Article – Page 11 – Adviceon Library

How does life insurance benefit a Testamentary Trust?

A testamentary trust is established using a will when someone dies, including the following types which direct a named trustee to manage and distribute assets and income to named beneficiaries of the trust.

You can designate the number of years it will survive, within permissible, legal limits. The trust becomes effective at the time the will is probated. The assets undergo the probate process and are therefore, exposed to creditors’ claims. Note: If your intent is to avoid probate, a living trust would be a more suitable alternative especially adapting the use of life insurance. However the potentially lower marginal tax rates allowed with the testamentary trust, needs to be weighed against potentially higher future income tax payable. When using a testamentary trust (versus an inter vivos trust) make sure your beneficiaries are properly specified to work according to your trust directives. A qualified tax advisor should assist you as you make these decisions.

Individuals commonly choose between two types of trusts: family and spousal.

Family trusts

Minor Trust This trust protects the interests of underage children.

Protective Trust This trust protects any family member with special needs such as:

• Safeguards adult children’s assets from creditors or divorce settlements.

• Manages funds for spendthrift adult children.

• Minimizes disclosure of small business assets that could be susceptible to lawsuits or creditors.

Spousal trusts are established to provide your spouse with funds.

• Protects the testator’s children’s assets should your spouse remarry or can assure the inheritance of children from a previous marriage.

• Reduces income tax through income splitting.

How are trusts funded?

If an estate will have significant capital gains tax due and/or debts, consider using life insurance to cover all liabilities. You can also increase the death benefit to pay off business agreement liabilities (if any) and provide specific trusts with the necessary cash.

How do you establish a Testamentary Trust?

You establish a testamentary trust in a Will. It directs a named trustee to manage and distribute assets and income to designated beneficiaries of the trust.

You can designate the number of years it will survive, within permissible, legal limits. The trust becomes active at the time the will enters probate. The assets undergo the probate process and are, therefore, exposed to creditors’ claims. If you intend to avoid probate, a living trust would be a more suitable alternative. Individuals commonly choose between two types of trusts: family and spousal.

Trusts re carefully designed estate planning tools and will need the guidance of a good tax lawyer.

The purpose of a Family Trust is to:

• Protect the interests of underage children and any family member with special needs
• Safeguard adult children’s assets from creditors or divorce settlements
• Manage funds for spendthrift adult children
• Minimize disclosure of small business assets that could be susceptible to lawsuits or creditors

Spousal Trusts are established to provide your spouse with funds. These trusts also:

• Protect your children’s assets should your spouse remarry. It can assure the inheritance of children from a previous marriage
• Reduce income tax through income splitting

Funding trusts

If an estate will have significant capital gains tax due and/or debts, consider using life insurance to cover all liabilities. You can also increase the death benefit to pay off business agreement liabilities (if any) and provide specific trusts with the necessary cash.

What types of life insurance are available?

Life Insurance Plans for Individuals
Life insurance is a type of coverage that pays benefits upon a person’s death to designated beneficiaries. A small premium gives you immediate coverage and provides for a significant death benefit payable upon the insured’s death to provide capitalization to pay an income for dependents. In some cases, there may be a maturity date where the insured, if still living, can receive the proceeds.

Tax deferral is allowed with some types of life insurance to offer insurance with an investment component, allowing increased funds to pass to heirs. Tax specialists can maximize an estate’s value while using life insurance. And the investment after achieving growth can enhance retirement income.

Types of Life Insurance
Life insurance has two primary classes:

1. Term Life Insurance Term Life is less expensive, but most term periods are generally temporary. Many people choose term life insurance (or term rider on a permanent plan) when beginning a family, as they try to keep costs lower while covering many liabilities.

Term Life Insurance plans include:
The death benefit coverage continues for temporary terms set in 5, 10, or 20 years; or a lifetime level term to age 100.

