Beneficiary Designations: Pillar One of Potentially Perilous Estate Planning Strategies

Beneficiary designations, properly constructed, can be a useful estate planning tool with the added benefit of helping to reduce exposure to Ontario’s estate administration tax of 1.5% on values over $50,000. However, utilizing beneficiary designations is not without its pitfalls, including drafting complexity to ensure they take effect as intended. This article[1] will canvas key issues related to beneficiary designations and examine certain drafting challenges.

What types of structures permit beneficiary designations?

There are several forms of plans and policies that permit the designation of beneficiaries, such as:

1. Pension plans;[2]
2. Registered Retirement Savings Plans (“RRSPs”) and Registered Retirement Income Funds (“RRIFs”);
3. Tax Free Savings Accounts (“TFSAs”);
4. Registered Disability Savings Plans (“RDSPs”);[3]
5. Retirement Education Savings Plans (“RESPs);[4] and
6. Life insurance.[5]

What is a beneficiary?

For the purpose of this article we will leave aside the trust concept of a beneficiary, which includes a person who has any present or future interest, vested or contingent, and also includes the owner of an interest by assignment or other transfer and as it relates to a charitable purpose trust, includes any person entitled to enforce the trust, and instead focus on the context of plans and policies. In the context of plans and policies, the concept of a beneficiary is determined by the law governing the plan or policy. For example, the Insurance Act defines “beneficiary” with respect to life insurance policies as follows[6]:

“beneficiary” means a person, other than the insured or the insured’s personal representative, to whom or for whose benefit insurance money is made payable in a contract or by a declaration;

[Emphasis added.]

The Succession Law Reform Act (“SLRA”)[7] does not define beneficiary and, instead, specifies how beneficiaries may be designated at s.51 as follows:

51 (1) A participant may designate a person to receive a benefit payable under a plan on the participant’s death,

(a)  by an instrument signed by him or her or signed on his or her behalf by another person in his or her presence and by his or her direction; or

(b)  by will,

and may revoke the designation by either of those methods.

Same

(1.1) A designation under clause (1) (a) may be provided electronically in accordance with the Electronic Commerce Act, 2000.

Idem

(2) A designation in a will is effective only if it relates expressly to a plan, either generally or specifically.

[Emphasis added.]

The term “plan” is defined at s.50 of the SLRA as follows:

“plan” means,

(a)  a pension, retirement, welfare or profit-sharing fund, trust, scheme, contract or arrangement or a fund, trust, scheme, contract or arrangement for other benefits for employees, former employees, directors, former directors, agents or former agents of an employer or their dependants or beneficiaries,

(b)  a fund, trust, scheme, contract or arrangement for the payment of a periodic sum for life or for a fixed or variable term, or

(c)  a fund, trust, scheme, contract or arrangement of a class that is prescribed for the purposes of this Part by a regulation made under section 53.1,

and includes a retirement savings plan, a retirement income fund and a home ownership savings plan as defined in the Income Tax Act (Canada) and an Ontario home ownership savings plan under the Ontario Home Ownership Savings Plan Act.

The Insurance Act (Ontario), in addition to defining “beneficiary” also includes a provision for the designation of a beneficiary at s.190 as follows:

190 (1) Subject to subsection (4), an insured may in a contract or by a declaration designate the insured, the insured’s personal representative[8] or a beneficiary as one to whom or for whose benefit insurance money is to be payable.

Electronic declaration

(1.1) Despite anything to the contrary in the Succession Law Reform Act, a declaration under this section may be provided electronically.

Same, Authority rule requirements

(1.2) An electronic declaration under this section must comply with such requirements as may be prescribed by the Authority rules.

Change in designation

(2) Subject to section 191, the insured may from time to time alter or revoke the designation by a declaration.

[Emphasis added.]

There is a distinction between the provisions in the Insurance Act and the SLRA. The latter talks about designating a person to receive a benefit whereas the Insurance Act talks about designating a person to whom or for whose benefit insurance money is payable. Relevant to this distinction is the provision at s. 193 of the Insurance Act that allows a trustee to be appointed for a beneficiary. It reads:

193 (1) An insured may in a contract or by a declaration appoint a trustee for a beneficiary and may alter or revoke the appointment by a declaration.

Payment to trustee

(2) A payment made by an insurer to a trustee for a beneficiary discharges the insurer to the extent of the payment. 

The SLRA does not contain a similar provision and the author will return to the discussion of insurance and plan trusts in a later section of this article.

