Vassalo & Associates Private Wealth Management, Summer 2024

The concept of insurance dates to ancient times (as early as 4000–3000 BCE) as a fundamental tool of protection. It is a tried-and-true means of safeguarding against those “What if?” scenarios, providing funds needed to cover ongoing expenses or debts. Life insurance is also a tried-and-true way to provide a tax-free benefit to loved ones and can be set up to bypass probate, executor and legal fees.

But once you’ve have gotten through that “pure protection” stage and you’re financially self-sufficient, is there still a place for insurance?

Not only is there simply a place for insurance when you could self-insure, there are in fact myriad potential uses for insurance beyond the protection stage. While term life insurance provides temporary protection, permanent life insurance policies provide lifetime protection and may also build cash values. These added features make these policies much more versatile and powerful financial planning tools.

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Financial planners who do not discuss the many uses for life insurance are doing clients a disservice.The insurance discussion is part and parcel of intelligent financial planning making the most of the tools at one’s disposal to maximize financial success.

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In part I of this article, we explore some of the many personal uses for permanent life insurance that go beyond the traditional protection mindset. In part II, we’ll look at some ways life insurance can be of benefit to corporations.

 

Thinking outside the conventional box we conjure for life insurance: it’s personal

 

Personal uses for life insurance

An efficient way to cover estate tax (and preserve family assets)

Estates must pay taxes on gains realized from capital properties that are considered to have been sold on the date of death. And unless registered assets (RRSPs, RRIFs) can be rolled over to a qualified spouse or minor child, they become fully taxable on death. This is in addition to probate, executor and legal fees.

Not only can non-taxable insurance benefits be used to cover these costs, they can also provide a source of readily accessible cash to ensure that non-liquid assets (such as a family business or cottage) need not be sold to cover these taxes and fees.

A growth-minded legacy planning strategy

The benefit to an estate on death can be significantly greater if investors move some of their excess non-registered money into a permanent life insurance policy. Participating life insurance (or par), for instance, includes an investment component that allows growth on a tax-free basis (within legislative limits), as long as the funds remain within the policy. The insurance benefit is paid out tax free upon death.

Insurer software can illustrate the potential growth of a custom permanent insurance policy and compare it to expected after-tax returns for comparable-risk investments. Your financial planner should be able to use that illustration to demonstrate how a policy could impact your legacy goal.

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Admittedly, these first two ideas are not as “outside the box” as some of the ideas that follow. Still, if you were brought up on the notion of “buy term and invest the rest,” permanent insurance may not be something you’ve considered. It is, however, worth exploring, especially when contemplated alongside the next strategy in this list.

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An alternative, low risk asset class investment

Rarely does an insurance policy come to mind when people are asked to name an investment class. Yet participating life insurance is known to be a stable, low-risk asset that can producing better after-tax rates of return than traditional, conservative investments (such as GICs and bonds).

The par accounts backing participating insurance policies are an important aspect to consider. Top insurers in Canada who offer participating life insurance have held their large par accounts since before the turn of the last century (yes, the 1800’s), managing them to meet the long-term needs of policyholders. These factors help support strong, steady, low-risk growth for policies over the long term.

In addition, investment gains and losses are brought into the policies’ dividend scale interest rates gradually over time to “smooth” the highs and lows helping give more stability for any dividends the policy may receive. While dividends are not guaranteed, these top insurers have distributed participating policyowner dividends consistently, even in difficult economic times.

A tax-efficient source of retirement income

While permanent insurance may be purchased for estate planning purposes, cash values (if included in the type of permanent insurance policy that was purchased), may also be used as a tax-efficient source of income if needed (doing so will impact policy values).

A common way to access a tax-efficient source of income is to use the policy as collateral for a line of credit or a loan from a financial institution. Such loans are received tax-free under current tax laws and can be structured so no interest is payable until death. On death, the loan is repaid from the death benefit and any remaining benefit is paid to named beneficiaries.

Cash values may also be withdrawn directly or through a policy loan from the insurer, though these options may trigger tax consequences.

