The latest COVID news is not reassuring. Despite our best efforts, outbreaks continue in many places and new variants are reported. Mandatory masking is now under discussion and may be making a comeback, even for the multi-vaccinated. Many experts say that living with a pandemic is likely going to be a part of our lives for decades to come.
Aside from lurking COVID dangers, who would have predicted unforeseen events like the deadly collapse of a condo building in Florida, or unpredictable flooding in Western Europe that killed hundreds and destroyed communities that have been around for centuries? We must adjust to living in a world with more risk and unknowns than we’ve grown accustomed to.
Although we can’t predict the future, we all wonder what we can do now to protect our families if something bad happens.
We predict that income tax rates will rise significantly, that taxes will be payable on principal residence gains, and that there will be an inheritance tax and a wealth tax. And estate taxes which currently are at 25% to 70% without proper planning, will continue to rise, leaving even less for your family.
Life Insurance will become more costly
Insurance rates are going to rise, as insurance companies need to produce profits for their shareholders. Claims due to pandemics impact profits. And with investment returns reduced, coupled with less disposable income for average taxpayers, the insurance companies will have to increase premium rates. We may even get to a time where premiums are “not guaranteed” and could become variable. As a result, now might be the best time to lock in those rates.
Underwriting for Life Insurance may become more difficult due to the pandemic – More people won’t qualify, and Life Insurance will become something that is only available to the youngest and healthiest Canadians. If you put off applying for Life Insurance, you have no guarantee that you will still be insurable when you want it most.
A successful business person can suddenly become uninsurable. We can never take good health for granted. The time to start thinking about how you will mitigate your tax liabilities is now, while the sun is shining, while you are alive and healthy, and options are available to do the necessary planning.
Why Life Insurance?
In a world of growing uncertainty, aside from getting basic planning together like up‑to-date wills, two powers of attorney and having an updated Estate Directory, there’s never been a better time to review your Life Insurance. The cost will likely rise in the future.
The primary purpose of Life Insurance is to provide your family with the financial certainty they need to carry on when you are no longer around. When doing estate planning around estate taxes, one should consider joint and last-to-die insurance, which covers both spouses and is paid out after the second death. It is much less costly than single-life coverage (by up to 40%) and can provide relief from capital gains taxes and other expenses related to the estate for pennies on the dollar.
In fact, Life Insurance is one of only four remaining tax-free investments that Canadians can still access. The other three are TFSAs, your principal residence and – if you are lucky – lottery winnings.
The COVID plague made it easier than ever to buy Life Insurance. It wasn’t so long ago (pre-COVID) that people who wanted Life Insurance had to meet with an insurance advisor to complete an application, have a nurse come to their home to obtain blood and urine samples, and patiently await completion of the insurance underwriting process.
Out of necessity, Canada’s Life Insurance companies responded quickly to COVID by reducing underwriting requirements and streamlining the entire process. In many cases, clients can get up to $5 million of Life Insurance with no medical underwriting, no blood or urine samples and no in-person meetings. All it takes now is a 15-minute phone call.
Many taxpayers are taking advantage of the opportunity by topping up their own coverage or getting new term and permanent policies for spouses, children, and grandchildren. The policy beneficiaries can include a spouse and other family members, as well as a charity − which is a lot better than leaving half or more of your savings to the government in the form of taxes.
Canadian taxpayers who are single, widowed or divorced may not realize that the government discriminates against them. When they die − without a spouse − they leave the government up to 50% or more (dependent on the province) of their RRSPs and RRIFs, and another 25% on the growth of non-registered holdings.
There are several ways to use Life Insurance. The primary one is for the executor of the estate to use the death benefit of the deceased’s policy to pay off taxes owed before distributing the remainder to family or charity.
As a tax-exempt investment you can overfund a policy (pay more than the premium required) and build up cash surrender value (CSV). For business owners, high income professionals, real estate investors and people with substantial investment portfolios, one can consider the Immediate Financing Arrangement (IFA) strategy. It allows them to buy Life Insurance without tying up their money paying premiums, while securing their Tax and Estate Planning needs.
Example
A 65-years-old real estate investor had built a $50 million property portfolio he wanted to pass on to his children. Because he had done no estate, tax, or insurance planning, he would face a $10 million tax bill on his death.
In this example the taxpayer could use Life Insurance to cover those taxes so his family wouldn’t be forced to sell assets to pay the tax bill. He was reluctant to use his own money to buy Life Insurance but loved the idea of getting it while still having access to his premiums for other investments.
The insurance policy’s CSV serves as collateral to secure a loan with a Canadian chartered bank. The taxpayer paid the initial premium with his own money, then used the policy CSV to secure the loan to reinvest in his real estate business. He would then continue to pay only the loan interest, which would be tax-deductible. The loan will be paid off on his death with the Life Insurance proceeds. The balance goes to family and charity, virtually tax-free.
Business owners enjoy the advantage of using corporate dollars to pay the premiums on their Life Insurance. Corporations get taxed at a lower rate than an individual shareholder’s personal tax rate. For example, in Ontario, the corporate tax rate applicable to active business income is about 13.5%, and 50% on investment income (though about half of that is refundable once enough dividends are paid out). The top individual marginal tax rate in Ontario is about 53.5%. Corporate-owned Life Insurance is used by wealthy business owners to accumulate passive wealth inside a company in a tax‑effective way. They can also access that wealth and transfer it tax-free to surviving beneficiaries.
For business owners particularly, Life Insurance can protect a family or business against the sudden loss of a key person in the business. It can also be used to fund a shareholder buy/sell agreement so that heirs have a guaranteed buyer for their shares and a guaranteed market value with Life Insurance proceeds, for pennies on the dollar.
Along with proper estate planning, Life Insurance can give you the peace of mind that comes from knowing you have looked after your family and supported a charity of your choice − all crucial during the pandemic. In every generation there seems to be one or two milestone events like war, famine, depressions, and recessions. If you plan now while you and your family are well, and your business is steady, your planning ideas will work as intended.
Don’t do this alone. There are many ways to help reduce taxes now and, in the future, but they require comprehensive estate planning and working with experienced, knowledgeable people.