Life Insurance as an Estate Planning Tool

The Financialist • Issue 93 • April 2007
BY KEN HAWLEY BComm FLMI CFP RFP CHFC

Most people recognize one need for life insurance: income protection for a family in case of the breadwinner’s untimely death. However, many people are unfamiliar with the use of life insurance as a tax-efficient way to transfer family wealth to the next generation or to charities. It is first necessary to identify if and why you need life insurance; then comes determining the type of life insurance that best suits your particular financial circumstances and objectives.

Here are some situations where you should consider using the financial tool of life insurance in your financial / estate planning:

TO COVER TAX LIABILITIES AT DEATH:

Our Canadian income tax rules allow a spouse to defer tax liabilities by leaving their estate to a surviving spouse, but eventually the tax must be paid. The use of permanent life insurance payable upon the 2nd death is an excellent way to take care of this eventual tax bill to the estate because it is payable exactly when needed (at the time of death), is tax free, and can be purchased with discounted dollars. It may also assist with the following:

• Recreational property:

A summer cottage or winter retreat held for a number of years may have significantly increased in value. Unfortunately, 50% of the capital gain is taxable when you pass it on to your children – before or after your death occurs. This can be a problem because the tax will have to be paid from the sale of other assets or investments unless you insure this tax liability.

• Real estate investment property:

This type of investment, if held for a number of years, can generate very substantial deferred tax liabilities from capital gains and capital cost allowances for depreciation.

• Business:

The growth in the value of a business will generate tax liabilities, but the sale of a business at death for its full value may be very difficult. Yet, the tax department will still want the tax payable on the capital gains. In addition, there may be a need to buy out a business partner.

• RRSPs, RRIFs, LIFs, Pension Plans:

All of these registered plans become fully taxable at the time of death when left to someone other than a spouse, and will shrink in value by almost 50% after the tax bills are paid. Life insurance can cover the tax payable, thereby preserving the full value of your investments for your heirs.

TO PROVIDE BENEFITS TO CHARITIES:

There are many creative ways to use life insurance to provide substantial legacies through your favorite charities. It is possible to get a charitable tax credit for the premiums paid for a life insurance policy, or to get a tax credit for the full amount of the death benefit of a policy to offset other taxes payable in your estate such as from RRSPs or RRIFs etc.

TO PROVIDE A LIFETIME GIC:

This concept was discussed in detail in our January 2007 Financialist. It is a strategy that combines the use of life insurance and a life annuity to provide an enhanced guaranteed lifetime income while returning all of the capital to the estate tax free at the time of death.

TO PROVIDE FOR A SPECIAL NEEDS CHILD:

The lifetime care costs for children who require special assistance can be staggering – the use of life insurance is an excellent way to make sure the funds are available when needed to provide ongoing care after your death.

TO TAX SHELTER CURRENT INVESTMENT ASSETS (ESTATE BOND):

The majority of our clients will never "spend" their estate capital during their lifetimes and the use of a life insurance estate bond is a great way to tax shelter investment growth today to provide for an enhanced tax free benefit to your children or charity at the time of death.

TO PROVIDE A CONFIDENTIAL ESTATE BENEFIT TO ANYONE:

The distribution of assets via a Will is public information and may be subject to being challenged under the Wills Variation Act. Using a life insurance plan it is possible to make a private confidential gift to anyone, and the gift cannot be challenged or altered.

These are just a few of the many ways in which life insurance later in life can be used very effectively as part of your financial / estate plan. If any of these situations fit your circumstances, you should discuss them with your Rogers Group financial advisor.