Planning for Special Needs Persons: Are Henson Trusts all Grown Up?

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1 Planning for Special Needs Persons: Are Henson Trusts all Grown Up? JULY 2005 In 1987, nearly twenty years ago, Judy Henson was a person dependant on public support in Ontario because of her special needs. The provincial rules of the day stipulated that provincial benefits would be reduced or even cut off for recipients with too many liquid assets. Ms. Henson was a beneficiary of a well thoughtout, fully discretionary trust. As such, she had no right to compel the Trustees to give her any of the income or capital. If they did, it was purely based on their voluntary choice. The province claimed those assets were available on behalf of Ms. Henson. Ms. Henson was successful in challenging the rules of the day. An Ontario Court held that assets in such a fully discretionary trust were not within the definition of liquid assets as they applied in Ontario. But that was in Fast-forward nearly two decades. Very gradually, knowledge has trickled down from trust specialists to legal generalists, and other disciplines. Advisors in many fields of endeavour are familiar with this seemingly mysterious legal tool. It is commonly nicknamed a Henson Trust, because of the case where it came to public attention. But there is really no such thing as a Henson Trust. It is really no different from any other fully discretionary life-time trust. Trusts, including discretionary trusts, are hundreds of years old. To link the use of such flexible legal tools primarily to planning for special needs individuals is to perpetuate a somewhat blinkered view of their utility. However, the term is constantly used, sometimes as practically an automatic response to any situation calling for planning for the vulnerable or disabled. After years of offering the same solution, perhaps a bit out of habit, advisors might be well advised to take a fresh look at how they recommend socalled Henson Trusts. They may be overlooking a more critical aspect of such important planning. Imagine if provincial benefits were completely cut off; something to be dreaded, but entirely possible at some point during the beneficiary s lifetime. The key question is not, do you have a Henson trust? but rather is there enough capital to sustain this vulnerable person for a lifetime without Government help?

2 Provincial Laws change Henson s case was decided in Ontario under an old statute replaced in 1998, by the Ontario Disability Support Program Act (ODSPA), That statute is still the law in Ontario with many amendments. But the laws of the provinces evolve, and will continue to do so as governments and public attitudes change. A recent and instructive lesson can be learned from Alberta, one of the richest provinces. It changed its rules too, and effectively cancelled the utility of discretionary Henson trusts in that province. While it is generous in permitting other assets to be exempt, with a simple stroke of a pen it decreed that all trust assets, discretionary or not, will be taken into account in determining whether a beneficiary of that trust has resources available that disqualify them. The possibility is enough. Whether or not the Trustees open the trust pursestrings, the public purse for such people will be closed. Then the Trustee will come face-to-face with the real problem; is there enough capital to provide support? Trustees can increase discretionary payments if provincial benefits are reduced or cut off. But increased payments simply deplete the trust faster. Without adequate capital, a downward financial spiral is going to begin, and no amount of cleverly drafted discretionary authority is going to fix the problem. Trust planning, including post mortem income splitting, can help a family make capital last longer and stretch farther. Trusts can build tremendous flexibility into estate administration, enabling trust benefits to be adjusted to future changes in the rules. Even faced with such provincial resolve as Alberta s, discretionary trusts are still a very useful planning tool but not a sufficient solution. Nothing can circumvent government policy intent on forcing families to spend personal assets before resorting to the public purse. For many families with a special needs individual, a primary planning consideration is ensuring that Government benefits and services will be adversely affected as little as possible. This is especially true if they are necessary for the health or well being of that individual, or cannot be readily obtained on a cost-effective basis. This certainly needs to continue. Changes to provincial funding legislation pose ongoing new challenges but also provide new opportunities for special needs beneficiaries and their families, and the advisors who work with them to create a prudent and workable estate plan. Life insurance is frequently the least expensive financial instrument that families can use to fund arrangements for a relative with an impairment. Ontario legislation an example Ontario s disability support legislation represents the modern style of legislative drafting in that many of the defined terms and other provisions of the Act are prescribed in the regulations or refer to prescribed matters. Thus, advisors who work with persons with an impairment must be aware of the legislative scheme that pertains in their province and, perhaps more importantly, the attendant regulations in order to be able to make qualified recommendations. Ironically, Ontario s ODSP legislation, with its companion regulations, is very strict in some senses but arguably quite generous in others. For example, the cash asset ceiling for a supported single person is only $5,000.

