Permanent life insurance: A tax efficient tool used by many affluent families

When we are young, life insurance is used to protect our family by providing money to replace our income. However, as we approach retirement our need for income replacement lessens and the focus switches to wealth protection. Wealth protection is a permanent concern, so it requires permanent solutions. 

In this article, we’ll discuss how permanent life insurance is a tax efficient tool that helps many affluent Canadians address three main concerns:

  1. Providing estate liquidity through Estate Preservation
  2. Providing additional liquidity for Estate Equalization
  3. Enhancing the value of your after-tax estate through Estate Maximization

Estate Preservation

Let’s first look at estate liquidity.   If your estate has a large tax bill that exceeds the available liquidity of your estate after you pass – where is the money coming from to pay the tax bill?  What are your options?

  1. Assets could be sold to fund the obligation – does that make sense?
    • Selling assets may reduce the long-term income from the estate assets. Killing the goose that lays the golden egg is not a good long-term strategy.  There could be transaction costs and additional taxation costs to get the cash to the estate reducing the effectiveness of this solution
  2. Borrowing is an option to pay the tax bill. 
    • Will the estate have the capacity to borrow? Will someone else lend to the estate the cash to pay the tax bill.  The loan must be repaid and likely with interest, making it an inefficient solution
  3. Save up for the tax bill. 
    • How do you know when you need the money? How do you know how much to save each year?  Tying up large amounts of passive investments may not be a good long-term strategy for investing    
  4.  Insurance
    • In most cases, for a very small percent of the tax value annually, insurance can provide a solution that provides 3 key benefits:
      1.  Provides the liquidity exactly when needed.  In less than 30 days after death, the money could be in the estate bank account ready to cover all the needs of the estate;
      2. Provides the liquid cash tax free;
      3. If a private corporation is involved insurance can be even more efficient as the proceeds are received by the corporation tax-free and largely transferred to the estate of the shareholder on a tax-free basis using the Capital Dividend Account.

Estate Equalization

Consider this:  You own a unique and valuable asset that you want to leave to one beneficiary specifically.  Or perhaps you’re in a blended family situation and you want your children from your first marriage to have part of your estate.  How can you help distribute your estate more equitably?

Many wealthy Canadians buy insurance for estate equalization.  Even if the estate preservation has been addressed there may be issues with equalization.  If one beneficiary is receiving a disproportionate amount of the estate from the other beneficiaries, or in situations of blended families and trying to distribute assets to specific individuals, insurance can be the ideal solution.  Permanent life insurance can provide a tax-free, cost effective means to get cash to other beneficiaries of the estate.

Insurance can provide a lifetime of insurance protection as well as the potential for tax-deferred policy growth.  This value can provide you financial opportunities or income needs during your lifetime.  On your death a tax -free death benefit can be paid to your named beneficiaries, bypassing the estate, and avoiding probate. It can also help address privacy issues which may be important in blended family situations.  If you own a private company and it is going to one beneficiary, there can be ways to fund the insurance through the company and use special shares to transfer the insurance proceeds to the other beneficiaries.

Estate Maximization

Some Canadians have excess capital that they will not need for retirement needs during their lifetime and they have a strong desire to leave a legacy.  Most people rely on traditional investments to increase the value of their estate.  Others believe that real estate or business ownership are the solution.  While all of these are useful, they do have tax implications. 

What if, instead of investing in traditional investments with the excess money we reallocate the funds to a permanent insurance policy.  An exempt permanent life insurance policy provides tax-deferred policy growth while alive and pays out tax-free on death to your named beneficiaries or the estate.

Also, if you have a private corporation, using this strategy can have extra benefits. During your lifetime, contributions to the permanent life insurance will grow tax-deferred and can reduce your passive investment income tax. Not only is the death benefit received tax-free but the death benefit less the Adjusted Cost Basis (ACB) produces a credit to a corporation’s Capital Dividend Account (CDA) – Capital Dividends can be paid out to the shareholders of the company on a tax-free basis adding to increase in estate value.

If any of these estate planning concerns might be relevant to you, or you’d like to learn more about permanent life insurance, your IG Consultant can help assess your personal situation.  For more information on this topic, please also ask them to share a copy of our white paper “Why affluent Canadians buy permanent life insurance”.