distributing wealth
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This article appears in the June 2021 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

Some older clients are looking at using permanent life insurance to preserve wealth not just for their kids, but for several generations.

“Baby boomers have so much cash, they’re trying to find the best tax solution [for] the transfer [of wealth],” said Melissa Harrell, a financial advisor with Howe Harrell & Associates in Winnipeg. “They want to leave a gift or a legacy to their child or grandchild [while] at the same time minimizing annual taxation and avoiding probate.” There are several ways permanent life insurance can help achieve those goals.

The cascading legacy

Cascading life insurance works well for an affluent grandparent who wants to leave a legacy for their grandchild.

With the cascade method, the grandparent takes out a permanent life insurance policy on their adult child and names their grandchild as the beneficiary. The adult child is the contingent owner of the policy from the get-go, and once the grandparent dies, the adult child becomes the outright owner.

“The grandparents could just leave money to their minor grandchild in a will or trust, but inside the insurance policy, [the assets] grow and can eventually be transferred tax-free and bypass the estate,” Harrell said.

Permanent life insurance doesn’t always require a death before the cash can be realized. The contributions are invested over a specific period. At maturity, the policy would pay out a tax-free death benefit and money could be withdrawn at the policyowner’s discretion.

“With some universal life policies, you can even choose how you invest the money, the same way you would with a tax-free savings account or any other investment,” Harrell said. “At some point in the future, the beneficiary can decide whether to cash in the policy or leave it in place, continue to fund it and possibly roll it over into a policy for future generations. They may never even touch it in their lifetime.”

Financial buffer

A life insurance policy is considered an asset of its current owner, regardless of the beneficiary designation. That’s another reason the cascade method is popular — it provides a layer of security for the middle generation, even if not in the form of cash.

“When the adult child becomes the contingent owner of the policy, even if the grandchild is the beneficiary, the owner can claim that insurance as an asset and borrow against it,” said Chris Fernandes, senior investment advisor with Wellington-Altus Private Wealth Inc.

The contingent owner has full control over how to manage the policy — they could, for example, change the beneficiary or cash out a policy prematurely. A grandparent could prevent this by naming the grandchild as an irrevocable beneficiary. This added level of complexity requires the contingent owner to get consent from the beneficiary to make changes to the policy.

Naming an irrevocable beneficiary “is not something that’s put in place often because it’s complicated and doesn’t guarantee the middle generation won’t find a way to collapse the policy,” Fernandes said. “But collapsing a policy is a big taxable event and completely undermines the idea of the insurance policy as a tax-free legacy.”

Another option is to cut out the middle generation altogether.

“If the grandparent is concerned, they could simply make the grandchild both the owner and the beneficiary of the policy, regardless of who they’re insuring, and take control away from the parent,” Fernandes said. “It’s also possible to have multiple policy owners.”

Beyond legacy giving

“Cascading can be about preserving insurability,” said James Kirk, partner and financial planner with Lawton Partners Wealth Management in Winnipeg. “I’ve had clients in their 30s or 40s who’ve had difficulty getting insurance for themselves.”

To prevent the same issue from happening to their children, these clients “insure their children early on with a permanent life policy so their eventual grandchildren will one day receive a death benefit,” Kirk said.

A cascade policy also can help a client’s family pay probate or generational transfer taxes on a family business. The older generation may not want their heirs to be forced to sell a family business when the owner dies because the family can’t afford the taxes owing on the capital gains incurred by the client’s estate.

“Life insurance can provide the right liquidity at the right time,” Kirk said. “There is a cost to it, and with multigenerational policies, somebody has to commit to the ownership and oversight of these policies. But if the cost is manageable and sustainable, it’s a fantastic way to provide a benefit to your family.”

Profile of a legacy leaver

Cascading life insurance isn’t for everyone. Normally, the strategy works for those who foresee their money outliving them. The right client is likely to hold a lot in non-registered investments.

“It’s all based on affordability,” said Jack Lumsden, financial advisor with Assante Financial Management Ltd. and author of Preserving Wealth: The Next Generation. “If you’re doing a cascade approach, can your client afford to put $100,000 into an insurance policy over a five- to 10-year period? The client has to be in a position to say, ‘That money is no longer ours and it’s not going to affect our retirement lifestyle.’”