Creditor Protection and Life Insurance

Last updated: February 2024

An attractive feature of life insurance policies is that they may be able to provide protection from the owner’s creditors.  This occurs where the right beneficiary designation is made, and the designation is done prior to any notice of potential creditor claims.  This Tax Topic will summarize the nature of creditor protection of life insurance policies. It should be read along with the “Limitations on Creditor Protection and Life Insurance" Tax Topic (which also includes a discussion on registered and non-registered annuities – RRSPs/RRIFs). 

Traditionally, life insurance policies have been given special protection against the claims of creditors under provincial insurance legislation.  The legislation, which is generally consistent across Canada, is intended to protect the rights of the beneficiaries under the contract.

Creditor protection during the life of the individual whose life is insured can be achieved in two ways: by the owner making an irrevocable beneficiary designation in a life insurance contract or by designating as beneficiary’s certain family members specified in provincial insurance legislation. In all provinces except Quebec, the relationship must be between the life insured and the beneficiary.  In Quebec, it is between the owner and the beneficiary.

Where a beneficiary is designated irrevocably, the owner, while that beneficiary is living, may not alter or revoke the designation without the consent of the beneficiary.  The insurance money is not subject to the control of the owner or the owner’s creditors and does not form part of the owner’s estate.

Where certain family members are designated as beneficiary, the legislation prevents creditors of the owner from seizing and surrendering the contract during the lifetime of the individual whose life is insured.  In the common law provinces, the family member must be a spouse, child, grandchild or parent of the life insured under the policy.  In Quebec, the class is wider and includes all ascendants and descendants of the owner (Quebec Civil Code, Art. 2457). 

The definition of spouse may include common law spouses or same-sex spouses, depending upon provincial legislation. In Quebec, only married and civil union spouses can benefit from creditor protection.  Common law partners have to be designated irrevocably to get the same benefit.

Where the beneficiary is a member of the designated class, the contract is exempt from seizure, even where the appointment of the beneficiary is revocable.  In the case of the appointment of a revocable beneficiary other than one in the designated class, the policy does not qualify for creditor protection under provincial insurance law during the lifetime of the insured. 

Where the owner or the owner’s estate is designated, there would be no creditor protection available during the lifetime of the life insured or at death when proceeds are paid to the estate. Under provincial insurance legislation the definition of “beneficiary” excludes the owner or the owner’s personal representative. 

Creditor protection is not available if the life insurance policy is surrendered by the owner for its cash value.  One exception to this rule is annuities purchased with locked-in RRSP funds, which are in themselves derived from registered pension plans. In relation to annuity payments the Ontario Court of Appeal in, Whalley v. Harris Steel, 1997 CanLII 1318 (ON CA) held that when in pay-out mode the insurance monies are creditor protected.

Creditors of the policy owner cannot make a claim against the proceeds of a policy which are payable upon the death of the life insured.  Where a beneficiary is designated, the insurance money, does not form part of the estate of the owner and is not subject to the claims of the owner’s creditors. The exception to this rule would be a dependant relief claim which may result in the claw back of insurance proceeds or when a fraudulent conveyance argument is successfully made by a creditor.

Proceeds that are paid to a beneficiary who has their own creditors (not creditors of the owner of the life insurance policy) will not be protected.  The protection only lasts when in payout mode but once it reaches the hands of the named beneficiary, those proceeds can be attacked by creditors of that beneficiary.

Where creditor protection during life is important, it is advisable to name alternate beneficiaries within the protected class since the exemption from seizure can be lost if the designated beneficiary dies.

It may be possible to designate an irrevocable beneficiary to receive a portion of the death benefit proceeds of a policy, and to designate revocable beneficiaries for the remainder.  Similarly, part of the death benefit proceeds could be designated for receipt by members of the protected class, and the remainder by others.  Although there have been no decided cases on point, one could argue that, in either case, the policy remains creditor protected.  Caution however, should be used with this approach, as it is unknown how a Court would decide the issue. 

Where both irrevocable and revocable beneficiaries are designated to receive portions of the death benefit proceeds, an issue arises as to whether the policy owner maintains the ability to change the beneficiary designation in respect of the revocable beneficiaries he or she has designated.  For instance, sections 191(1) and 197 of the Ontario Insurance Act requires the consent of the irrevocably designated beneficiary to alter or revoke the designation.  These provisions were intended to protect the rights of irrevocably named beneficiaries and not to give them a veto power with respect to transactions which do not affect their rights.  If there is one beneficiary designated irrevocably to receive a small percentage of the death benefit proceeds, these provisions would not prevent the policy owner from naming other beneficiaries for the remainder of the death benefit.  However, the irrevocably beneficiary would have to consent to any exercise of ownership rights by the owner which would affect his or her interest (for example, the surrender or partial surrender of the policy, or the absolute transfer or collateral assignment of the policy).

While creditor protection remains available in many instances it is important to be aware of the limitations that exist to its application.   The Tax Topic, “Limitations on Creditor Protection and Life Insurance”, addresses that issue in detail and should be read in conjunction with this Tax Topic in order to gain a full understanding of this area.

Tax, Retirement & Estate Planning Services at Manulife writes various publications on an ongoing basis.  This team of accountants, lawyers and insurance professionals provides specialized information about legal issues, accounting and life insurance and their link to complex tax and estate planning solutions.

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