A Family Trust as the Owner of a Life Insurance Policy

Picture a parent who owns a life insurance policy and has started to worry about something other than the death benefit. The worry is the years in between. What happens to the policy if the parent can no longer manage it? Who decides whether it is kept, changed or used, and who receives the money, and when, if the children are young or one of them is not ready for a large sum?

Some families answer those questions by making a trust the owner of the policy. The trustees, not one individual, hold the contract. The trust does not die and does not lose capacity, so the policy has an owner on the worst day as well as the ordinary ones. When the death benefit is paid, it reaches people who already have written instructions. That is the appeal. It comes with real costs, tax rules that need careful work, and a yearly filing that does not go away.

This page explains why a family trust is sometimes chosen as the owner of a life insurance policy, how premiums reach the trust, what happens at the death of the person insured, how the 21-year rule and the yearly filings apply, and what is different in Quebec. It is general information from a licensed insurance professional, not tax, legal or investment advice. The arrangement itself is drafted and reviewed by an accountant and a lawyer or, in Quebec, a notary.

If the word trust is still new, read what a trust is for a policyowner first, then come back here.

Why would a family have a trust own a life insurance policy?

Families usually do it for control and continuity. Trustees manage the policy under a written deed, the policy keeps an owner even if the person insured dies or loses capacity, it stays outside that person's estate, and the deed decides how the proceeds are shared. Tax savings are not the usual reason.

The first reason is control by trustees. When an individual owns a policy, that person alone can change the beneficiary, borrow against the cash value, surrender the contract or let it lapse. When a trust owns it, those decisions belong to the trustees, acting under the deed and owing duties to the beneficiaries. Some families prefer that decisions about a large asset be shared and written down.

The second is continuity. A policy owned by an individual follows its owner's life. If the owner is not the insured and dies first, the policy passes under the owner's will or to a successor owner. If the owner loses capacity, someone needs legal authority to act. A trust avoids both gaps, because it does not die and its trustees can be replaced under the deed. The roles of owner, insured and beneficiary are set out on what a policyholder is.

The third is keeping the policy and its proceeds out of the estate. The policy is the trust's property, so it is not part of the insured person's estate, and the proceeds are paid to the trust. Where a province charges a fee on the value of an estate, that can matter, although a direct beneficiary designation does much the same at no cost. The comparison is on beneficiary or estate.

The fourth is creditor considerations, and the honest word is considerations. Property that genuinely belongs to a trust is not the settlor's. But a transfer made to avoid existing creditors can be set aside, and a trust as beneficiary may not enjoy the provincial protection some family designations have. Those rules are on the designation and what a creditor can reach.

The fifth is distribution. A deed can say who benefits, in what shares, at what ages, and with what discretion left to the trustees. It is the purpose a testamentary trust serves, except that this trust exists today.

Who is the insured, the owner and the beneficiary in this arrangement?

In the usual arrangement, a parent or grandparent is the person insured, the trust, acting through its trustees, is the owner, and the trust is also the beneficiary, so the proceeds are paid to the trustees. The family members meant to benefit are named in the trust deed, not on the insurer's form.

When the trust is both owner and beneficiary, the children usually appear nowhere on the policy. Their rights come from the deed. The insurer deals with the trustees, and the trustees with the beneficiaries. The table compares the two ways of owning a policy.

Another arrangement keeps the individual as owner and names a trust, or its trustee, as beneficiary. That testamentary route is on a death benefit and a testamentary trust. Choosing between the two is a drafting decision for the lawyer or notary.

How do the premiums reach the trust?

The trust pays the premiums from money it holds. A family trust rarely has income of its own, so that money usually comes from the settlor or another family member as a gift or a loan. Each route can bring in the attribution rules or subsection 75(2), and only your accountant can say how they apply.

Start with the gift. A parent can give the trust money each year to pay the premium. Sections 74.1 to 74.5 of the Income Tax Act deal with property transferred or lent to a spouse or common-law partner, or to a minor who does not deal at arm's length with the person, or who is a niece or nephew. The Act says these rules reach a transfer made directly or indirectly by means of a trust. Where they apply, income from the property is treated as the income of the person who provided it.

Then there is subsection 75(2). It applies where a trust holds property on condition that it may revert to the person who contributed it, may pass to people that person picks later, or cannot be disposed of without that person's consent. Income and gains from that property are then taxed in the contributor's hands while the contributor is alive and resident in Canada. Whether a deed avoids it turns on its exact wording.

A loan is the other route. Under subsection 74.5(2), the attribution rules do not apply to income from lent property if interest is charged at not less than the lesser of the prescribed rate and an arm's length rate, and each year's interest is paid within 30 days after the year ends. Miss a payment and the protection can be lost.

