Insurance-based contracts with no beneficiary or all predecease the life insured or annuitant

Catrina is a sixty something single woman with two daughters, one of whom, Sabrina, has two children of her own. Catrina wishes to leave a legacy for her grandchildren. She recently signed a new Will outlining her wishes regarding her estate. She purchased two permanent participating life insurance policies covering her granddaughters as a financial kick start for them. She also set up separate guaranteed investment fund contracts with each child as annuitant. Her intention is to transfer ownership to the grandchildren some time after each reaches the age of majority. They can carry on the life insurance policies at affordable rates locked in at their issue ages and access any cash in the policy for any purpose they choose. They can contribute more money to the investment plans as well as rebalance their investment policies to suit their risk tolerance and plans for the future.

As the owner, she assumed she would also be beneficiary, something that the grandchildren could change once they became owners. Her lawyer advised her to name her estate as primary beneficiary. She named their mother as contingent beneficiary.

What happens if Catrina dies or Sabrina dies before the grandchildren assume ownership?

There is no tax-sheltered transfer or rollover of a life insurance policy via a Will.

If a beneficiary is not named for a life insurance policy or an insurance-based investment, or if all named beneficiaries predecease the life insured or annuitant, any benefit that becomes payable, will be paid to the owner, in this case, Catrina while she is alive or to her estate. Catrina’s estate becomes the owner of the grandchildren’s policies as no successor owner was named.

A deemed disposition would occur on Catrina’s passing, which may trigger tax on the excess of the cash value of each policy over their respective adjusted cost basis. The policies are then transferred as per the instructions in the Will. A second disposition occurs on a transfer from the estate to the next owner. There is no tax-sheltered transfer or rollover of a life insurance policy via a Will.

A taxable disposition would be triggered on the guaranteed investment funds each time ownership changed hands.

If this is not what you were expecting, then take the opportunity to name beneficiaries and contingent beneficiaries as well as successor owners of policies, particularly when looking at juvenile life policies.

In Catrina’s case, she could have named her daughter, Sabrina, as successor owner of all the contracts in the event that she predeceased her daughter. The policies would bypass the estate. Sabrina would assume ownership of the life insurance policies without triggering any taxes. Her children could be named successor owners. Sometime after her children reach the age of majority, ownership of the life insurance policies could be transferred to them, again without triggering any taxes. Any monies then taken out by the grandchildren, if taxable, would be taxable in their hands. The balance would continue to enjoy tax sheltered growth and be accessed for any purpose while they were alive or paid out to the beneficiaries of their choice on their passing. Catrina's other daughter could be named as successor owner should her sister, Sabrina, and then Catrina pass away before the grandchildren are ready to assume ownership of the policies. This assumes that there isn't a guardian or other person appointed to look after the grandchildren's interests. Each transfer of the life insurance policies to a successor owner set up this way would be done on a tax-deferred basis.

A taxable disposition would be triggered on the guaranteed investment funds each time ownership changed hands. The transferring party would be responsible for any taxes owed. The investments themselves and the contract would remain intact with associated features and benefits.

It’s prudent to review ownership and beneficiary structures and periodically stress test them to see if they meet the client’s objectives and minimize adverse impacts. Make changes as needed to match then current situations.

? 2024 by peter a wouters

The material in this article is current as of the date published. This material is presented for informational purposes only, and is not a legal, tax or investment opinion. The provision of the information contained herein and any oral or written communication regarding the same should not nor is intended to be construed as such. Interested persons should seek and retain independent professional advice before acting or foregoing action in relation to any of the matters mentioned herein reflected as of the date published or updated.