Other periods can run to age 65, 75.
The premium remains constant for these terms.
The low cost of insurance for a certain level of death benefit is the essence of this plan, generally with less emphasis on a cash value.
You can buy more term coverage for less premium, which does increase upon each term period renewal (for example, a five-year term rises in cost in the sixth and eleventh year and so on).
Term insurance can generally be converted to Permanent Life Insurance coverage without medical underwriting, but check with your advisor about renewal and conversion options when you plan to buy a policy.

2. Permanent Life insurance The coverage continues to the time of the decease of the insured or pay one a level or an increasing lump sum at a certain age of maturity (usually age 100), or offers cash value or premium pre-payment incentives. Where there are cash values associated with a Permanent plan, the insurance cost can be lowered as the increasing cash funds accumulating in the program replace the level of insurance needed.

Permanent Life Insurance plans include:

Whole Life, can offer a level premium and a cash value table in the policy in some cases, guaranteed by the insurer;
Limited Premium Payment, is a policy that can be paid up fully in a specific period of time (such as over 10 or 20 years; or paid up at age 65).
Endowment Life is where the cash value grows to a level equal to the insurance coverage.

Life insurance premiums vary according to the policy type. In some cases, paying a little more premium offers enhanced benefits. Tax-deferral strategies may change due to legislation.

What powers do you assign to an executor?

Consider what is involved before naming or agreeing to act as an executor.

• An executor carries out the instructions in your will. Co-executors can share the task.
• Jurisdictional laws define what the executor must do, whether they are a friend, relative, professional, or a trust company—however, the will can specify even more extensive powers.
• The executor may have to deal with some or all of the following at an emotional time: a funeral home, beneficiaries, past or ongoing taxes, insurance and investment companies, government and business pension departments, real estate agents, lawyers, accountants, appraisers, stock brokers, and business partners.
• They may also be empowered to convert the estate to cash or divide assets equally among beneficiaries. They can also make payments to the parent/guardian of a beneficiary in most cases.
• The executor (especially if inexperienced in legal or financial matters) should know how complex the estate is before agreeing to the task. If necessary, appoint a co-executor who is a legal and accounting professional.
• Have a clear and objective idea of what will be involved before asking someone to be your executor and agreeing to act as one.

Discuss the parameters of an executor with your lawyer, before enabling one, or taking on the responsibility if given or offered to you.

What are the warning signs of over-indebtedness?

Too much debt can threaten your future and destroy your peace of mind. Here are five warning signs to watch for:

You are spending more than 20% of your after-tax earnings on debt. Total up all you owe, excluding your mortgage, e.g. student loans, car payments, and credit card bills. Now total up how much of your after-tax income is dedicated to servicing this debt.
You are paying for daily essentials with credit instead of cash. Consequently, you are close to the credit limits on your cards. Credit cards charge notoriously high interest rates, which is exasperated by compounding when credit cards are not paid off monthly. This can also increase your actual gross cost of goods purchased.
You are deferring important expenditures. You may need maintenance work (on your car, your home, and your teeth) as you struggle to get by.
You seem to spend your paycheque the day you get it. This may be a sign that you’re also over spending, an activity that leads to debt.
You are not differentiating between ‘good’ versus ‘bad’ debt. Good debt is money borrowed for productive purposes to help generate wealth over time (such as an education, build a small business, or purchase real estate). Fancy cars, expensive vacations, restaurant meals, and over-indulgent gift giving may indicate a lifestyle that for many do not justify the average household’s paycheque.

If you are in serious debt, consult a debt counselor who will arrange a repayment schedule with your creditors.

Be careful not to maximize your HELOC Debt

Consumers are shifting unsecured high-interest credit card balances and debts such as car loan balances to a low-interest Home Equity Line of Credit (HELOC). This transference happens on a larger scale when people consolidate their debts while backing them with their home value. Once your home secures this debt, it is no longer unsecured debt in your portfolio.1

You may indeed be able to save a sizeable chunk of interest by transferring debt from a high-interest credit card to a low-interest HELOC. For many, this works well insofar as they have an intelligent debt repayment plan in place.

When developing a financial strategy, assess all of your credit cards and other loans, including a Home Equity Line of Credit (HELOC). Total your combined debt while you weigh this against all of your retirement and your non-retirement assets.

