Most families today require both parents to work to afford the lifestyle they enjoy.  Losing one of those incomes through premature death, illness or a disability is a real risk that many families would have a difficult time facing emotionally and financially.

How do you protect your family?

• Life insurance is designed to protect your family by providing the resource to replace income, pay off debt, and fund future education costs in the event that one of the parents dies.
• Disability, or income replacement insurance, is designed to replace lost income if an individual is not able to work due to accident or sickness.
• Critical Illness insurance will pay a lump sum benefit in the event of a diagnosis of many major illnesses.

If you and your spouse work for a company that provides employee benefits, you may already be insured for both life and disability insurance and in some cases critical illness.  Be aware that for the most part, employee benefit programs provide only a minimum amount of life insurance, usually based on one or two years of income.  If long term disability coverage is provided it may be enough for personal needs but that is not always the case.  Each situation is different, so it’s important that you and your spouse review your respective plan information to ensure that you have sufficient coverage in place. There are options to top up your coverage either through your group insurance or individually.

How much life insurance do you need?

If you or your spouse dies, the family will require a lump sum of capital to replace earned income.  You should aim to have enough cash for the following needs:

• insurance to pay off any outstanding debts and mortgages
• enough income from the invested capital to replace the lost income
• an amount to cover future education costs

Think life insurance premiums are too expensive? 

Term insurance is an affordable solution for a growing family with a tight budget.  A 35-year-old non-smoking male can purchase $1,000,000 of ten-year renewable term insurance for less than $45.00 per month. A non-smoking female of the same age would pay approximately $30.00 per month for the same coverage. A relatively small cost to protect a family for $2,000,000 of tax free benefit in the event of an untimely death.

Let’s have a discussion about how we can build a program of protection specifically designed for your needs and circumstances.  Knowing what the needs are and what protection is in place goes a long way to providing peace of mind.

When it comes to most forms of insurance, many people understand the importance of having coverage. Whether it’s your car, your home, or other valuable possessions, having insurance means that you’re financially protected should disaster strike.   One of the first things you do when you buy a new car is to make sure it is protected before you drive it off the lot.  Why? Because if you are involved in an accident chances are good you would suffer financially.

But, what about life insurance?

Although this form of protection works the same way as all other types of insurance, many are reluctant to open the conversation.  Perhaps one reason is that life insurance involves the planning for the worst-case scenario – your death.  The truth remains however, that if someone, your family or your business for example, would suffer a financial loss due to your death, life insurance is the answer.  In fact, life insurance is one of the smartest ways to provide for both yourself and your loved ones.

For today, take stock of your current situation and consider these important reasons why life insurance is needed:

Protect your future insurability

 Even if you are just starting out, perhaps single, with no immediate dependents, life insurance should still be considered.  If your future includes having a family and all the obligations that go with that then your continuing insurability is important. Selecting an insurance plan now that guarantees your ability to purchase more coverage in the future regardless of your insurability will go a long way in protecting your future family. For young people, the cost of life insurance is minimal and could also provide a long-term saving plan growing tax-free that could be utilized later.

Insure your debts

Unfortunately, debt is a natural part of modern life for most Canadians.  The Bank of Canada reports that for every $1 of income earned by Canadians, $1.70 is owed. So, chances are good that you have significant debt, whether it’s tied to credit cards, a car payment, or a mortgage. Ideally, you’ll be able to pay off these debts long before you die. However, should the worst happen, much of that debt will pass to your loved ones.

If you don’t want to burden your family with debt, having a life insurance policy is a wise choice. Not only can the death benefit cover any debt you already owe, but it can help alleviate additional costs, such as funeral expenses.

Provide for your family

If you are married and/or have children, then you owe it to your family to have life insurance.  This is especially true if you are the primary breadwinner in the household. Although most people don’t want to think about what may happen if they pass on at a relatively young age, the fact is that you need to make sure that your family is still looked after financially if that does occur. A life insurance policy can offer peace of mind, knowing that your spouse and children will be provided for no matter what.