This practice does not resolve these questions. Bring them to your accountant before the trust pays its first premium:

• Who settled the trust, with what property, and who will fund the premiums each year?
• Is any beneficiary a spouse, a minor child, a niece or a nephew?
• Could subsection 75(2) apply, given the deed's wording?
• If premiums are lent, what rate and schedule keep the loan within subsection 74.5(2)?
• What does the trust report each year, and who prepares it?

What happens when the person insured dies?

The insurer pays the death benefit to the trust, as the beneficiary on file. Under the Income Tax Act, a payment because of the death of the person insured under an exempt policy is not a disposition, so it is not taxed as income on arrival. From then on, the trust deed governs what the trustees do.

The tax treatment of the death benefit is the same whether a person or a trust receives it. Subsection 148(9) excludes from the definition of disposition a payment under an exempt policy made in consequence of the death of the person insured. More is on taxes on death benefits.

What changes is what follows. The proceeds are now trust property. Some deeds say to divide the money at once, others to hold it until a child reaches a stated age or to use discretion. If the trust invests the money, the rules in section 104 apply. Income that becomes payable to a beneficiary in the year can be deducted by the trust and is included by the beneficiary. Income the trust keeps is taxed in the trust, at the highest individual percentage under subsection 122(1).

Illustrative example: an invented family, used only to show the sequence. Two parents settle a family trust while their children are young. The trust owns a policy on one parent's life and is its beneficiary. That parent dies years later and the insurer pays the trustees. The deed says each child receives a share at a stated age, and that until then the trustees may pay for education and care. No child was named on the insurer's form, and none had to be.

One design point matters more than any other. The beneficiary on the insurer's records must match the plan. If the trust owns the policy but an old designation still names a person or the estate, the money goes there. The trustees, as owner, can correct it and should confirm it in writing with the insurer. The risks of naming a minor are on a minor beneficiary and a beneficiary who cannot be found.

How does the 21-year rule touch a trust that holds a policy?

Subsection 104(4) deems most trusts to dispose of their capital property at fair market value on the 21st anniversary of their creation, and every 21 years after. How that rule reaches an interest in a life insurance policy is a technical question your accountant must answer for your trust, well before the anniversary.

In plain words, the rule stops a trust from deferring tax on its gains forever. On the day that is 21 years after the latest of 1 January 1972 and the day the trust was created, the trust is treated as having sold its capital property, other than depreciable property, at fair market value. Built-up gains become taxable although nothing was sold.

A life insurance policy is not ordinary capital property for tax purposes. The Act has its own rules for policies in section 148, including how a disposition of a policy is measured. So how the 21-year rule applies to a policy in a trust, and to the trust's other assets, needs a specific answer from your accountant. This page does not give it.

What families can do is plan for the date. Many deeds let trustees distribute property to beneficiaries before the anniversary, and handing a policy to a beneficiary is itself a transfer with its own tax rules. Raise this when the deed is drafted and again a few years before the anniversary.

What happens when an existing policy is moved into a trust?

The owner signs the insurer's change of owner form and the trust becomes the policyowner; the person insured stays the same. For tax, a gift of the policy, or a transfer to a person the owner does not deal with at arm's length, is a disposition under subsection 148(7), measured by the greatest of three amounts.

Subsection 148(7) treats the old owner as receiving the greatest of the value of the interest, which the Act ties to the cash surrender value, the fair market value of anything the trust gives in return, and the adjusted cost basis. The trust acquires the policy at that same amount. Any excess over the adjusted cost basis is income to the old owner in the year of the transfer.

Three steps come first. Ask the insurer, in writing, for the cash surrender value and the adjusted cost basis on the planned date. Give both to your accountant before signing. And have the lawyer or notary confirm that the deed lets the trustees hold a life insurance policy and pay its premiums.

A change of owner does not usually need new medical evidence, because the person insured does not change. What changes is control: the trustees now sign for the policy. Review the beneficiary designation at the same time, because an old one stays in force until the owner changes it, and in Quebec a spouse's designation can be irrevocable. Whether to start with a new policy or move an existing one is for your accountant, and the wider choice of owner is mapped on who can own a life insurance policy.

What does the trust have to file every year?

A family trust resident in Canada that is an express trust and not a listed trust files a T3 return every year, no later than 90 days after its year end, with Schedule 15 setting out its beneficial ownership. A trust subject to Quebec income tax generally also files the Quebec trust return, TP-646.

The yearly filing is the cost families most often underestimate, because it lasts as long as the trust does. The Canada Revenue Agency's FAQ on the enhanced reporting rules says an express trust resident in Canada that is not a listed trust must file a T3 return annually, and its filing page says the return is due within 90 days after the trust's year end.

