Among the many tools available to preserve wealth, permanent life insurance is one of the most versatile. Although the premiums are high, the advantages in using permanent life insurance for the wealthy can be numerous: part of the cash value of premiums can be used to invest tax-free, and the death benefit also is tax-free.
But clients are not always aware of these benefits. Says Andrew Wilkin, partner and financial advisor with Cowan Wilkin Financial Services Inc., which operates under Sun Life Financial Assurance Co. of Canada’s banner in Waterloo, Ont.: “Most people may have a preconceived notion that [permanent life insurance] may be expensive. But then, when they see what the commitment is, they’re very pleasantly surprised and say, ‘Hold on, I can get this amount of money for 2% or 3% of the face amount?’ They realize that’s a pretty good deal.”
As Wilkin notes, the estate planning goals that high net-worth (HNW) clients can achieve with whole or universal life insurance vary widely: monies can be created for the support of dependent adults; debts such as mortgages or business loans can be paid off; and assets can be provided for charitable giving, among other goals. Insurance policies also are relatively easy to set up, unlike trusts or other investment structures, and provide great flexibility in terms of choice of beneficiary and amounts to be paid out.
Another key feature – and one that’s often an influential factor when clients are weighing the pros and cons of insurance – is the tax advantages that permanent life insurance can provide. For example, the death benefit can be used to pay taxes owing as a result of the deemed disposition rules that arise upon death. Under those rules, assets of the deceased are – with some exceptions, such as a spousal rollover – deemed to be sold upon death. If a capital gain is realized, income taxes may be payable on 50% of the gain.
“In preserving an estate, sometimes people don’t realize what the income tax liability will be at the time of death,” says Christine Van Cauwenberghe, vice president, tax and estate planning, with Investors Group Inc. in Winnipeg. Although probate fees are low in Canada – less than 1% of the estate value in all but three provinces – clients often are shocked to learn that significant income taxes may be due.
Van Cauwenberghe tells of a client couple who had an estate worth $20 million, including significant real estate assets, which they hoped to divide equally between their two children. “These clients were appalled to find that their estate was worth $15 million [after taxes] and not $20 million,” she says. “They immediately signed up for $5 million of life insurance because they wanted to leave an estate that was worth $20 million.”
Small corporations also can use life insurance to generate tax-free cash that can be paid out to shareholders, a technique that can be attractive to HNW clients who own small businesses. The corporation is the owner of the insurance and when the benefit is paid to the corporation upon the client’s death, the money is placed in a corporate account that allows it to flow through to shareholders on a tax-free basis.
Mark Halpern, CEO of Markham, Ont.-based WEALTHinsurance.com, often uses life insurance to reduce tax liabilities for HNW clients who are business owners. “Corporate-owned life insurance is an excellent solution to use [to create] after-tax corporate money to mitigate taxes,” he says. “The insurance is owned and paid for by the corporation. The beneficiary is the corporation.”
But this strategy, while still useful, has become somewhat less tax-efficient following rule changes that came into force in 2017, says Kevin Wark, managing partner with Integrated Estate Solutions in Toronto. The effect of the revised rules is to create a higher policy adjusted cost basis (ACB). The higher ACB reduces the amount of the life insurance benefit that is credited to the corporation’s capital dividend account and reduces the tax-free dividend that can be paid to shareholders.
The 2017 changes also reduced the usefulness of permanent life policies as investment vehicles. One of the most attractive features of these policies is a rule, known as the “exempt test,” that permits part of the cash generated by premiums to be invested, with the gains exempted from taxes. But as of January of 2017, there is substantially less room for clients to hold tax-exempt investments in permanent life insurance policies.
However, some advisors suggest that concerns about the impact of the new rules have been exaggerated. Says Jim Ruta, executive vice president with the Covenant Group in Toronto: “[Before 2017], the premiums used to allow you to accept more money faster and that built a faster cash value in a whole life contract. The government said, ‘Wait a minute, we’re not making enough money [on taxes on the gains].’ So, they fixed it. But, in my opinion, they can’t fix it enough to make it a bad deal.”