Benefit from the tax advantages

If you want a more pragmatic reason for getting life insurance, what about the fact that the death benefit is tax-free?  This fact is the reason why life insurance is used to provide estate liquidity in paying taxes that become payable as a consequence of death. In addition, there are several ways that you can make your policy a haven for any funds that you don’t want exposed to income tax.

If you invest in permanent, cash value life insurance such as Universal Life or Participating Whole Life, the investment growth in the policy is tax-free should you die.  The cash value may also be accessed while you are living.

Transfer assets to children and grandchildren

Establishing cash value policies for your children and grandchildren is a recognized method of both guaranteeing their insurance future while you control the investment portion which is growing tax-free on their behalf.  When the time is right for you to transfer the policy to them, the change of ownership occurs free of income tax.  This is truly a tax-free intergenerational wealth transfer.

Save for retirement

Although life insurance is typically paid out when you die, there are options to take advantage of the money in your policy while you’re still alive.   If you have exhausted other retirement vehicles (e.g. RSP’s, TFSA’s), investing in a Universal Life or Participating Whole Life policy is a method to augment your retirement savings.  Universal Life policies will perform based on the equity or other asset class investment options you select.   Participating Whole Life policies provide stable, increasing returns which are favourable compared to the risk.

Using cash value life insurance for building wealth to be accessed in the future, is a strategy consistent with proper diversification of assets.  The fact that the investment growth in a life insurance policy is tax-advantaged is a definite bonus.

To protect your business

 If you own or operate a business, you most likely are aware of the corporate need for life insurance.    All significant corporate debt should be insured.  In fact, many lenders will insist upon it.  Just like all machinery and fixed assets of a business are insured, so should the key people who contribute to the profits be life insured as well.  If the company or partnership has a Shareholders or Partnership Agreement, they should be funded with life insurance to provide for the transfer of shares or partnership interest from the beneficiaries of the deceased to the firm.

Using cash value life insurance in a private corporation avoids the punitive tax levied against any passive investments in the corporation which, depending on the province, could be higher than 50%.  Tax-free benefits can be paid out of the corporation upon the death of the insured for the benefit of the surviving shareholders or family.

Remember that in addition to you and your family, there may be employees who are dependent on the continued success of your company for their livelihood.  Life insurance owned by the business goes a long way to guarantee this.

To equalize your estate

If your estate includes shares in a business that you may have designated one of your children to inherit in lieu of another child, consider equalizing the bequests by life insurance.  Another example of where life insurance could be used for estate equalization is leaving your primary residence or other real estate (such as a cottage) to a specific child instead of one or more of his or her siblings.  If the other assets being left are not enough to compensate, life insurance should be considered.

To donate to charity

You can provide significantly for your favourite charity using life insurance.  Whether it be by taking out a policy to benefit the charity, by transferring an existing policy you no longer need to a charity, or by just naming the charity as a beneficiary to a life insurance policy prior to your death, you or your estate will benefit from significant tax credits.  Your legacy will be remembered by the fact that your generous act contributed to the charity’s humanitarian endeavors.

Consider how life insurance can fit into your financial plan

Even though some people have a reluctance to think about life insurance, no matter how you look at it, life insurance is a necessary part of modern life. Without it, you could be condemning your family to financial instability. Whether it’s debt, last expenses, guaranteeing your children’s education, providing for income for your family, protecting your business, or tax and estate planning, life insurance provides tax-free dollars when it will be needed the most.  You buy life insurance, not for what it is, but what it does.

One of the biggest variables in this scenario is the fact that it’s impossible to know how long your money will have to last. Whether it’s 20 years or 40 years can make a huge difference, particularly if you’re not earning money from various investments.

With that in mind, we want to discuss how retirees (and soon to become retirees) can use insurance to help provide for their health and well-being well into their golden years. You don’t want to be left in the lurch because you failed to plan. Here’s what you can do.

Life Insurance

Regardless of your circumstances, getting a life insurance policy is always better to do sooner rather than later. While there are still options if you decide to do it just before or after you’ve retired, it’s advisable to apply for insurance when you’re younger and healthier. Plus, it will be less expensive the younger you are.

