Insurance Strategies
Immediate Financing Arrangements
Your investments should allow you to accumulate wealth in the short and long term. One strategy for accomplishing that is through Immediate Financing Arrangements (IFAs). Essentially, you purchase an exempt life insurance policy and overpay the premiums each year. This significantly increases the cash value of the policy. Then, you can assign the bank as the owner of the policy as collateral to take out a line of credit or loan. With those funds, you could further invest in property or a business which brings you extra income. You would pay the interest on the line or credit each year. Then, claim both that interest expense as well as the collateral insurance deduction (lesser of premiums paid or NCPI) against taxable income for the year.
The amount you save from those taxable deductions helps to offset the amount you pay in interest each year. You can also borrow an additional amount from the bank each year equal to the interest paid minus the amount you saved through tax deductions. Ultimately, your policy’s cash value continues to grow each year and your need for collateral decreases. You might also receive an increase in your line of credit. When you pass away, the proceeds from your policy repay the outstanding line of credit balance. Any leftover funds go to your beneficiaries.
Asset Transfer
One of the consequences of having a diversified pool of assets is the potential sacrifice of cash accessibility. Not to mention the large tax liability when you pass away. One strategy to combat those risks is called the Individual Asset Transfer (IAT). In this strategy, you purchase a life insurance policy and pay the premiums with your current investment portfolio. This provides protection for your estate as well as building a tax-efficient cash value. If you need to access your policy’s cash value, there are numerous ways to do so. You can withdraw cash from the policy, take out a policy loan, or lend the policy to an institution in return for a loan. Cash values from a life insurance policy offer higher collateral values and allow you to access up to 90 percent. This strategy is best suited to those who have an affluent income that exceeds the demands of their lifestyle and personal expenses. Your financial future is secure and you have a high net worth, and you’re interested in minimizing your tax burden. Perhaps you’ve already hit capacity on RRSP and TFSA contributions so you’re looking for ways to diversify your portfolio.
A similar strategy exists for corporations called Corporate Asset Transfer (CAT). The goal of this strategy is to protect the value of your corporation so future generations can enjoy it. Essentially, you purchase a life insurance policy and name your private corporation as the owner. Your company owns the policy, pays the premiums, and is the beneficiary. When you use the corporation’s investment income to fund a life insurance policy, you reduce the amount paid on investment taxes. Plus, the company has more options for accessing the cash value of the policy than other traditional investment accounts. When you pass away, the corporation can post the death-benefit- minus the value of the policy’s adjusted cost basis- to its Capital Dividend Account. This strategy is best suited to those who are key-players or shareholders of a Canadian Controlled Private Corporation and are looking for ways to lower the company’s tax burden.
Retirement Strategy
Affluent Canadians who have maxed their RRSP contributions and have taxable investments are often concerned about the tax liability when they pass away. It’s important to protect your estate for future generations, but you also may want to access your non-registered investments for supplemental retirement income. Individuals in this scenario should consider the Individual Retirement Strategy. In this strategy, you purchase a life insurance policy to secure your estate and fund the policy’s premiums with your cash flow or other investments. The policy’s cash value accumulates tax-free which offsets the amount you would be paying on investment income. When you pass away, your policy’s death-benefit pays off outstanding loans and the remainder goes to your beneficiaries. It’s important to note that the remainder left for your beneficiaries bypasses any associated estate settlement costs.
The Corporation Retirement Strategy is a similar strategy suited to corporations with immense wealth in taxable assets. By purchasing a life insurance policy owned by your corporation, the value of your company is protected for future generations. The corporation pays the premiums and is named as the beneficiary. The accumulating cash value of the policy is tax-free and can be used as collateral for the corporation to gain tax-free loans. The company would then pay you a taxable dividend to supplement your retirement income. It can also enable shareholders to borrow funds from the lender. When you pass away, the death benefit would be used to pay off any outstanding loans. The remainder of the benefit- minus the value of the policy’s adjusted cost basis- would get posted to the corporations capital dividend account. You may want to consider this strategy if you’re a key person or shareholder of a Canadian Controlled Private Corporation that has excess income and a prosperous future. It’s also useful for those who want to reduce their corporation’s tax burden and potentially use the cash value for future business ventures.
Tips for the Wealthy
Life insurance is often used to replace the loss of income that occurs when one passes away so that their family members have continued financial stability. However, life insurance has many other uses that go beyond income replacement.
Wealthy Canadians can use life insurance to create investment growth, tax-free. It can become part of a non-registered investment portfolio with an attractive rate of return benefit. This enhances intergenerational wealth transfers. Then, there’s the fact that the cash value of a life insurance policy is considered an asset. So, cash from the policy can be accessed during the policyholder’s lifetime. Especially in whole life policies, holders get a stable, steady rate of return on their investment. Their funds are used conservatively to invest in bonds, equities, real estate and mortgages. These returns are smoothed out over time which reduces any volatility. Another feature of life insurance policies is that they can be combined with a life annuity which creates a lucrative insured annuity. Canadians over 65 years of age with non-registered assets can seriously benefit from using life insurance in these ways.
As previously discussed, our tax system in Canada applies a capital gains tax when you pass away. This is based on the deemed disposition of your assets, and means that parents who want to transfer their shares to their children will subject those shares to capital gains tax. You could either prepare to pay this liability tax by using cash, selling assets, borrowing funds, or using life insurance. Life insurance is the most cost-effective option. It can also be used to buy family members out of their shares for a family business.
It’s important that Canadians choose a life insurance advisor who’s experienced with these elevated strategies. They need to be transparent, reliable, and have a proven record of effective life insurance strategizing. Choose an advisor that can explain these advanced concepts to you in a clear and concise way so you can fully understand your choices. They should be creative, adaptable, and highly knowledgeable of the Canadian tax system. Consider looking for someone with experience underwriting life insurance policies for larger values and higher-income individuals.
Wealth Transfer
Affluent clients accumulate money to leave to their children or grandchildren by investing in RESPs, and TFSAs (subject to contribution limits). Other non-registered investments may be subject to tax and won’t provide flexibility upon transfer of this wealth.
In Canada there exist attribution rules when a parent or grandparent invest on behalf of a child or grandchild. If income producing property, or money which is used to purchase income-producing property, is transferred or loaned to a related minor, either directly or indirectly, or by means of a trust, the income from the property will be attributed back to the person giving the gift or loan. Although there is no attribution on capital gains, in order to have it taxed in the hands of the child the capital gain must be paid out to the child. The parent or grandparent cannot have any control over the funds as it may be possible for the capital gain to still be attributed back to the parents or grandparents.
A tax effective way to transfer wealth to your children or grandchildren is by purchasing a permanent life insurance policy on the life of the child through the Wealth Transfer strategy. The parent or grandparent with excess wealth is the owner of the policy and pays the premiums. The policy builds cash value (whole life or overfunded universal life) and at some point in the future (usually age of majority), ownership of the policy is transferred to the child. Under rules outlined in the Income Tax Act, the transfer may qualify as a tax free rollover and the child becomes the new policy owner.
With the child now being the owner, age 18 or older, they can access the funds from the policy. Any income arising from a policy gain is attributed to the child, not the parent or grandparent. The child can use the policy’s cash value to fund post secondary education, purchase a new home or simply for cash flow needs. This wealth transfer not only avoids attribution rules, but can also form part of the child’s future estate needs with many years of growth ahead.