The Pension Benefits Act (“PBA”) does not define “beneficiary” although there is provision for a retired member to designate a beneficiary to receive the remaining balance in the event the member does not leave a spouse[9] surviving. It is the spouse who has the first right to the remaining balance without being named as a beneficiary, and the spouse can disclaim their entitlement.

There is no provision in the PBA for appointing a trustee to receive remaining proceeds. However, the designation of beneficiaries for plans governed by the PBA is covered by the SLRA. In a later section, trusts in respect of plans such as RRSPs will be discussed and should be taken, by extension, to apply to all forms of plans to which the SLRA applies unless otherwise determined at law.

Who can make a beneficiary designation?

The owner of a policy or plan, sometimes referred to as the plan holder or the insured, depending on the financial product, can designate a beneficiary in respect of products they control as permitted by the applicable legislation. What is still somewhat controversial is the issue of whether an attorney for property can record a beneficiary designation. The Substitute Decisions Act[10] at ss.7(2) permits an attorney for property to do on the grantor’s behalf anything in respect of property that the grantor could do if capable except make a Will. The term “Will” has the same meaning as in the SLRA and includes any form of testamentary disposition.

As a result, it is important to distinguish between making a beneficiary designation and recording one already in existence where there is a change of financial institution for example or an RRSP is required by law to be converted to a RRIF. If an attorney for property does not carry over the existing beneficiary designation, it could change the distribution of the plan proceeds on the death of the annuitant, which would be a testamentary disposition. Maintaining the existing designation preserves the testamentary disposition of the plan proceeds. This is the issue that was discussed in Desharnais v. Toronto Dominion Bank[11].

When can you make beneficiary designations?

Unlike Wills and powers of attorney, there are no legislative rules regarding capacity to make beneficiary designations with respect to policies or plans such as pensions, RRSPs, RRIFs and TFSAs. Instead, we must look to the common law rules regarding capacity to make a gift, which state that the person must be of legal age and have capacity to manage property. In addition, for a gift to be valid it must be made free from coercion or undue influence.

It should be remembered that not only are there rules regarding the capacity to make a gift, but there are also rules regarding capacity to accept a gift as a person cannot be forced to accept a gift. Where a person is of legal age and capable of managing property, they are presumed to accept a gift unless they disclaim the gift. The opposite is true where a person is not of legal age or not capable of managing property.

Designations need to be made prior to the happening of the event that triggers a payment of the proceeds under the plan or policy, which is the death of the plan holder or life insured (who may not be the insured or owner of the policy).

The above comments apply of course to policies and plans that have not been cancelled, collapsed, lapsed or otherwise ceased to be in force.

How can you revoke beneficiary designations?

The SLRA contains provisions regarding the revocation of beneficiary designations at section 52, which reads as follows:

52 (1) A revocation in a will is effective to revoke a designation made by instrument only if the revocation relates expressly to the designation, either generally or specifically.

Idem

(2) Despite section 15, a later designation revokes an earlier designation, to the extent of any inconsistency.

Idem

(3) Revocation of a will revokes a designation in the will.

Where will invalid

(4) A designation or revocation contained in an instrument purporting to be a will is not invalid by reason only of the fact that the instrument is invalid as a will.

Idem

(5) A designation in an instrument that purports to be but is not a valid will is revoked by an event that would have the effect of revoking the instrument if it had been a valid will.

Earlier designations not revived

(6) Revocation of a designation does not revive an earlier designation.

Effective date

(7) Despite section 22, a designation or revocation in a will is effective from the time when the will is signed

The Insurance Act deals with revocations of designations in a Will, where the Will is revoked by operation of law or otherwise, at ss.192(3) which states that the revocation of the Will revokes the designation. Subsection 190(2) states that, subject to section 191, the insured may from time to time alter or revoke a designation by declaration, which is defined at ss.171(1):

“declaration”, except in sections 207 to 210, means an instrument signed by the insured,

(a)  with respect to which an endorsement is made on the policy,

(b)  that identifies the contract, or

(c)  that describes the insurance or insurance fund or a part thereof,

in which the insured,

(d)  designates, or alters or revokes the designation of, the insured, the insured’s personal representative or a beneficiary as one to whom or for whose benefit insurance money is to be payable, or

(e)  makes, alters or revokes an appointment under subsection 193 (1) or a nomination referred to in section 199.

For a time, there was a concern that the common phrase in Wills saying all previous testamentary dispositions were revoked would capture not only Wills and codicils but beneficiary designations as well. This concern was finally resolved in the recent case of Alger v. Crumb[12] where the Court of Appeal stated that the phrase did not revoke designations as it did not comply with the requirements of the SLRA to be more precise in order to take effect. The court’s decision even included sample clauses that it would find acceptable.