Nonetheless, life insurance policies are designed to provide financial protection and stability for your loved ones. Even if your children are living independently and making families of their own, there can be many different expenses that you don’t want to pass on.

Funeral costs, mortgages, and other debts can derail your family’s lives if you’re unprepared. Also, if you leave a spouse behind, his or her pension benefits could be greatly reduced upon your death which could severely impair his or her standard of living.

If you’re still relatively young, then you have many different options when it comes to life insurance. Term life insurance can last for a predetermined amount of time (i.e.,20, 30 or 40 years), while permanent insurance such as Universal Life or Whole Life insurance could last for as long as you live. You’ll want to talk with your financial advisor to figure out which option is best for you and your family.

There are some of retirement age who believe that even though they can see the need for additional life insurance, they feel that, at their age, they are too old to purchase it.  This is not the case.  While the premiums will be higher than if they had purchased it when they were younger, it is available to them and it can be shown to make financial sense when one considers the rate of return of the premiums paid compared to an alternate investment in creating the death benefit.

Know Your Retirement Income Options

If you are one of those fortunate to work for a company with a defined benefit pension plan, you will retire enjoying a monthly cheque.  If you have a spouse, it is important for you to discuss with your employer the income and survivor benefit options.  Pick the one that is most appropriate for your circumstances.  For example, if your spouse is considerably younger than you, don’t immediately choose the income option that provides you the highest amount of monthly income without considering what your spouse will live on afterwards.

If your retirement is to be funded by your RSP or RRIF, then consider how long the funds need to last.  Many people retiring today, fear that they will outlive their retirement savings.  Life annuities may be somewhat of an answer but with the low interest environment, they are often discounted as a viable option. Don’t overlook, however, the comfort that a worry-free regular monthly income can offer.

Some retirees will say that they wished that they had started their retirement planning many years before they did. Under these circumstances, hopefully there is another source of retirement income such as non-registered investment plans, inheritances, large equity in the home or re-entering the work force.  Also, in these situations, life insurance could be vital in making sure the surviving spouse has adequate income.  With that in mind, don’t cancel any life insurance upon retirement without considering all the options.

Long-Term Care Insurance

Whether it’s an illness, advanced age, or something else preventing you from being independent, the cost of long-term care (at home or an assisted living facility) can be extremely expensive. This type of coverage helps avoid making withdrawals from your investments which are meant for retirement.  Without it, your retirement funds will be depleted much more rapidly which doesn’t auger well for your surviving spouse.

The problem in Canada is there is only a couple of companies still offering this type of coverage.  So even if you are young (and that is the best time to buy Long Term Care coverage in any event), get it while it is still available.

Although you hopefully won’t have to endure this kind of care during retirement, having long-term care insurance may be a smart idea to protect you and your family if the worst happens.

Bottom Line – Be Prepared

No matter which route you choose, you want to have confidence and peace of mind in retirement. If your finances are not in order, then you could be facing some harsh realities during your golden years impacting your ability to reap the rewards of your hard work. Having insurance can help ensure that your retirement is spent in comfort.

Connect with me if you wish to discuss this further. As always, please feel free to share this with anyone you think will find it of interest.

• Your residence;
• Cottage or other recreational property;
• Investment real estate;
• Stocks, bonds, mutual funds and commodities
• Life insurance;
• Any other assets you wish to leave to your heirs.

After paying off any liabilities, taxes arising at death, last expenses etc., what is left over is what your family will use to maintain the lifestyle that you created for them.

Two easy ways to make sure debt and investment losses do not impact the estate you leave for your family

• Insure your debt
• Insure against market drops and other investment losses

Consider life insuring your debt and investment declines so that your heirs are not burdened by outstanding liabilities and market fluctuations.

In 2008, many investors experienced a decline of 40% to 50% in their equity portfolios resulting in a significant reduction in the amount of the estate to be left to their beneficiaries.

A greater problem was experienced by those that had used bank loans to leverage their investments.  The value of those investments may have declined by up to 50% but the loan balance didn’t decrease at all.

