Estate Planning: It's Not Just Who Receives the Money, but How

When a Lump Sum Doesn't Make Sense

Many estate planning conversations come down to a seemingly simple question: 

Who gets your assets when you die?

But there is another question that can be just as important: 

How should they receive it?

Some people are comfortable leaving a large inheritance to their beneficiaries, but that's not always the case. Many more are less comfortable with the idea of their child or heirs receiving hundreds of thousands, or even millions, of dollars all at once as a lump sum.

The concern could arise for many reasons: spending habits, limited financial experience, a difficult relationship, addiction, creditor concerns, or simply the belief that a large inheritance should provide long-term security rather than a one-time windfall.

Whatever the reason, leaving an inheritance does not necessarily have to mean writing someone a cheque for their entire share of the estate.

If the goal is to distribute an inheritance to a beneficiary over time, several strategies are available, each with its own advantages and trade-offs.

Option 1: Create a Testamentary Trust

One of the traditional solutions is a testamentary trust, meaning a trust created as a result of someone's death, generally under the terms of their will.

Instead of giving a beneficiary their entire inheritance directly, assets can be held in trust and managed according to instructions established in the estate plan.

Why a testamentary trust may work

• Control over timing. Instead of a $500,000 cheque, the will could say, for example: $2,500/month, periodic lump sums, or distributions at specified ages.

• Protects against poor money management. Useful where the concern is that a large inheritance could be spent quickly.

• Flexibility. The trustee can potentially be given discretion to pay extra amounts for things like housing, education, health needs or emergencies, depending on how the will is drafted.

• Professional management can continue. Investments can remain managed rather than forcing the beneficiary to suddenly manage a substantial portfolio themselves.

• Potential asset protection. Depending on the trust terms and circumstances, keeping assets in trust can provide greater separation from some beneficiary-level financial risks than an outright inheritance.

• Can accommodate special circumstances. There are specific Canadian rules for certain testamentary trusts, including qualified disability trusts and lifetime benefit trusts.

Important trade-offs

• More complicated than a direct inheritance. The trust has to be established, administered and eventually wound up.

• Ongoing cost. There may be trustee fees, investment-management costs, legal work and annual accounting/tax-return costs.

• Someone has to be trustee. Choosing the right trustee matters because that person or trust company may be making decisions for years. Family members may not have the needed skills, knowledge or desire to steward the assets for several years, and professional trustees come with a recurring added cost.

• The beneficiary has less control. That's partly the objective, but it can also create frustration or conflict, particularly with discretionary distributions.

• Tax treatment can be unattractive. This is a big Canadian consideration. Since 2016, ordinary testamentary trusts generally don't automatically enjoy graduated individual tax rates. The special graduated-rate treatment is largely confined to a Graduated Rate Estate for up to 36 months, plus certain Qualified Disability Trusts.

• It can be overkill for a modest inheritance. Paying annual trust administration costs for many years may not make economic sense if the amount involved isn't substantial.

Rule of thumb: A testamentary trust is most useful when the plan requires ongoing judgment and flexibility, not simply scheduled payments. Because a trust involves ongoing legal, tax, accounting and trustee responsibilities, it is generally more appropriate when the amount being placed in trust and the beneficiary’s circumstances justify the added cost and complexity.

Option 2: Using the Estate to Purchase an Annuity

What if the goal is not to control exactly how the beneficiary spends the money, but simply to make sure they don't receive everything at once?

An annuity may provide another solution.

Rather than distributing, for example, a $500,000 inheritance as a lump sum, the estate plan could direct the executor to use all or a portion of the inheritance to purchase an annuity for the beneficiary, subject to appropriate legal drafting and the availability and terms of an annuity when the estate is settled.

The annuity can then convert that capital into a predictable stream of payments.

Why an annuity may work

• Predictable payments. The inheritance can be converted into a defined stream of income rather than paid as one large amount.

• Simple for the beneficiary. The beneficiary does not have to manage or invest the inherited capital.

• No ongoing trustee decisions. Payments are determined by the annuity contract rather than by a trustee exercising discretion.

• Guarantee options may preserve value. A guaranteed payment period can address what happens if the beneficiary dies earlier than expected, depending on the contract selected.

• Can provide lifetime income. Depending on the annuity purchased, payments may continue for the beneficiary’s lifetime.

Important trade-offs

• Limited flexibility after purchase. Once the annuity has been established, its terms generally cannot respond easily to changing needs.

• No access to the underlying capital. The beneficiary ordinarily receives the contracted payments rather than having direct access to the original amount.

• Terms depend on conditions at purchase. Payments will depend on factors such as the beneficiary’s age, interest rates, guarantee period and annuity features available when the estate is settled.

• Still subject to estate administration. The executor generally cannot purchase the annuity until the necessary estate work has been completed, which may delay the start of payments.