Where can you make beneficiary designations?

Designations can be made in the plan or policy instrument; a written declaration including a Will; electronically as permitted by the provisions SLRA or Insurance Act.

What are some samples of beneficiary designations?[13]

1. Simple

• All to my spouse, Elizabeth Montgomery
• All to my children in equal shares per capita
• All to my issue in equal shares per stirpes
• All to the Canadian Cancer Society, for its general purposes

None of these require the express requirement of survivorship. Instead, if a specified beneficiary does not survive or exist on the date of the triggering event then the proceeds result to the owner’s estate absent a gift over, or cy-prés clause in respect of charitable gifts.

2. Complex

All to my spouse if she survives me, provided that if she is not then living, all to my children then living in equal shares per capita and, further provided, that if one of my children should predecease leaving issue then surviving, the issue of my deceased child shall be entitled to the share to which my deceased child would have been entitled.

In the event none of the said persons are then surviving, the proceeds shall be divided into enough equal shares to give effect to the following: [insert provisions]

3. Inter vivos insurance trust

As stated above, the Insurance Act contains provisions to designate a beneficiary as well as the authority to appoint a trustee to receive proceeds on behalf of a beneficiary. Where an inter vivos trust exists that owns an insurance policy the proceeds of which are to be held as part of the capital of the trust when received, the beneficiary would be the trustee in his/her/its fiduciary capacity since the trust already exists. It is also possible that the policy could be owned outside of the trust with the intention of the insured to have the proceeds contributed to the trust on the happening of event that results in the policy becoming payable.

Again, in this situation a hybrid solution is needed to flow the policy proceeds to an existing inter vivos trust since trusts are not persons and, therefore, do not qualify in their own right to be designated as beneficiaries. The designation of the trustee in his/her/its fiduciary capacity to receive the proceeds and hold them on the same terms as the original trust is a further contribution to the trust that results in what would otherwise be two trusts being consolidated.

An example of structuring a distribution to an inter vivos trust can be found in the Privy Council’s decision in Grand View Trust[14]. This case involved a trust to trust designation rather than insurance, but the principles are the same making the case a useful illustration.

An example of a designation designed to flow proceeds to an inter vivos trust is as follows:

With respect to policy #12345 in respect of the life of ZZ, I hereby revoke all previous designations and designate DD, in his capacity as trustee of the Smith Family Trust 2012 settled the 17^th day of November, 2012, as the beneficiary of said policy. Upon receipt of the proceeds, DD shall add them to the capital of said trust and hold them upon the same terms.

4. Testamentary insurance and RRSP/RRIF trusts

Testamentary trusts are trusts that arise as a consequence of death[15] and can be recorded in a Will or other written instrument[16]. Now that graduated tax rates only apply to a restricted range of testamentary trusts such as graduated rate estates and qualified disability trusts, it is less important to ensure that proper drafting and implementation is used to maintain testamentary status, but caution dictates that testamentary status be preserved. An example of how to ensure that a testamentary insurance trust is established is as follows:

With respect to policy #12345 in respect of my life, issued by ABC LifeCo., I hereby revoke all previous beneficiary designations and appointments of trustees and designate my spouse to be the beneficiary of said policy provided she survives me. In the event that my spouse does not survive me, I designate my issue in equal shares per stirpes who survive me to be the beneficiaries of said policy and I appoint my cousin, YY, to be the trustee with respect to said policy to receive the proceeds of the policy and hold them upon trust according to the following terms.

Where this type of provision is included in a Will rather than in a separate insurance trust declaration, it is important not to state that the trustee receives the proceeds to be administered according to a paragraph in the Will that includes dispositive provisions as this flows the proceeds into the estate. As discussed above, this hybrid method of naming a person in their fiduciary capacity as the beneficiary of a policy only works for inter vivos trusts or where the estate trustee (i.e. personal representative) is named in order to flow proceeds to the estate.

In the event that the intended trustee of what would otherwise be a testamentary trust undertakes to the insured to receive the proceeds and hold them upon trust, this could create an inter vivos trust which would not qualify for the graduated income tax rates. For contexts such as disability planning, this distinction is critical.

To this point, the discussion has been about testamentary insurance trusts. Annotations to the definition of “testamentary trust” in s.108(1) in the Practitioner’s Income Tax Act annotated by David M. Sherman, shown below, suggest otherwise. RRSPs and RRIFs can also give rise to a testamentary trust of the proceeds.