Schedule 15 asks for the name, address, date of birth, country of residence and tax identification number of every trustee, settlor, beneficiary and controlling person. Trustees must keep those details current for everyone the deed names, including minors. The listed exceptions include a trust whose assets do not exceed $50,000 throughout the year. Whether a trust holding a policy fits any exception is for your accountant to read against the CRA's current pages.

The CRA's page on what has changed adds that certain bare trusts may need to file starting with taxation years ending on or after 31 December 2026. In Quebec, Revenu Québec says that, as a rule, a trust subject to Québec income tax for a year must file the Trust Income Tax Return.

What is different in Quebec?

In Quebec, a trust is not a relationship in which trustees own property for beneficiaries. Under article 1261 of the Civil Code it is a patrimony by appropriation, distinct from the settlor, the trustee and the beneficiary, in which none of them holds a real right. The deed, often prepared by a notary, and the Code's designation rules shape the arrangement.

Article 1260 describes a trust as an act by which a settlor transfers property from his patrimony to another patrimony he constitutes and appropriates to a particular purpose, which a trustee accepts to hold and administer. Article 1262 adds that a trust is established by contract, by onerous or gratuitous title, by will or, in certain cases, by law. A family trust settled during a lifetime is usually created by a deed of trust prepared by a notary or lawyer.

Article 1278 gives the trustee control and exclusive administration of the trust patrimony, with titles drawn up in the trustee's name. In practice, the insurer's records show the trustees, in that capacity, as policyholder. The insurer usually asks for the deed before recording the change.

The insurance articles matter too. Under article 2449, designating a married or civil union spouse as beneficiary, in a writing other than a will, is irrevocable unless otherwise stipulated, so the spouse's consent may be needed before a policy is moved. Under article 2457, where the designated beneficiary is the spouse, a descendant or an ascendant of the policyholder, the rights under the contract are exempt from seizure until the beneficiary receives the sum insured. A trust as owner and beneficiary changes who those people are, and how the articles then apply is a question for your notary or lawyer.

What does a family trust cost, and where are its limits?

A family trust costs legal fees to draft and settle, accounting fees every year it exists, and trustee time for as long as it holds the policy. Its limits are just as real: it does not make the death benefit more tax favoured, it does not guarantee protection from creditors, and the 21-year rule follows it.

The setup cost is the deed, the settlement and the work to make the insurer's records match. The yearly cost is the T3 return and Schedule 15, a Quebec return where one applies, and the bookkeeping behind them, for as long as the policy is in force. Whether the policy is term coverage or a specially designed, high-cash-value, participating whole life insurance policy, these costs come on top of the premiums.

Then there is the human cost. Trustees must be willing, organised and available for many years. They keep records, answer the insurer and owe duties to every beneficiary. A trust company can act, for a fee. Families often name one family member and one independent trustee, and the deed must say who replaces a trustee who dies, resigns or can no longer act.

The limits deserve plain statements. A trust does not reduce the tax on a death benefit, which already reaches a beneficiary free of income tax when the policy is exempt. It is not a shield in every case, because a transfer made when debts already exist can be challenged. And it does not replace a will, a mandate or power of attorney, or regular policy reviews. When a holding company is also involved, the chain is set out on a family trust, a holding company and the policy.

What this page will not tell you

This page does not tell you whether a family trust suits your family, how a deed should be worded, whether the attribution rules or subsection 75(2) apply to you, or how the 21-year rule reaches your policy.

It does not compare a trust's cost with probate in your province, take a tax position, or say how much coverage to hold. Those questions belong to your accountant and to a lawyer or, in Quebec, a notary. A licensed insurance professional can explain what the contract says, show what the insurer needs to record a trust as owner and beneficiary, and confirm in writing what the insurer has on file. When a corporation may be the owner instead, see personal or corporate ownership of the contract; the wider topics are on the estate planning page.

Who this does not suit

A family trust as policyowner does not suit a household that only needs a beneficiary designation, cannot carry the yearly accounting cost, has no one willing to serve as trustee for many years, or expects the trust to cut tax or erase creditor risk.

It is usually not the right fit when:

• The goal is simply to pay a spouse or adult children directly, which a designation already does at no cost.
• The policy is modest and yearly legal and accounting costs would take a meaningful share of it.
• No one is willing and likely to be available to act as trustee for twenty years or more.
• The family expects the trust to cut tax on the death benefit or to protect against debts that already exist.
• The settlor wants to keep personal control of the policy, which may defeat the purpose and can bring subsection 75(2) into play.

If one of these describes your family, the testamentary route, or a careful designation with a contingent beneficiary, may reach the goal with far less machinery. If none does, the next step is a joint conversation with your accountant and your lawyer or notary.