Life insurance products are the most creditor-protected financial products available in Canada.
Creditor protection is especially valuable for entrepreneurs, small business owners, sole proprietors, the self-employed and professionals.
- many die with some debts (e.g., mortgage or other loans, income tax due, business debt if business owners)
- creditors can sue your estate to recoup losses
Corporate-owned life insurance usually has the corporation as the beneficiary. Having the holding company as owner and beneficiary provides protection against the claims of creditors of the operating company.
Time of Protection
If you name a beneficiary with the specific goal of thwarting creditors, they can seek redress while you are alive, but generally not after your death.
While The Policyowner Is Alive: Cash Value
The cash value is protected from creditors of the policyowner if there is
- an irrevocable beneficiary
- a preferred beneficiary: spouse, child, grandchild or parent of the life insured (not based on relationship to the policyowner)
- there is no creditor protection if
- the beneficiary is the policyowner or
- there is a revocable beneficiary in the nonpreferred class
- if some beneficiaries are outside the protected class, creditor protection may be lost
- best to keep all beneficiaries within the preferred class
When The Life Insured Dies: Death Benefit
The death benefit is an asset of the beneficiary. So it is protected from the creditors of the policyowner.
Note: there is no creditor protection if the death benefit is payable to the policyowner's estate
If the beneficiary is the trustee, then creditor protection is unclear
- consider naming the beneficiary first and then naming the trustee
- courts likely to look through the trust to the relationship of the ultimate beneficiary to the life insured
Sources of Creditor Protection
Uniform Life Insurance Act
- section 196 specifically provides creditor protection if the designated beneficiary is a spouse, child, grandchild or parent
- the beneficiary cannot be the estate of the policyowner
- same provisions as for life insurance since a life annuity is considered to be life insurance
- wording of Section 144 PEI
- (1) Where a beneficiary is designated, the insurance money, from the time of the happening of the event upon which the insurance money becomes payable, is not part of the estate of the insured and is not subject to the claims of the creditors of the insured. When insurance money not part of estate of insured
- (2) While a designation in favour of a spouse, child, grandchild or parent of a person whose life is insured, or any of them, is in effect, the insurance money and the rights and interests of the insured therein and in the contract are exempt from execution or seizure. R.S.P.E.I. 1974, Cap. I-5, s.143.
Federal Bankruptcy and Insolvency Act
- can void “settlements” (gratuitous transfers of property to a third-party) in some circumstances within stipulated time periods
Supreme Court 1996 Decision
- upheld protection of an irrevocable beneficiary, but creditors can attack insurance transactions if the insured intended to defeat the claims of creditors by
- buying a life insurance policy, or
- designating an irrevocable beneficiary or a family-class member beneficiary