A trust funded from the proceeds of an RRSP or RRIF on death qualifies as a TT if the RRSP/RRIF designation is a testamentary instrument under provincial legislation: doc 2003-0007365.

External T.I. 2003-0007365 states:

Principal Issues: Whether a trust funded from the proceeds of an RRSP or RRIF available on the death of an individual would qualify as a "testamentary trust" within the meaning of subsection 108(1) of the Act, assuming that the RRSP or RRIF designation amounts to a testamentary instrument.

Position: Yes.

Reasons: Assuming that the RRSP or RRIF designation amounts to a testamentary instrument, then the transfer of the RRSP or RRIF proceeds to the trust would be considered, pursuant to subsection 248(8), as occurring as a consequence of the death of the taxpayer, thereby meeting the condition in paragraph (b) of the definition of "testamentary trust" in subsection 108(1).

The SLRA defines a “will” at ss.1(1) to include: a testament, a codicil, an appointment by will or by writing in the nature of a will in exercise of a power, and any other testamentary disposition. Therefore, a Will is a form of testamentary instrument but not the only one.

Given the broad application of the SLRA to various types of plan designations beyond RRSPs and RRIFs, arguably the same arguments can be made in favour of testamentary trusts for the proceeds of other plans such as TFSAs or pensions.

When is it worth creating designations and policy or plan trusts that will exist outside the estate and/or Will?

Creating a separate policy or plan declaration with full trust terms outside of a Will (or primary Will) is the more conservative approach to try to ensure probate minimization is achieved. However, this may increase professional fees compared to including the provisions in a Will where it may be possible to reference the purely administrative provisions, but not the dispositive ones. In either case, there will be a separate trust for persons who likely will also have a trust created for them under the terms of the Will. This can double the compliance burden in terms of tax filings and disclosure, as well as trust financial and other recordkeeping. When all factors are considered, having proceeds flow in the estate to be subject to the provincial estate administration tax and managed on a consolidated basis with the other funds or assets for the same persons may be the preferred option.

What cannot be done with beneficiary designations?

1. Conditions such as survivorship by 30 days.

The purpose of a beneficiary designation is to specify one or more persons to receive proceeds on the happening of the triggering event such as the death of the life insured or RRSP/RRIF annuitant. Survivorship conditions necessitate holding the proceeds in trust for the survivorship period and having someone determine that the condition has been met. In the interim, the proceeds must be managed and to the extent income may be earned during the gap it would need to be vested in a person or there would need to be the ability to accumulate undistributed income.

2. Incorporate Amendable Documents

Designations cannot incorporate amendable documents such as the terms of a Will. Even if the plan or policy designation is contained in a Will, it is not permissible to incorporate provisions of the Will into the designation recorded in the Will as a matter of convenience but must stand on its own merits as if it were recorded outside the Will.

The doctrine of incorporation by reference in Canada requires that the incorporated document be in existence at the time it is referenced and that it not be revocable or amendable. Wills are revocable instruments, with the exception of mutual Wills that are the subject of a contract between the parties to not later revoke their respective Wills. Trusts can be either revocable or irrevocable with the latter being more common in Canada and the status is usually obvious on the face of the trust deed. The issue of whether a trust is amendable and to what degree is less clear.

It is common to include provisions in a trust deed that permit the amendment of administrative provisions although more expansive provisions can also be included such as the ability to add or delete beneficiaries. Even in the absence of an amendment clause in a trust deed, provincial legislation such as Ontario’s Variation of Trusts Act[18] allows the court to amend a trust. As a result, it can be argued that a trust is never irrevocable or immune from amendment.

A designation that says “to my insurance or plan trustee to be administered according to the provisions of paragraph 24 of my Will” attempts to incorporate dispositive provisions of the Will into the designation. Also, it does not provide a beneficiary designation for the plan or policy, other than estate beneficiaries. The trustee is not the beneficiary as the comments above indicate, at least not in respect of establishing a testamentary trust.[19] As result, this type of designation has been found by the courts to include the proceeds in the estate of the deceased to be reportable for estate administration tax purposes[20].

What are some traps that exist in using beneficiary designations?

