Section 148, of the Income Tax Act, is one of the few remaining tax sanctuaries
How to build a tax exempt estate with insurance? Ronald and Sonia are ecstatic. At 55 and 50 respectively, they’re the proud grandparents of Victoria, their first grandchild. They’re already planning sleepovers and outings. But having their first grandchild has got them thinking about estate planning…
Ronald, an engineer, and Sonia, real estate broker, earn very good incomes and they pay a healthy amount of income tax, too. They told me that, over the years, they’ve worked with several advisors as they could not find the appropriate one. Thank goodness that both of them had been careful money managers, as it has put them in a fortunate position and they have extra funds they want to use to build an inheritance for Victoria and the others to come.
Ronald and Sonia were referred to me by a friend of theirs, who is in a similar situation. After our initial consultation I told Ronald and Sonia, that they’re in a great position. You’ve maxed out your RRSPs; you’re taking full advantage of your TFSAs; and you have extra money left to invest; you’re not finding a suitable place to put away extra money because your combined incomes bring you into the highest tax-bracket. So far, everyone is in agreement.
Both of you said you would like to build more wealth and pass it on to your grandchildren and leave something to your favorite charities if you can. In doing so you expressed that you really don’t want to pay any more tax if at all possible.
I told Ronald and Sonia that they can rest easy with what they would like to accomplish. Before we parted, I gathered additional information from them and we booked another appointment in 14 days’ time.
Critical Illness/Insurance Creation
SECTION 148, INCOME TAX ACT
Deposit flexibility — you can change the frequency and amount of your deposits.
TAX-FREE build-up of earnings within the tax-exempt plan.
TAX-FREE income through an innovative loan program when required.
TAX-FREE money to heirs upon the death of the life insured.
Creditor protection — money in the plan can enjoy creditor protection where structured properly.
Assets in the tax-exempt insurance plan can be used as collateral.
No mandatory or minimum income payments in retirement — if you don’t need or want the income you can continue sheltering the growth within the plan.
Since income streams properly structured from the plan, is not included in taxable income, the plan could prevent claw-backs on Old Age Security.
At the beginning of our next meeting, I explain to Ronald and Sonia that I meet my clients at different points in their lives so no one situation is the same, just like no one’s fingerprints are the same. I then read something like the following to them… When a full plan is complete and we get up from the table and shake hands. The following would be true about my client’s situation that was probably not true before?
• If a breadwinner dies prematurely, the family’s lifestyle will not be fatally compromised. They will stay in their home and retain the family cottage if they have one. Educational plans will remain financially intact and on track. The family business, if they own one, won’t have to suffer a forced sale at massive discounts.
• Similar outcomes will prevail in the event of a serious disability or critical illness.
• The children, and/or grandchildren of the family, will be able to afford the very best education for which they are suited and for which they can qualify, without still being saddled with student loans when they themselves have children.
• The current generation of the family will be able to retire at their own time and on their own terms, with a high degree of confidence that they will never outlive their income. Above all, that their dignity and independence will not be undermined by decades of rising living costs.
• The current generation will, if necessary, be able to contribute meaningfully to the support of the parents. Moreover, this generation will never become a financial burden to the children, even if extended nursing home stays are required.
• Even as retirement income rises to offset inflating living costs, the capital will continue to grow over time, endowing meaningful legacies to the succeeding generations.
• Estate taxation, debts and costs, won’t force the sale of the family’s important assets such as the family home, recreational property, and business. This liability will be properly identified and will be funded out residual capital and/or discounted through an appropriate insurance structure.
After I answered questions Ronald and Sonia had, we went with my first example. I explained the beauty about “life insurance” is that it offers you insurance protection and the opportunity to invest and accumulate money in the policy without tax implications. But there has to be a proper balance between the amount of investments and the amount of insurance.
Some life plans take care of the balancing act for themselves by automatically adjusting the amount of insurance. This means they keep the amount of insurance low, while at the same time ensuring the policy stays tax-exempt. It keeps the cost of insurance in check too and makes for easy, hands-off insurance management.
These products have been designed for people like you. Giving you that alternative to taxable investing you’re looking for and leave a tax-exempt benefit. Sonia and Ronald were both very intrigued about me saying that this type of insurance plan is a good alternative to a taxable investment. They ask if I can show them just how good it is. We went over an illustration based on some parameters that I gathered in our first meeting.
The following is an outline of the discussion of the scenario:
DEPOSIT(S)
• Initial deposit is $25,000
• Deposits are made up to the 10th policy year
• A 2% deposit load is deducted from each deposit for the provincial premium tax that the insurance company pays
INVESTMENT ACCOUNTS
• Your deposit(s) go into an investment account or accounts you choose
• The availability of investment accounts vary with carriers, so it helps ensure that your plan is customized to suit your specific investment profile, risk tolerance, etc.
LIFE INSURANCE PROTECTION
• The amount of your initial deposit determines the initial amount of insurance you’ll need to keep the policy tax-advantaged
• Each year, on your policy anniversary, the amount of insurance is adjusted to keep it at a minimum, while at the same time making sure it stays within government guidelines for tax-exempt policies
Male 55 non-smoker and female 50 non smoker have an aggregated age of 42 on a joint last policy. The assumed interest rate is 5% and we have deposited $25,000 for a 10-year period.
• At year 10, the cash value is $301,884
• At year 20, the cash value is $502,072
• At year 30, the cash value is $793,260
• At year 40, the cash value is $1,272,577
Remember, these details are taken from an illustration. Amounts, ages and investments used will vary with each insurance company, so the final outcome will differ.
Avoid probate fees, pay less tax, take advantage of life insurance trusts for estate planning
There are two types of trusts: Inter Vivos trusts, created during the life of the settlor, and testamentary trusts, created after the death of the settler. For tax planning, testamentary trusts are generally preferable, because income retained by the trust is taxed at graduated rates. To meet the definition of a testamentary trust, in subsection 108(1) of the income Tax Act (Canada) (ITA), the trust can only receive property from an individual, on or after and as a consequence of that person’s death.
Life insurance trusts are increasingly popular for estate planning because of their flexibility, tax advantages, creditor protection and the control they allow after death. They involve a three party agreement, in which the person who creates the trust (the settlor) directs property to trustees, who as a trustee hold and manage the property for the benefit of the beneficiaries. Trusts must have three certainties: certainty of intent (intention to create a trust), certainty of subject matter (property) and certainty of objects (beneficiaries).
A properly structured life insurance trust ensures the trust qualifies as a testamentary trust and the life insurance proceeds do not flow through the estate. For example:
Life insurance declaration in the will. The declaration provides that that life insurance proceeds are paid to trustees in a separate life insurance trust. The wording ensures trustees hold property for the benefit of designated beneficiaries. It clearly identifies the life insurance trust separate from other trusts established by the will.
Life insurance trust structured outside the will. The life insurance trust is set up before death, but the life insurance proceeds actually settle the trust. It’s extremely important from a tax perspective that the trust arise as a result of death.
Hybrid arrangement. The life insurance declaration is made outside the will, but the terms of the life insurance trust are set out in the will. These terms are incorporated by reference in the declaration.
It’s important that you work closely with an experienced advisor to ensure the proper products are used for the desired outcome.