Shelter from the creditors

Current bankruptcy laws work against the self-employed

by Scott Adams
Financial Post

Lawyer Deborah Grieve warns self-employed to transfer RRSPs to an insurance company as a matter of course.
CREDIT: Peter Redman, National Post

The creditors are circling, looking to take the house, your possessions -- including the car -- and what is left of your bank account. But surely they can't raid your retirement savings? After all, your registered retirement savings plan was set up to take care of you in old age as it seems more likely the government will be unable to do so as the number of retirees grows.

Most investors in RRSPs would be surprised to learn the money in their plans is vulnerable to creditors unless simple measures are taken to protect them.

There are two places where money is safe from creditors: Pension plans and insurance plans.

Pension plans are safe because it makes little sense for creditors to go after what an individual would theoretically receive from a pension plan sometime in the future. Pension plans that are locked in or non-voluntary are creditor-proof. Similarly, employees who are fired from a job and receive pension monies as part of a severance can protect this money as long as it is moved into a locked-in RRSP.

Investors can also find safety in RRSPs with insurance companies. Creditors cannot raid insurance products and fortunately, insurance companies offer a wide range of RRSP products, from mutual funds to segregated funds, to index or income products.

"If you are an executive or a director of any kind of company today, or a business person, I tell my clients to have everything [in your RRSP] with a life insurance company," says Paul Barbour, an independent insurance agent in Burlington, Ont.

However, for this safety of capital to apply, individuals must be mindful of two things. One is individuals must have their RRSPs placed with insurance companies well before bankruptcy -- at least one year before, and preferably two years. If the RRSPs are transferred to an insurance company a few weeks ahead of bankruptcy, the creditors still have full access to them.

"I'll often be consulted by people who are starting to feel financial pressures," says Deborah Grieve, a bankruptcy lawyer with Blaney McMurtry LLP. "That's the wrong time to [transfer RRSPs to an insurance company]. You should do it as part of good financial planning rather than waiting until you are in trouble."

The second thing to watch is who you choose as beneficiary. In Canada, creditors cannot access an insurance company RRSP as long as the beneficiaries are direct beneficiaries -- the children, parents or grandparents of the individual. "I had a case where the bankrupt-to-be was quite convinced she was safe to have designated her brother as her beneficiary, went bankrupt and lo and behold, that money didn't go to her family but went to the creditor," Ms. Grieve says. "It was a case of creditor-proofing gone bad."

Many people have considered this creditor protection step and realized it does not quite make sense: Why would an insurance RRSP be safe and a non-insurance RRSP be vulnerable when both are providing for retirement?

Plainly, the government has realized this, too. The Standing Senate Committee on Banking, Trade and Commerce recently examined the issue and recommended that all RRSPs should be exempt from creditors.

"The current rules favour employees and are against people who are self-employed and have to invest their own money," Ms. Grieve says.

The committee recommended all funds in an RRSP be exempt from seizure as long as three conditions are met: The RRSPs must be locked-in, contributions made within one year prior to bankruptcy can be clawed back, and a maximum amount must be set.

Individuals should not count on these changes happening soon, though. It often takes government a long time to make changes, if at all. As Ms. Grieve says: "It's only a report and a recommendation."