Beneficiary designations can be a convenient and efficient way for policy owners and plan holders to specify who is to receive the proceeds at the relevant time, provided care is taken to ensure that the intended distribution is in line with the overall estate plan. If this is not done, there may be unintended consequences such as:

1. Accidentally disinheriting persons due to an absence of appropriate gift over provisions. An example would be a beneficiary designation to “all children who survive in equal shares”. If one child predeceases the plan holder, only the remaining children who survive will receive the plan or policy proceeds. However, in many cases the Will of the plan or policy owner will contain gift over provisions that would flow the proceeds of the deceased child down to that person’s children or more remote issue. Since the Will does not govern the policy or plan, one segment of the family may be left out.
2. Insufficient liquidity in the deceased’s estate to pay taxes, debts and various gifts under the Will. Designations take proceeds out of the policy or plan holder’s estate. However, plans such as RRSPs and RRIFs create an income inclusion for income tax purposes on the death of the annuitant. As a result, the plan proceeds may go in one direction with the tax liability flowing in another.

Sections 106.2(1) and (2) of the Income Tax Act[21] respectively create joint and several liability for the taxes owing with respect to RRSP and RRIF plans, which allows the Canada Revenue Agency (“CRA”) to trace the proceeds to the recipient and assess that person for taxes owing. The decision of the Tax Court of Canada in O’Callaghan[22] is chilling where it states at paragraphs [24] and [26]:

[24] The liability of the appellant was engaged because she was the sole beneficiary of the RRSPs of the deceased. As such, the appellant received the funds of the RRSPs directly from the trustee of the plans without any deduction at source. Because the appellant has received a benefit from the deceased’s RRSPs she became jointly and severally liable with the deceased to pay the deceased’s tax for the year of his death. Subsection 160.2(1) of the Act was applicable in the circumstances and all of the conditions for an assessment under subsection 160.2(1) have been satisfied in that Siegfried Starzyk had a tax liability arising out as a result of the collapse of his RRSPs and in that the appellant was the sole beneficiary of his RRSP funds.

[26] As written, subsection 160.2(1) does not impose any obligation on the Minister to attempt to collect an amount from the estate or from the legal representative of the estate before issuing an assessment. The purpose of subsection 160.2(1) is to effect collection of the tax owed by the deceased that is associated with the collapse of his RRSPs. In this particular case, the CRA had reasons to believe that the estate did not have enough money to pay the total amount of the tax owed by the deceased.

A similar provision exists at s.160.21(1) of the Income Tax Act with respect to RDSPs.

More information about tax implications and filing obligations following the death of an RRSP annuitant or RRIF annuitant is available on the CRA website.[23]

3. Nullifying beneficiary designations by moving to and becoming resident in a civil law jurisdiction, such as Quebec, that makes limited or no provision for beneficiary designations, which can result in the proceeds falling into the estate instead of being distributed in accordance with the original designation.
4. Entering into family law agreements that do not address existing beneficiary designations.

If beneficiary designations are not specifically addressed, it could create confusion about the intentions of the parties. For example, the family law agreement may contain provisions stating that each party waives entitlement to each other’s estate including any right they might have to act as the estate trustee, in addition to setting out the division of their respective and joint property, and outlining agreed support payments. Notwithstanding these types of provisions, agreements sometimes go on to say that the terms of the agreement do not prevent the parties from making gifts to each other and appointing each other as estate trustee.

Where a party to the family law agreement leaves beneficiary designations in place, or the estate trustee appointment, it is not clear that this was done intentionally. This can be further compounded by the party forming a new relationship and the new partner has expectations of receiving the proceeds or a policy or plan, but so too does the former partner or the children of the first relationship.

While it creates some additional paperwork, it may be safer to redo various designations and appointments after the family law agreement is executed particularly if it is a separation agreement. In the case of marriage and cohabitation agreements that will only later become separation agreements on a breakdown of the relationship, it may be necessary to include protective language in the agreement to state that designations and appointments in place on the date of the relationship breakdown are revoked and all property will be divided as if they did not exist regardless of the legal status of the revocations.

5. The possible application of the presumption of resulting trust as set out in Pecore[24]. A detailed review of Pecore and the cases that ensued can be found in the article by the author and Matthew Rendely, et al[25]. For the purpose of this article, it is sufficient to state that the presumption can apply to both realty and personalty, but not to plans and policies where specific legislation applies to the designation of beneficiaries as it would undermine those legislative provisions.

Conclusion

Beneficiary designations are simple on the surface, but similar to an iceberg there is much under the surface that can sink otherwise carefully considered estate plans. The twin peril to beneficiary designations is joint ownership planning, which was the focus of the Pecore decision and the many cases that followed. Probate planning: beware all ye who dare to enter.

 

Any article or other information or content expressed or made available in this Section is that of the respective author(s) and not of the OBA.