Even if the investments are not leveraged, there is always a risk to the estate should the equity markets decline.

Be Prepared – The risk of waiting to insure for losses

Of course, you could always top up your life insurance when the market declines right?  Not necessarily.  If you have lost all or part of your insurability due to health that could be a problem.

Consider hedging against possible future decreases in your investments by purchasing life insurance specifically for this reason.

For hedging purposes, any form of life insurance can be used. Term insurance is an inexpensive way to insure for shorter terms such as 10 or 20 years.

Participating Whole Life Insurance should be considered for protecting your investments through diversification and building in stable returns. It is the only type of life insurance that is guaranteed to increase in value and death benefit regardless of equity market conditions.

Other benefits of Participating Whole life include

• Can be used as an investment in place of bond or GIC-type investments.
• The cash values of these policies grow on a tax-deferred or tax-free basis.
• If funds are required for unforeseen expenses or to make additional investments, the policy can be borrowed against either from a lending institution or directly from the insurance company.

Using Participating Whole Life insurance satisfies two objectives – providing a hedge against equity values declining prior to death and adding additional stability and less volatility to the overall portfolio.

Summary of how to manage the risk of estate shrinkage due to adverse equity market conditions:

Hedge the estate value of your investments

Select a percentage of your equity investments that you wish to protect if you die when market values have fallen.  Purchase life insurance for this amount.  For example, if you have $2,000,000 of equity investments and you wish to hedge 40% consider buying $800,000 of life insurance.

Life insure the loan in a leveraged investment strategy

It’s always a good idea to life insure debt. This is particularly the case when insuring leverage loans to protect against investment values falling prior to death while the loan is still outstanding.

Consider Participating Whole Life as a method to optimize your estate

Unlike equity investments, the values of a whole life policy cannot decrease.  As long as the premium is paid the cash value and death benefit will continue to increase.  This provides stability in your investment portfolio and reduces volatility.  The increasing death benefit will optimize the value of your estate for the benefit of your family and heirs.

Combining your investment portfolio with an effective life insurance strategy to maximize the value of your estate is a prudent means to provide for your family.  Great comfort comes with the knowledge that even if your investments decline your family will be adequately provided for in the manner you wished them to have.

Connect with me if you wish to discuss this further.  As always, please feel free to share this with anyone you think will find it of interest.

The primary needs for corporate owned life insurance to satisfy the risk management purpose are as follows:

Key Person Life Insurance

Any prudent business would insure its company facilities and equipment that is used in creating revenue.  It follows then that the business should also insure the lives of the people that run the company and make the decisions which contribute to its profit.  Any owner, manager or employee whose death would impair the future growth and success of the company is a key person and should be insured as such.

The proper amount of key person life insurance should be determined through discussion with the company’s management, life insurance advisor and accounting professionals. This discussion would analyze and estimate the amount of the loss that could occur to the company should a key person die.

Funding the Shareholders or Partnership Agreement

When more than one person join together to own a company or partnership, it is common business practice that there be a Shareholder’s or Partnership Agreement.  These documents set forth the terms and conditions under which the parties co-exist in the business venture.  It also spells out the financial interest that each hold in the concern and how much would be owed to the heirs of a shareholder or partner should that individual die.  The use of life insurance owned by the corporation for this purpose guarantees that sufficient funds will be available to trigger the agreement.  If there was no life insurance in place and no agreement covering how those funds were to be used, the future existence of the company could be in jeopardy.

 To Repay Debt

Like an individual insuring debt to avoid burdening his or her family with outstanding liabilities in the event of death, a business owner should also consider providing life insurance to cover the corporation’s obligations.  This would ensure that the net value of the company is optimized when it passes either to the heirs and beneficiaries of the owner or to a successor owner which might be a family member.

One of the advantages of corporate owned life insurance to retire debt is the existence of the Capital Dividend Account.  Should the insured business owner die, the life insurance proceeds are received tax-free by the company.  The death benefit less the adjusted cost basis of the policy is credited to a notional account – the Capital Dividend Account (CDA).  Even if all the life insurance proceeds are paid by the company to the creditors to retire the outstanding debt obligations, the credit remaining in the CDA can still be paid tax-free to the surviving or successor shareholders.  This allows any surplus or future earnings to be received by the heirs as tax-free capital dividends up to the amount of the balance of the CDA subsequent to the death of the insured.

