High net-worth (HNW) clients usually pay closer attention to tax minimization strategies than other clients do. The fewer taxes HNW clients pay, the more of their wealth they can preserve for themselves and their families. Wealthy clients typically are in the highest income-tax bracket, says Tony Maiorino, vice president and head of wealth planning services in Royal Bank of Canada‘s wealth-management division in Toronto. So, taxes are one of the biggest expenses for your HNW clients.
Once traditional tax-minimization strategies, such as investing in RRSPs and tax-free savings accounts (TFSAs), have been used, Maiorino says, HNW clients normally turn to more sophisticated approaches, such as insurance strategies and charitable giving, to preserve their wealth.
Specialized insurance strategies involve the use of permanent life insurance products, such as whole life and universal life. While these products provide life insurance protection, they also have a savings component. Your client can contribute substantially more than the premium of the policy, and that excess amount is invested within the policy to grow tax-free.
The savings accumulated in such a policy can be used to supplement retirement income while your client, the policy owner, is still alive. Upon the client’s death, the proceeds from the policy, including accumulated assets, can be: distributed to the client’s estate or to beneficiaries tax-free; used to cover estate tax liabilities and probate taxes; or donated to charity.
Clients who are 10 to 15 years from retirement and who have maximized their RRSP and TFSA contributions should consider using specialized insurance strategies. This strategy would be appropriate for HNW clients who have disposable income but do not have adequate life insurance coverage.
“Now is an interesting time to consider purchasing permanent life insurance,” says Henry Korenblum, tax manager with Kestenberg Rabinowicz Partners LLP in Markham, Ont. “The laws surrounding the taxation of certain permanent life insurance products will be changing effective Jan. 1, 2017.”
In general, Korenblum says, the rules effective in 2017 and later years will provide for fewer income-sheltering benefits because the amount of accumulation room that qualifies for tax-exempt status will be lower than the current threshold. These changes take into consideration increasing life expectancy and changes in interest rates and inflation since 1982, when the current tax rules relating to the sheltering of income in insurance policies came into force.
All insurance policies acquired prior to Dec. 31, 2016, will be grandfathered under the old tax rules.
HNW clients also can minimize taxes while following their philanthropic interests through charitable giving and foundation planning, Maiorino says. The affluent, he says, dole out a significant amount of money each year to charitable activities. While most people donate directly to charities, the affluent often establish private foundations that support planned giving.
With a private foundation, gifting can be controlled by the donor and his or her family, Maiorino says. A foundation also can provide a philanthropic legacy that survives the founder’s death.
For example, he says, a HNW client can donate securities with a low cost base and a sizable capital gain to a foundation. The client would avoid paying taxes on the gain, but receive a tax receipt for the full donation.
“[These strategies] are minimizing taxes while [clients] are alive,” Maiorino says. The money remains in the foundation and continues to grow tax-free, he explains. The operation of the foundation can be passed on to the client’s heirs, creating a charitable legacy.
Clients also can donate shares of a private company and real estate to a charity. However, Korenblum says, proposed new rules surrounding the capital gains exemption may be extended to gifts of private-company shares and real estate beginning in 2017. The proposals would allow the capital gain realized from donated cash proceeds derived from the sale of a property to be exempt from taxation. The gift must be made within 30 days of the disposition (the sale) and the property must be sold to a purchaser who is not affiliated with the donor or the qualified recipient.
If all of the cash derived from the sale is donated, the entire capital gain realized on the sale will be exempt. Otherwise, the exempt portion of the capital gain will be pro-rated, based on the portion of the cash donated from the total proceeds.
“Certain anti-avoidance rules will apply,” Korenblum says, “to ensure that the exemption from taxes on any capital gains is not abused.”
This is the second part in a two-part series on tax strategies for high net-worth clients.
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