A safety precaution always estimates your decisions about how they will impact your net worth statement when subtracting liabilities from assets. Adding in your HELOC debt with your portfolio of obligations gives you proportional insight into your actual net worth. Add your HELOC level of debt alongside your unsecured credit cards. Compare interest rates, fees, and other features and the time it will take to pay these loans all off (some calculators do a great job comparing this).

That said, be cautious using HELOC debt as quick loans for vacations, 2nd residences, extensive renovations versus selling and repurchasing a new home, vehicles, businesses, or investments. HELOC credit cards offered with most lines of credit will also reduce your home equity value.2

This growing shift of unsecured credit card debt to HELOC debt enticed by lower interest rates (related to your mortgage) helps the lenders’ balance sheets because this debt, once transferred, becomes secured collateral against real estate assets then owned at a higher proportion by the bank. Taken to the limit, if the real estate market prices drop, your debt may surpass your home value — this happened in the 2007-8 mortgage debt crisis. Think seriously about reducing your debt portfolio, especially if you hold a lot of HELOC debt.

Many people are inadvertently reducing their home equity in the process of securing previously unsecured credit card debt while hinging it to and reducing their home value. When people sell their homes, they are often surprised that their home equity is considerably reduced after paying their mortgage. Why is this? You must pay all associated HELOC debt during the sale.

Source: Bank of Canada

1 Most credit cards are unsecured by any asset that you own. However, if you accept a credit card linked to your home which offers low interest, this may be secured against your home value. Many consumers are unaware of how this works.

2 If bankruptcy occurs, your home equity generally is safe unless it is secured against HELOC debt. Unsecured credit cards are often simply not necessary to repay should one seek bankruptcy protection. Always read your small print in all contracts. Don’t rely on sales discussions over the phone or in-person until you read the small print. It is only beneficial to a bank or financial institution to shift your debt from unsecured credit card debt to secured debt if bankruptcy ever does occur.

How much life insurance should I purchase?

Determining, how much life insurance is necessary for your family’s financial security will require an objective viewpoint as you assess the following:

Evaluate the death benefit that you need.

Your advisor can assess the death benefit you need, by using a mathematical calculation that is referred to as a “capital needs analysis”. You may want to have enough capital to pay for your funeral, final taxes in your estate, outstanding loans or a remaining mortgage, and/or your credit card debt.

If you earn an income and support dependents, you may need to provide a significant amount of money to invest, from which your family can earn an investment income to provide a quality lifestyle. Life insurance can also provide enough money to cover a child’s education or top up the potential retirement income needs of a spouse if a breadwinner dies.

Where there are two spouses providing an income for the family, many couples purchase enough life insurance to reciprocally protect the potential income loss of one or both income sources, by covering both spouses appropriately.

Business Owners have special insurance needs

In many families, one spouse is employed, and another is self-employed. If one spouse owns a sole proprietorship business, he or she may need to consider income replacement insurance which can create a replacement paycheck in case you become disabled. There may be business-related debts and expenses, which if not paid, can create liabilities for the family.

If you are in a business partnership, you may want to look at establishing a buy-sell agreement, and/or succession planning facilitated by life insurance capital if you or a partner die; or income replacement insurance if you or a partner are disabled and can no longer work at your business.

Critical Illness Insurance

Many are also using Critical Illness insurance for personal or business planning, which can offer capital solutions if one becomes critically disabled. Once you are certain how much you need, your advisor can offer quotes and several plans most suited to your circumstance.

How does a business create a Succession Plan?

Succession planning allows you to transfer your wealth creating potential.

Many who own family businesses, will move into retirement over the next two decades. A delicate process referred to as “succession” or “business continuity” planning can lead to relinquishing leadership roles while transferring their businesses to the next generation.

By developing a succession strategy you can fairly distribute business assets; transfer the power and authority associated with leadership from the senior to next generation; and cultivate family harmony. The successor then becomes the new steward of the family legacy.