To Facilitate Business or Investment Financing

Often when a company borrows to invest or for business operations, the bank will require that the principal(s) of the corporation be insured.  In this case, if the life insurance is purchased as a condition of the bank loan being granted, part of the life insurance premiums become tax deductible to the corporation.  The reasons for providing life insurance to cover the bank loans are consistent with the reasons stated in repaying debt, but with the bank’s written requirement for life insurance, there is now a tax deduction available as well.

There also may be a situation where an investor would look favourably on the business owner being insured before he or she invests in the company.  While there would be no collateral insurance deduction in this case, it may create a comfort level for an investor.

To Assist Family Business Succession

With a family business there is often a desire to transition the ownership of the company to the next generation.  One of the common objectives of this transition is to ensure that the company is left financially sound when it is received by the next generation.  This can be accomplished by having life insurance on the first generation owner to guarantee that the company is left financially viable and debt-free should the succession occur as a result of the death of the business founder.

The above items are all situations where life insurance is used by a business for risk management purposes.  When life insurance is held in a corporation it also can result in attractive planning opportunities.  These opportunities include the following:

Estate Planning for the Business Owner

Owners of private corporations in Canada that are qualifying small businesses have the first $500,000 of annual corporate income taxed at a very favourable rate.  For example, in B.C. and Alberta it is 12%.  The low small business tax rate combined with the Capital Dividend explained above presents the business owner with an opportunity to place life insurance designated for estate planning purposes (e.g. paying taxes arising at death from capital gains), in the corporation.

Sheltering of Corporate Investment Income

While the income tax rate on active business income is quite low, the tax levied against corporate investment income is extremely high.  In some provinces, this tax is over 50%.  Using tax exempt life insurance policies to shelter this investment income can provide substantial opportunities to defer taxes which would otherwise be payable.  All the insurance opportunities for risk management itemized above can also be satisfied by using cash value tax-exempt life insurance.  As a result, there are significant planning opportunities available with corporate owned life insurance.

Protecting the Small Business Income Tax Rate

In addition to the above, once a corporation earns more than $50,000 of passive investment income it starts to erode its small business tax limit of $500,000.  Once the passive investment income reaches $150,000 it loses all of the small business limit for that tax year.  This can be avoided by investing in tax-exempt life insurance policies.  Combined with the previous comments not only does the investment grow tax sheltered, it will not impact the small business income limit.

These are the primary reasons why business life insurance is so important.  Not only does it help manage risk, it can also provide significant planning opportunities for the business owner.  I am available at any time, should you wish to discuss how these ideas could benefit you and your company.

In a recent study conducted by the Life Insurance and Market Research Association (LIMRA), it was reported that 61% of Canadians hold some form of life insurance.  Surprisingly, it also revealed that only 38% of Canadians own an individual life insurance contract. This means that almost 40% rely solely on the life insurance provided by their employer. This can be problematic.  The disadvantages of having your employee benefit plan as your only life insurance protection include the following:

It is probably not enough to pay off your mortgage and/or provide income for your spouse and family.

The amount of life insurance protection provided by group insurance in most cases is equal to only one or two times annual income.  If this is not enough to do the job, the addition of individual life insurance should be considered.

If you lose your job, you may also lose your life insurance protection.

If you are currently employed in an industry or with a company that may be at risk due to economic conditions, you may find yourself with no life insurance at all.

Upon retirement, or if you leave your job, in most cases you will lose your group insurance.   While group life insurance usually contains an option to convert to an individual plan, the plans that are offered are usually restrictive or very expensive.

What place should group life insurance hold in your planning?

To answer that question, let’s first look at the differences that individual life insurance has compared to group. Individual life insurance comes in two forms– term life insurance (which expires at a certain age) and permanent life insurance (e.g. Universal Life or Whole Life) which provides protection for one’s entire life and can also build savings through a cash value.