An answer for blended families

Blended families who do not structure their estate plan properly run the risk of one branch of the family receiving the entire estate, with the other branch of the family receiving little or nothing. One way for individuals to both leave sufficient assets to their spouse and ensure they leave what they’d like to their own children is to buy insurance to fund the difference. This helps ensure each party will receive the desired amount and will be free to use their inheritance as they see fit. This is usually the most simple and practical solution, and the option most frequently recommended. 

If the children are adults, you can name them as direct beneficiaries. If your children are young, consider directing the insurance proceeds to an insurance trust, so that a trusted family member can manage the funds and distribute them over time or when the children are mature enough to use the funds appropriately. Otherwise, the provincial government may have the authority to manage the funds until they reach the age of majority, resulting in unnecessary expense, and then the children will be entitled to the funds when they are potentially still too young to manage them.

A way to equalize estates among beneficiaries

Similarly, the proceeds of a life insurance policy can be used to equalize an estate between beneficiaries where specific assets will be left to certain heirs. For example, if one child will be taking over a family business, and you want to leave an equivalent amount to another child, or if one child is interested in maintaining the family cottage but another lives too far away to make use of it, an insurance policy can allow for this without the need to sell other assets.

A tax-efficient strategy to cascade wealth to grandchildren

Here’s an interesting concept: You could purchase a permanent life insurance policy that you own and where your adult child is the life insured. You also designate them as the contingent owner (allowing a tax-free transfer of the policy to them at your death). Their children (your grandchildren) are the beneficiaries of the policy (again, if the children are young, consider directing the insurance proceeds to an insurance trust). Here are the advantages of this concept:

• Assuming your child’s good health, the ultimate benefit to your grandchildren can be higher than if you were the insured person because the cost of insurance is in large measure based on the age of the insured person.
• As you transfer non-registered assets to fund the policy, your future annual tax burden is reduced.
• Most permanent life insurance policies (such as participating life insurance) can be structured to allow growing death benefits and cash values where:
  • Policy values grow on a tax-free basis inside the policy (within legislative limits)
  • The policy owner has access to the cash value in the policy while they are living and
  • Over time, the growth of the death benefit can be substantial (depending on whether cash values were accessed)
• At your child’s death, the benefit would be paid to your grandchildren, again without taxes, probate or legal fees.

A smart way to make a charitable donation

Donating using life insurance can provide significant support for your chosen charity, while preserving the value of your estate passed to your heirs. There are a couple of approaches to consider when donating a life insurance policy. 

Retaining ownership of the policy: You can retain ownership of the policy, with the death benefit paid to your chosen charity. (The charity can either be named as the direct beneficiary or can receive the proceeds from your estate through your will.) When the charity receives the death benefit, your estate will receive a donation tax credit, which can provide large tax savings upon your death, particularly if there are significant taxes owed by your estate. Retaining ownership gives you the control and flexibility to revise your beneficiary designation or will at any time. 

Transfer ownership of the policy: If you transfer ownership of the policy to a charity during your lifetime and continue to pay the premiums, you’ll receive tax benefits throughout your lifetime, since each premium paid is eligible for a donation receipt (versus upon death). The ownership transfer itself will generate a donation receipt for the cash surrender value of the policy on the date of the donation, or fair market value if an actuarial valuation is obtained. (Tax rules may limit the donation amount that can be claimed to the policy’s adjusted cost base depending on when and why the policy was acquired).

Hopefully this brief overview of some of the many uses for life insurance has provided you with a glimpse into just how versatile and powerful a tool life insurance can be when structured appropriately. This overview, of course, is no substitute for independent professional advice. The concepts involve many important matters that must be considered including insurability, funding, structure, ownership and taxation. It is important to obtain personalized advice when dealing with insurance. Speak with your advisor for a full and complete review of your situation before making any decisions.

This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Teresa Schnurr is solely responsible for its content. For more information on this topic or any other financial matter, please contact an IG Wealth Management Consultant. Insurance products and services distributed through I.G. Insurance Services Inc. Insurance license sponsored by The Canada Life Assurance Company.