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An Insurance Policy Can Help You Make Sure Your Loved Ones – Not The Taxman – Get Your Inheritance

A life insurance policy is a useful tax-deferral tool that can help you build wealth without a big tax-bill – and leave more behind for your loved ones.

The more money you have the more you tend to have to pay out in taxes, and for those wealthy enough to max out traditional tax-saving vehicles like RRSPs, a life insurance policy can be an efficient tool to shelter capital.

While people tend to view an insurance policy as a way to protect themselves, their business or their family should anything unexpected happen, permanent insurance can also be used as an investment tool – and perhaps more importantly, as a way to grow money tax-free.

“It’s a good tax-deferral mechanism during your life, but in death, if the policy is a universal life policy …all of the cash that’s accumulated … plus the death benefit will be paid tax-free to the beneficiaries,” said Tina Tehranchian, a chartered life underwriter and certified financial planner professional with Assante Capital Management Ltd. in Richmond Hill, Ont.

Through permanent insurance policies like whole life or universal life insurance, you can accumulate wealth that you can transfer to your family, tax-free, when you die. While you can benefit from the money that you save during your lifetime, in the form of a policy loan or withdrawals (in case of universal life policies), it will also provide you with a safe way to build an inheritance.

“Often people have a portfolio of assets – they have their stock assets, they have their savings assets, they have their home, they have their capital and their companies – but what they don’t have is a tax-sheltered insurance product that provides them a security blanket in essence, not just for insurance purposes but for sheltering money,” said Michael Godsoe, president of Godsoe Financial Capital Ltd. in Toronto.

“As time goes on the sheltering of the money continues to grow inside that program, and one day you can turn it into an annuity tax-free. It gives people options and choices.”

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If you need to tap into those cash reserves during your lifetime, you can also borrow against the policy. In that case, you will have to pay some taxes because if you, for instance, begin a systematic withdrawal system, you’ll be triggering a partial disposition, said
Sam Albanese, an expert in mutual funds and insurance licensing who is also the industry director of insurance and wealth management programs at Seneca College in Toronto.

At that point, the difference between the adjusted cost base and the amount you’re taking out will be taxed. But because the adjusted cost base is considered a return of your own money, the only taxes you’ll pay will be on the difference, so you’d still benefit from tax savings over a vehicle like an RSP, where there is no adjusted cost base, so the entire amount is taxed upon withdrawal.

If you do make withdrawals during your lifetime, whatever funds you take out of your plan will be deducted from the death benefit later. The amount that remains in the plan, however, will be passed on to your beneficiaries on a tax-free basis.

“Just like a house, you can borrow against the value of the life insurance policy, so you never have to pay tax on the borrowing, the loan,” said Godsoe. “You just pay interest on the loan.”

The two kinds of insurance products that provide tax-sheltering benefits are exempt universal life and whole life insurance policies.

Under a universal life policy, you’re allowed to put extra money into your plan, as long as it’s within the difference between the minimum and maximum premium allowed.

If the minimum premium is $2,000 and the maximum is $10,000, for example, you can put an additional $8,000 into your plan and that $8,000 would grow in the universal life plan on a tax-deferred basis, Albanese explains.

“You could invest that money into almost anything – mutual funds, segregated funds, bonds, GICs, (all) depending on the risk tolerance of the client,” he said.

Whole life insurance is a bundled product, so you don’t have the same flexibility to add in additional cash or to choose your investment options. You pay for your premium and the insurance company chooses how to invest that money. But unlike universal life, which carries an element of risk because of its investment component, whole life is a fully guaranteed product, Albanese said.

“If I say to you that at age 70 you’ll have $100,000, you will,” he said.

These types of vehicles are often used by high net worth individuals, who have perhaps already topped up their Registered Retirement Savings Plans, Registered Education Savings Plans or their Tax-Free Savings Accounts.

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“If you’re used to earning a quarter million dollars a year, even though you maxed out your RSP every year, it’s going to be very difficult to amass a pension of some sort that’s going to generate a quarter million dollars a year for you … but you can supplement that with this kind of a plan,” Albanese said.

It can also be useful for business owners, who can take a universal life policy on their lives and make their company the beneficiary.

That money can eventually go into the capital dividend account of the corporation and get paid out, tax-free, to the owner’s family.

“The holding company can own a life insurance policy on the life of the owner – with the policy being paid for an owner by the company – and the company being the beneficiary,” Tehranchian said.

“That way they can keep the cash inside the corporation, have it sheltered and when they die (the majority of it) can be extracted from the company on a tax-free basis through the capital dividend account.”

Life insurance can also be a useful tool for self-employed individuals, who tend to have fluctuating income and may need some flexibility to take a premium holiday during lean years and invest more when their balance sheets are healthier, she added.

For the average person, these types of plans can be used to build an inheritance that unlike a RESP, can be used for anything the children or grandchildren wish.

A grandparent could, for instance, buy a life insurance policy on a grandkid, fund it, and leave that money to the grandchild through an inter-generational transfer upon his or her death, tax-free, Albanese said.

If the grandchild chooses to dip into those funds, the difference between the adjusted cost base and the withdrawal amount will be taxed, but it will be taxed in the grandchild’s hands, not the grandparent’s, and therefore (presumably) subject to a much lower tax-bracket.

Through an absolute assignment, the grandparent could also transfer the policy to the grandchild while still alive, and the same rules would apply.

But like with all insurance products, you have to keep two big things in mind when looking at a potential insurance policy: are the premiums ones you can afford, and are you healthy enough to qualify? If you’re not, this option won’t be available to you.

It’s also best to speak with a trained professional when dealing with these types of sophisticated products so you can make sure you fully understand your options.

“There are many different versions of these policies available (and) different factors that can affect the final result that you get,” Tehranchian said.

“Depending on your particular circumstances, one of these may be the right type of product for you, but it is very important to talk to somebody who is well-versed with these types of policies and doing planning around them.”


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