One can consider the specific type of life insurance, therefore, as being one of three categories:

• Permanent life insurance – the type you own. By paying your premiums each year you build up equity in your insurance.  At some point in time, the policy may be fully paid up or self-supporting.  You can even take advantage of your equity in the policy by borrowing – similar to borrowing against the equity in your home.

• Term life insurance – the type your rent. Term life insurance usually has a renewal period which could be ten years, twenty years, or even longer.  At the end of this period, your “lease” renews for a higher premium (“rent”).  When you rent a home you never build up any equity and this is the same with term insurance.  After paying all those rental premiums the policy expires at a certain age with no cash value.

• Group life insurance – the type you borrow. You, the insured do not have a contract with the life insurance company as that arrangement rests with the employer. The employer and the insurance company retain the right to cancel the entire benefit plan. As a result, the analogy can be made that your employer is “lending” you the coverage.

In reviewing these three types of coverage, it is advisable that you should have a base or foundation of permanent coverage which would provide protection for life at a fixed cost. This also provides the added advantage of creating equity which could be borrowed against should a future need for cash arise.

You could then consider layering lower cost term insurance to protect a growing family and ensure that there would be enough capital to retire debt and provide for family income.  With a family, there is a very high dependency period when the children are young, and the expenses are high.  Low cost temporary insurance is used to provide adequate protection during this period.  Term insurance also comes with the bonus of being convertible to permanent coverage should you become uninsurable with a far greater choice of options than those with a group life conversion.

Lastly, for those with group life insurance, this coverage can be looked upon as forming part of the term insurance needed or as a top up to provide for contingencies.

Give me a call if you would like to discuss restructuring your life insurance coverage to provide the maximum result.  As always feel free to share this article with those you think would benefit from this information.

Tax Adverse

The income from these investments are taxed at the top rates.  They include bonds, certificates of deposits, savings accounts, rents etc.  Depending on the province, these investments may be taxed at rates of approximately 50% or more. (For example, Alberta 48.0%, BC 49.8%, Manitoba 50.4%, Ontario 53.53%, Nova Scotia 54.0%).

Tax Advantaged

These investments are taxed at rates lower than those that are tax adverse.  These investments include those that generate a capital gain (stocks, equity funds, investment real estate, etc.), or pay dividends.  The effective tax rate on capital gains varies depending on province from approximately 24% to 27%.  For dividends, the range is between approximately 30% to 41.6%.

Tax Deferred

Tax deferred investments include those investments which are held in Registered Retirement Savings Plans or Registered Pension Plans (such as an Individual Pension Plan).  One advantage of these investments is that the contribution is tax deductible in the year it was made.  The disadvantage is that the income taken from these plans is tax adverse as it is taxed as ordinary income and could attract top rates of income tax.

The growth in cash value life insurance policies such as Participating Whole Life and Universal Life is also tax deferred in that until the funds are withdrawn in excess of their adjusted cost base while the insured is still alive, there is no reportable taxable income.

Tax Free

Very few investments are tax free in Canada.  Those that are tax free include the gain in value of your principal residence, Tax Free Savings Accounts (TFSA’s) and the death benefit of a life insurance policy (including all growth in the cash value account).

While Canada is not the highest taxed county in the world (that distinction belongs to Belgium) it is certainly not the lowest.  (According to the Organization for Economic Co-operation and Development, Canada sits as the 23^rd highest taxed country in the world).   It is also true that in addition to the taxes Canadians pay while they are living, the final insult comes at death.

Generally speaking, you have three beneficiaries when you die.  You have your family, your favourite charities, and the Canada Revenue Agency.  They all take a slice of your estate pie.  Most people would rather leave more to their family and charities than pay the CRA more than they need to.

As our estates grow, they include funds that we intend to leave to our children and possibly to charity.  They also include funds we are likely never going to spend while we are alive.

The secret to optimizing the value of your wealth for the benefit of your estate is to re-allocate those assets that you are never going to spend during your lifetime from investments that are tax exposed to those that are tax free.