• Less suitable for variable or emergency needs. An annuity provides scheduled income, but it does not offer the same discretion as a trust to respond to any unexpected housing, health or other support needs.

Rule of thumb: An estate-purchased annuity may fit when the objective is to produce dependable income, rather than ongoing control or discretionary access to capital, and the beneficiary does not require immediate access to the payments.

Option 3: Insurance or Segregated Fund with an Annuity Settlement Option

There is another strategy that many Canadians are less familiar with. Certain insurance contracts, including segregated funds, can allow the owner to establish an annuity settlement option.

Instead of the beneficiary receiving the insurance or investment fund's death benefit as a lump sum, the proceeds can automatically be used to provide a predetermined income stream.

Conceptually, the objective is similar to purchasing an annuity through the estate.

The major difference can be speed.

Where an insurance contract has individually named beneficiaries other than the estate, its death benefit may generally pass directly to those named beneficiaries outside of the estate and lengthy probate process.

The owner retains control of the assets during their lifetime and may specify how each beneficiary is to receive their share of the death benefit. One beneficiary might receive a lump sum, while another receives a stream of annuity payments. 

Why this approach may work

• Avoids one large lump-sum payment. The death benefit can be converted into a predetermined stream of income.

• May pass outside the estate. With a properly designated beneficiary other than the estate, eligible proceeds can generally pass directly under the insurance contract.

• Potentially faster access. Payment does not necessarily have to wait for the remainder of the estate to be settled.

• Useful for a dependent beneficiary. The approach may help replace financial support that stops when the contract owner dies.

• Less ongoing administration. Once established, the insurer administers the contracted payments rather than requiring a long-term trust structure.

Important trade-offs

• Must be established in advance. The contract, beneficiary designation and settlement instructions need to be properly arranged during the owner’s lifetime.

• Limited flexibility after death. The beneficiary ordinarily cannot redesign the payment arrangement after the owner dies.

• Contract-specific availability. Settlement options, guarantees and payment terms depend on the insurer and contract.

• No trustee discretion. It may not provide a mechanism for extra distributions based on changing health, housing or support needs.

• Requires coordinated planning. The beneficiary designation, will and broader estate plan must work together and should be reviewed after significant family or financial changes.

Rule of thumb: An annuity settlement option may fit when the objective is predictable income with potentially faster delivery outside the estate, and ongoing trustee judgment is not required.

CORE COMPARISON

Key feature	Testamentary trust	Estate-purchased annuity	Segregated fund with annuity settlement
Avoids an immediate lump sum	Yes	Yes	Yes
Provides predictable payments	Can be structured that way	Yes	Yes
Allows discretionary extra payments	Yes, if authorized	Generally no	Generally no
Can adapt to changing needs	Most flexible	Limited	Limited
Requires ongoing trustee involvement	Yes	No	No
Beneficiary responsible to manage investments	Not necessarily, trustee responsibility	No	No
Subject to estate administration	Generally yes	Yes	Generally no, where a valid direct beneficiary designation applies
May pass outside probate process	Generally no	No	Potentially yes
Can provide lifetime income	Possible, depending on the trust	Yes, depending on the annuity	Yes, depending on the settlement option
Best suited to	Control and flexibility	Simple, dependable income	Dependable income with potentially faster delivery
Set-up complexity and professional costs	High	Low	Low
Ongoing administration and tax filing	Yes, ongoing until wound down	Minimal once established	Minimal once established
Tax efficiency of income	Generally taxed at highest rate	Only portion of income taxable, at beneficiary's marginal tax rate	Only a portion of income taxable, at beneficiary's marginal tax rate

This comparison is general. 

The legal, tax and practical outcome will depend on the wording of the will or trust, the assets involved, beneficiary designations, the insurance contract and the beneficiary’s circumstances.

Questions to Consider

• How much will the beneficiary receive?

• How prepared are they to manage it?

• Are they financially dependent on you today?

• How quickly would they need access to money?

• Do they need predictable income, flexible support or both?

• Who should make decisions if their circumstances change?

At Prairie Wealth Planning Consultants, we help families think through how their wealth will actually reach the people they care about and how different estate, insurance and investment strategies can work together.

If this article made you think of someone who could benefit from that conversation, feel free to share it with them or introduce us.

Sometimes the most important estate-planning question isn't who receives the money. It's how they receive it.

Important Information

This article is provided for general educational purposes only and is not intended as financial, investment, legal, tax or estate-planning advice. The strategies discussed may not be appropriate for every individual or family, and their legal and tax consequences will depend on individual circumstances. Insurance products, contract features and settlement options vary by insurer and may be subject to specific terms and conditions. Before implementing an estate-planning strategy, individuals should obtain appropriate financial, legal and tax advice based on their circumstances.

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