The rationale for this is simple: life insurance proceeds are meant to be the property of the beneficiary. As such, it shouldn’t be subject to the claims of the owner’s creditors.
What insurance products are protected from creditors?
Life insurance: Not only is the death benefit shielded from the creditor, the cash value is also protected. This means your creditors can’t force you to surrender your policy for the cash value to repay them.
Annuities: In exchange for a lump sum deposit, the insurance company pays you a lifetime income. Annuities are a great tool for ensuring that you don’t outlive your savings.
Segregated funds: These are like mutual funds except with guarantees that only insurance companies can offer. You can invest in balanced funds, Canadian equity funds, global bond funds, and much more.
In all three cases, if you name the right type of beneficiary, you can protect your assets from creditors.
Planning
Knowing the classes of beneficiaries that can give your insurance policy creditor protection, here are a few things you can do to prevent claims from creditors:
- Name another specified family member as a contingent beneficiary in case the primary predeceases you.
- Give a small portion of the benefit to an irrevocable beneficiary and the rest to revocable beneficiaries.
- Overfund a permanent insurance policy like whole life and universal life insurance to shield the cash value from creditors.
- Put your assets in segregated funds if you don’t have an insurance need.
When does creditor protection not apply?
Creditor protection is not an absolute given even if you choose the right type of beneficiary. Below are some of the cases where creditor protection doesn’t apply.
The wrong type of beneficiary
The most obvious exemption to having creditor protection is when you don’t name a specified family member as a beneficiary. For example, there’s no creditor protection while you’re alive when you name siblings, aunts, uncles, nephews, nieces, business partners, charities, and trusts as beneficiaries.
However, when you die, the insurance proceeds go straight to the beneficiary. They bypass your estate and protect it from its creditors. In a way, you still have some creditor protection, just not while you’re alive.
Same owner and beneficiary
If you own a policy on the life of your spouse and name yourself as the beneficiary, there is no creditor protection. That’s because even though the beneficiary is a specified family member, the owner and beneficiary are the same person.
Corporate-owned life insurance
Corporate-owned life insurance also doesn’t get the benefit of creditor protection. That’s because the beneficiary of most corporate-owned policies is the corporation itself.
If your corporation needs creditor protection, you should consider using a holding company to own the policy instead of your operating company. However, if your holding company guarantees the loans of your operating company, protection may not be provided.
Estate as beneficiary
By default, if you don’t designate a beneficiary, the death benefit goes into your estate. Once the money is in your estate, it’s available to claims by creditors. You won’t have creditor protection both while you’re alive and after you die.
In the event that you name a specified family member or irrevocable beneficiary but they predecease you, then your estate becomes the beneficiary. To ensure continuous creditor protection, you should always name a contingent beneficiary. You can also name a new beneficiary after your primary beneficiary passes away.
The right type of beneficiary
Here are some situations where creditor protection is not afforded even with the right beneficiary designation.
Dependant relief claim: Family dependants may sue to recover insurance proceeds where you have an existing obligation to support them. A dependant’s relief claim can override a beneficiary designation resulting in the clawback of insurance proceeds.
Marriage breakdown: An insurance policy may become subject to property claims relating to marriage breakdown and equity arguments.
CRA: The taxman is no ordinary creditor. Claims by CRA for taxes owing can result in the loss of creditor protection. There have been many cases where insurance proceeds were clawed back into the estate to pay back CRA even with specified family members named as beneficiaries. Here is an example.
Fraud
You shouldn’t buy insurance for the sole purpose of creditor protection. If your creditors can prove that you intended to defraud them, you won’t get the benefit of creditor protection.
This means that if you transfer all your assets into a segregated fund the day before you declare bankruptcy, don’t expect the protection from creditors to hold up in court.
Creditors of your beneficiaries
Creditor protection is only given to the owner of the policy. Once the life insured dies, the insurance pays out the proceeds to the beneficiary. At that point, the cash is in the hands of the beneficiary and can be attacked by his/her creditors.
Need Creditor Protection?
Although creditor protection is one of the benefits of a life insurance policy, it’s only available under specific circumstances. There are also many exceptions. Creditor protection is a moving target and depends on legislation and court decisions, so it’s never guaranteed.
If creditor protection is important to you, consult a lawyer and learn more about current legislation and case law in your province.
Contact us at info@briansoinsurance.com or 604-928-1628 for more information on how you may benefit from creditor protection using life insurance.
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While we make every effort to keep our site updated, please be aware that timely information on this page, such as quote estimates, or pertinent details about companies, may only be accurate as of its last edit day. Brian So Insurance and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser. This post is a brief summary for indicative purposes only. It does not include all terms, conditions, limitations, exclusions, and other provisions of the policies described, some of which may be material to the policy selection. Please refer to the actual policy documents for complete details which can be provided upon request. In case of any discrepancy, the language in the actual policy documents will prevail. A.M. Best financial strength ratings displayed are not a warranty of a company’s financial strength and ability to meet its obligations to policyholders.
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