One of the best ways to do this is through life insurance.  As mentioned earlier, assets which are tax free include the death benefit of a life insurance policy.  Systematically transferring funds from the tax exposed investments to, for example, a Participating Whole Life Policy, not only eliminates the reportable tax on the funds transferred, it greatly increases the overall size of the estate to be left tax-free to your beneficiaries – your family and your charities.

Case Study

Let’s consider Ron and Sharon, aged 58 and 56 respectively.  They have been told that they have a liquidity need of approximately $1,000,000 which would become payable at the second death.  They are also unhappy about the taxes they are paying annually on their investments.  They elect to re-allocate some of their assets to a Participating Whole Life policy for $1,000,000 with premiums of $31,890 for 20 years.

Over this period, they will transfer a total of approximately $640,000 of investments exposed to income tax to a tax free environment.  If we assume that their life expectancy is 35 years, the Whole Life policy will have grown to a death benefit of approximately $3,300,000*.  This represents a pre-tax equivalent yield over this period of approximately 11%.  Not only is there more than enough to pay the tax bill but there are funds left over for the family and any charitable donation they wish the estate to make.

In addition, with the transfer from a taxable to tax free investment, income taxes that would have been paid during their lifetime has also been reduced.  Along the way, the Participating Whole Life policy has a growing cash value account which could be borrowed against should the need arise.  At the 20^th year for example, the cash value of the policy (at current dividend scale), would be slightly under $1,000,000.

This case illustrates only one example of how it is possible to optimize the value of an estate through asset re-allocation.  By using funds you are never going to spend during your lifetime, you can create a much larger legacy to benefit others while reducing the total cost of your tax bill.

If you would like to investigate this concept to determine the value it can provide you and your family, please be sure to contact me.  As always, please feel free to share this information with anyone you think would find it of interest.

* Values shown are using Equitable Life’s Equimax Estate Builder assuming current dividend scale for 2018.

If you have a will in place, great. A will, however, is only a fundamental first step, not a comprehensive plan, point out authors of the 2017 Wealth Transfer Report from RBC Wealth Management.

“One generation’s success at building wealth does not ensure the next generation’s ability to manage wealth responsibly, or provide effective stewardship for the future,” they write. “Knowing the value (alone) does little to prepare inheritors for managing the considerable responsibilities of wealth.” Overall, the report’s authors say the number of inheritors who’ve been prepared hovers at just one in three.

Worse, they say despite best intentions, individuals are repeating history in a negative way.

“Overall, our respondents reveal a marked level of discomfort when confronting the theme of wealth transfer directly: Only 40% say they are comfortable sharing details with their beneficiaries. As such, they risk subjecting their own heirs to the same lack of clarity and understanding they experienced during their own inheritance.”

Two thirds say their own wealth transfer plans aren’t fully developed – a critical barrier to having this discussion in the first place.

While the report focuses on wealthier beneficiaries in society, the lessons remain true for most: There is planning, communication, and a fair bit of education your heirs need in order to make the best decisions about your wealth when the time comes.

1. Recognize that action today can help you create a better future forever.

First, it’s important to acknowledge that creating an estate plan means contemplating your own mortality – an inescapable element of the process. It can also involve some awkward conversations, particularly if you’re not in the habit of talking about money with family and loved ones.

Without planning, however, the outcome you leave may not be the one you would choose.

2. Get help to build your plan, then share it with those who matter.

Estate planning typically isn’t a “do-it-yourself” project. Instead, you’ll probably need to rely on a network of professional advisors who can bring their expertise to different parts of your plan. Your network might include a lawyer and a financial advisor or other representative from your financial institution.

Once you have your plan in place, it’s time to ensure that the people who are impacted by it are aware of your wishes. In the survey, only 35 per cent of those who had inherited money in the past said their benefactors had prepared them in advance.

Members of your professional network can also help you explain your plan to beneficiaries and help those who inherit your assets to understand your preferences and the decisions you’ve made.

