Many people perceive life insurance as a financial instrument that only provides value to someone else. This could be their spouse, their children, their business partner. It is easy to understand why this is the case when a premium continues to be paid for a paper benefit that you only see on an annual statement but will never have the chance to actually use.
However, if properly structured, life insurance can have another side to it – one of the most efficient, under-utilized tax planning vehicles available. There’s no question that the largest benefit is created as a result of death of the life insured – but what the insurance policy can be used for along the way should not go unnoticed.
These four ideas are only scratching the surface of when it comes to tax-planning with life insurance. There are many more strategies in our arsenal – including those that can create significant tax benefits on death.
TAX SHELTERED ACCUMULATION
Within prescribed limits, deposits beyond the pure premium can be made to an insurance policy. These “additional deposits” grow on a tax-sheltered basis – accumulating without tax until the point of a withdrawal or other disposition. This can be a great fit for individuals that have maximized their contributions to their RRSP and their TFSA – yet are still looking for tax-advantaged methods of growing capital. It can also fit very well with passive investments in a holding company. Investments not used primarily for the purpose of growing your business – “passive” investments – attract a very high rate of tax (50.67% in Alberta). A corporately owned insurance policy that is properly structured can be used as an alternative investment vehicle – one that does not attract any tax and diversifies the overall portfolio.
TAX-EFFICIENT RETIREMENT INCOME
Combined with #1 above, an option when taking advantage of the tax-sheltered accumulation is to actually use the money rather than simply save it. For many clients, the portion of their assets redirected to an insurance vehicle represents surplus – assets designed for their legacy. However, simply because the capital has been transferred to an insurance policy doesn’t mean you can’t use it. It can be used in two different ways – (1) for investment purposes by borrowing against the assets in the insurance policy and investing elsewhere, or (2) using the accumulated assets in the policy to supplement your retirement income. When considering supplementing your retirement income, it is possible to enjoy the tax-sheltered accumulation to increase the size of your nest egg, then in the future borrow against the investment value of the policy to provide a tax-free income stream over a period of years. The loan value will never exceed the cash value of the insurance policy, allowing you to capitalize the interest and allow the loan to be repaid on your death. The base amount of death benefit remains intact and will pay to your beneficiaries tax-free as originally designed.
TRANSFERRING FUNDS FROM ONE GENERATION TO ANOTHER - TAX FREE
This is also referred to as a “cascading wealth strategy”. Insurance policies can be transferred to an insured child once that child reaches the age of majority. Consider a recent case where one of our clients insured each of his children and transferred a sum of capital to each policy. As owner and beneficiary, he retains full control of the policy, including the tax-sheltered investment value. Once his children reach the age of majority, he can transfer the ownership to them on a tax-free basis. If he would like to retain some input with respect to how his children use the investment capital, he can do so through a beneficiary election. This tax-free transfer surpasses conventional methods of intergenerational giving which typically need to occur on an after-tax basis.
REDUCING THE VALUE OF A CORPORATION
This strategy involves a combination of insurance vehicles. First, passive investment capital (otherwise attracting a high rate of tax) is used to purchase a life annuity contract on the shareholder. In return for the lump sum of capital, an income stream that produces both interest (taxable) and capital (non-taxable) results. The capital used to purchase the annuity is no longer an asset - the only value of the annuity is that of a future income stream with an unknown termination date. While this will reduce the capital gain reportable on death, it also reduces the amount of capital available to the estate. This is where the second piece comes in. Using the after-tax cash flow generated by the annuity contract, a permanent life insurance policy insuring the shareholder is purchased. The amount of insurance equals the amount of capital used to purchase the annuity – making the estate whole.
Personalized transparent Risk Strategies have become a top priority with Wealth and Asset Management clients looking for insight into their holdings. If you have questions or concerns regarding Risk Strategies as part of your financial and tax planning, let us know. We would be happy to have a conversation about how we can help you achieve your goals.
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Wealthco is a corporate group that includes, WealthCo Planning Services Inc. and WealthCo Risk Management Inc. and WealthCo Asset Management Inc. Investment Management services are provided under WealthCo Asset Management. That firm is registered as an Exempt Market Dealer in the provinces of Alberta, British Columbia, Manitoba, Saskatchewan and Ontario. It holds a Portfolio Manager license in the provinces of Alberta, British Columbia, Manitoba and Saskatchewan and an Investment Fund License in the province of Alberta. The information in this article is directed to individuals registered in those provinces. The information provided here is for general information purposes and should not be construed as providing advice. Any opinions set out herein are subject to change and the Wealthco does not undertaken to notify the reader of such changes.