3 But they can own their principal residence as an exempt asset. Even an interest in a second property might be permitted, if the province can be convinced it is necessary for the health or well-being of the recipient. Owning a home would naturally disqualify a recipient from getting a shelter allowance, which may be a substantial part of a monthly benefit. But most families of disabled beneficiaries would consider this a modest drawback. For many, choosing between owning a home or getting a bigger monthly benefit would not be a difficult choice. Consider House Trusts Homes are just another kind of property that can be owned by Trustees. If a trust can own and provide a home for a vulnerable person, without terminating all provincial benefits, then so much the better. At least the vulnerable person will have a friendly landlord; and never be evicted for failing to pay rent! House or housing trusts are another tried and true vehicle that have wide applicability in estate planning for the vulnerable and the disabled. Trustees can be given the power to buy and sell, downsize, or even rent accommodation. Yet these vehicles are less well known than the so-called Henson type trusts. Sometimes overlooked in the drafting is that house trusts need capital too, to provide for property taxes, insurance and maintenance. Knowing the Rules Helps to Stay in the Game Another important change signals that we have entered a different age from when Judy Henson did battle with the Government. Advisors can now learn what they need to know about provincial rules over the Internet. Ontario s ODSP Handbook, for example, is freely available online. Definitions, explanations, legislative references are all available for free, running to hundreds of pages of official policy whats, whys and wherefores. Insurance Planning Strategies can still work In the past 20 years, product offerings from the insurance and investment industries have improved dramatically. The range of products and applications available is greater than ever before. Consider the recent introduction of Critical Illness and Long Term Care insurance to financial security planning. The coming of age of so-called Henson trusts gives advisors and their clients a reason to re-assess the utility of life insurance. This is especially true when looking at insurance as a potential funding vehicle. But it is also worthy of consideration as an estate planning tool for some income support recipients themselves. Disabled people cover a very wide spectrum of humanity. Many work, and have families; they may want and need to take advantage of insurance planning too. For example, benefit recipients (in Ontario at least) can enjoy the tax-deferred accumulation that is available within a cash value life insurance policy. The cash surrender value of life insurance is capped in Ontario at $100,000 without affecting benefits. However, in another example of how the rules change, this upper value limit is now to be shared with the asset value of a trust dedicated to the support of a benefits recipient. This is

4 for insurance owned by the benefit recipient or their immediate family. It does not address intergenerational insurance under which they are only the life insured. Outright and proper insurance trust beneficiary designations continue to be useful in ensuring that the insurance proceeds flow outside the probate estate of the life insured, avoiding probate fees or other settlement costs where these apply. Potential creditor protection can still be a valuable benefit when family class or irrevocable beneficiaries are designated on policies. Transferring cash value life insurance High net worth clients, especially those involved in volatile or high-risk businesses with frequent creditor issues (such as construction), can purchase a cash value life insurance policy on the life of a healthy child who is receiving ODSPA benefits. The values within an exempt life insurance contract will accumulate on a taxdeferred basis, unless the values are withdrawn from the policy during the life of the insured individual. Under the Income Tax Act, the policy can be transferred to the child on a tax-deferred rollover, either on death using the contingent owner mechanism, or by inter-vivos gift. Thereafter, subject to the recipient s asset accumulation limits in their province, this option creates tax-deferred value, which the child can access through policy withdrawals, leveraging, or a policy loan. Outright designation of life insurance proceeds A public benefit recipient who is capable of managing his or her own financial affairs can still be the designated beneficiary of a life insurance policy. As discussed earlier, consideration must be given to whether the life insurance proceeds, either alone or in combination with an inheritance, will be sufficient to provide for all of the individual s future income and capital requirements. If so, the outright designation will probably result in termination of provincial income support payments. Creation of a discretionary trust more useful than ever before As they have been for hundreds of years, recipients who cannot look after their own finances are still candidates for trusts. The focus of this Bulletin is mostly on special needs individuals at the younger end of the life spectrum. Yet virtually all the same techniques can be put to use for the benefit of vulnerable seniors: the very elderly, the infirm, and those who suffer from dementia. Trusts are very flexible tools that can benefit this growing population of special needs individuals in many different ways. The Trustee of a properly prepared trust can be designated as the beneficiary of a life insurance policy, and will receive and administer the funds. With proper planning, the trust will still qualify as a testamentary trust, taking advantage of graduated tax rates on accumulated income. Testamentary trusts can be the owners of life

5 insurance, just as other trusts can. This planning option can be used to help moderate taxable trust income just as it helps living affluent policyowners accumulate assets in a tax-sheltered environment. Conclusion Insurance and discretionary trusts, whether testamentary or inter vivos, can still be integrated into an estate plan involving special needs individuals. But family and advisors need first to determine what present and future needs exist, and what other provisions the family is willing and able to make. Advisors should consider revamping their planning approach to designing complete financial support in families that can afford the premiums. Life insurance is often the least expensive vehicle for creating support funding, outright or in trust. With provincial budgets stretched by spiralling health care costs, there is less appetite for public purse support of individuals if other assets are available. Insurance can provide a foundation of financial certainty to any plan; something that shifting Government benefits and discretionary trusts cannot. This article is intended to provide general information about life insurance illustrations. Every effort has been made to ensure the accuracy and currency of the information provided, but any examples presented in this article are for illustration purposes only. No one should act upon these examples or information without a thorough examinationof the tax and legal situation with their own professional advisors, after the facts of the specific case are considered. Sun Life Assurance Company of Canada is a member of the Sun Life Financial group of companies. Sun Life Assurance Company of Canada, 2006.