3. Encourage education early.

Most of the people surveyed are not confident that the wealth they pass on will be preserved by the people who inherit it. Nearly 60 per cent of Canadian parents said they aren’t sure that their children will preserve or grow their inheritance, though almost 70 per cent said their children were first in line to inherit.

Here’s where a little financial education can go a long way: If you’re concerned about the money management skills of those to whom you’ll leave assets, now is the time to start putting structures in place to build financial literacy. Having a plan is itself an important first step. The survey showed that 58 per cent of those with a plan are confident the next generation will sustain their wealth, compared to just 33 per cent of those who haven’t taken time to prepare.

Finally, although creating an estate plan sounds as though it will only have an impact after you’re gone, the confidence (your own confidence, and the confidence you instill in others with a little bit of preparation) is one of the benefits you can enjoy in life. In sum, these three steps – developing a plan, communicating it to those who matter, and taking action to ensure your wishes will be sustained over generations – can lead to confidence now about the future you’re creating.

Let’s get together to discuss how you can create your wealth transfer plans, and get help in communicating those plans to the people who matter the most.

As always, please feel free to share this article with anyone you think would find it of value.

Income earned by a corporation and then distributed to a shareholder is subject to tax integration which results in the total tax paid between the two being approximately the same as if the shareholder earned the income directly. Integration also means that if a corporation is in receipt of funds which it received tax-free, then those funds should be tax free when distributed to the shareholder.

The Capital Dividend Account is a notional account which tracks these particular tax-free amounts accumulated by the corporation. It is not shown in accounting records or financial statements of the corporation.  If there is a balance in the CDA it may be shown in the notes section of the financial statements for information purposes only.

Generally, the tax-free amounts referred to, are the non-taxable portions of capital gains received by the corporation and the death benefit proceeds of life insurance policies where the corporation is the beneficiary.

Life insurance proceeds received by a private corporation

The death benefit of a life insurance policy that is owned by a private Canadian corporation less the adjusted cost basis (ACB) of that policy, can be credited to the Capital Dividend Account.  The government’s reasoning in deducting the ACB from the CDA credit is that if the corporation had paid the premiums to the individual shareholder to pay for the insurance, those payments would have been taxable.

In calculating the ACB, the following factors are taken into account:

• Premiums or deposits made to the policy increase the ACB;
• Policy loans, paying of dividends in a participating policy and partial dispositions reduce the ACB;
• Repaying policy loans, purchasing paid-up insurance and adding any term insurance riders increase the ACB;
• The annual net cost of pure insurance (NCPI) reduces the ACB.

The NCPI is the pure mortality cost of the life insurance and is contained in a table in the Income Tax Act.  The NCPI, which increases each year with age, is applied to the net amount at risk in determining the reduction of the ACB for that policy year.  The net amount at risk is defined as the total death benefit minus the cash value of the policy.

Normally, the ACB of the policy increases each year ultimately resulting in a total erosion.  Once the ACB reaches zero, the full amount of the death benefit is eligible for Capital Dividend Account credit.

Frequently asked questions about the Capital Dividend Account

Does the corporation have to be Canadian controlled? No.  It is only required that the company is a Canadian private corporation.

Can the corporation be publicly owned? No. Only private corporations qualify.

What is the tax treatment of a Capital Dividend paid to a non-resident shareholder? Capital dividends paid to a non-resident shareholder are subject to a withholding tax.  In the absence of a resident of a country without a Canadian tax treaty the withholding tax is 25%.  With a tax treaty, the rate will be reduced.  For an individual living in the U.S. for example the withholding rate would be 15%.  The capital dividend would most likely be taxable to the non-resident in their own country.

Does the company still get a CDA credit when a policy is assigned to a bank and the death benefit is paid directly to the lender? Yes.  Although the proceeds of the life insurance policy may never actually be received directly by the corporation, it still creates a CDA balance equal to the total death benefit minus the ACB of the policy.

For many business owners the ability to have life insurance paid with lower taxed corporate dollars and still be able to have the proceeds eventually flow to their families on a tax free basis is an opportunity that should not be not overlooked.

As always, please feel free to share this article with anyone you think would find it of interest.