An excellent plan will establish the best possible tax planning to limit liabilities that can occur.

When is the best time to sell or buy a new home?

People begin putting their homes on the market early in the year, though peak home purchasing occurs around June once school has ended, the weather warms up, and vacations begin. In mid summer people begin to have more time to house hunt. Income tax refunds can also increase payments, adding to the increase of volume.

While buying is steady in the summer, it begins to taper off in early fall, with another spike in mid-Autumn when overly optimistic home sellers in Spring, begin to lower their prices.

Like investing in the stock market it pays to be a patient house hunter. Though there are more Springtime homes to choose from, sellers hold their prices to the ceiling because of demand. During the late fall and early winter between Thanksgiving and New Years Day sellers can be more motivated to except a lower offer (people want to limit the time to sell during these holiday seasons when they are busy with families).

Large layoffs or announcements of a planned corporate headquarters moving out of a neighbourhood can result in more homes on the market for the short term with lower pricing by motivated sellers. Conversely, a corporation coming into an area can result in increased home prices.

Homes can sell for 3-5 percent more than the annual average in May through June; closer to the average annual price in very early Spring and Autumn; dropping to 3-5 percent below the average annual price prior to winter in December and January.

Sellers generally have a larger buying market during May through August during which time nearly half of the annual sales close. Bear in mind, that while deed transfers peak between May and August, most of those sales began one to three months earlier (it takes time to close home transactions).

Don’t be too stubborn. A home priced unreasonably high (up to 15% above market value) may be difficult to sell at any time, especially in a buyer’s market (in most cases is in early Spring). A “buyer’s market” in a city means more inventory is available, whereas a “seller’s market” means fewer homes are for sale.

Where possible, place your home for sale far in advance of buying the new one. This removes the possible need to juggle two mortgage payments in addition to the other complications of home selling. You will have more time; as well as more choices if you start during your new region’s peak inventory season.

Movers book up solid in the summer so plan this well in advance once you know your closing date. Shop around and call for an estimate. Book tentative dates until you know for sure adjusting your strategies as you go along.

The Internet offers virtual tours, and neighbourhood data, to help the decision-making process. With the advent of commission free websites, some sellers are listing their homes on sites such as comFree.com without the traditional real estate agent or fees. However it is important to get listed on MLS, and few people know the intricacies of bringing an offer to the status of a concluded deal.

What are the most common mistakes of fund investing

Here are several common mistakes that investors can make:

No clear investment goals. Determine what you want from your mutual fund portfolio. This will help you choose the right investments to realistically meet your future expectations.

Trying to time the market. Don’t get caught timing the market – when influenced by either of the two emotions – greed or fear. Greed compels people to buy when the stock market (and a fund’s unit value) is high. Conversely fear causes many to sell when the stock market’s value (and a fund’s unit value) is low. Make regular investments to benefit from dollar cost averaging (DCA) to level out the peaks and valleys of the market. It is time in the market, not timing, that counts.

Not selecting investments with a long-term track record. Don’t just look at a mutual fund’s most recent performance. For a long-term investment, it is important to check out performance over one, three, five and ten year periods.

Shopping for a specific mutual fund, not a family of funds. The fund you select today may not be the best one for tomorrow. By choosing a reputable family of funds, you ensure that you can switch in the future with minimal cost. A family of funds also allows you to move into a money market fund if the market is reacting in a state of fearful unrest such as prior to the debt crisis and the current continuation of the debt crisis in the Euro nations. Note: Fear is measured by a special volatility index called the VIX, which when above 40 can precipitate market sell-offs which can also affect a fund’s performance. It takes great skill to navigate the market (and fund investing) at these times.

Investing too conservatively. Even if you are in your 50s, you still have about 30 years of investing time ahead. Look at investing some of your money for growth by using equity funds while keeping some in bond funds and dividend funds, and/or balanced funds.

Not seeking financial advice. Making investment decisions can be confusing and intimidating. Unless you have exceptional knowledge of the market, your portfolio could be healthier with the help of a qualified financial advisor.