The right type of tax and estate planning should aim to reduce your taxes. What people also fail to realize is that if you have a large estate, your tax and estate planning should also aim to reduce your taxes after you die. Planning what happens to your estate while you are alive is always better and more tax efficient than passing away and letting your family deal with it after the fact. The right type of permanent life insurance can achieve both of these aims – build up tax-deferred growth inside the policy and transfer your estate tax efficiently to your beneficiaries.
When most people hear the word life insurance they generally think about how it helps their dependents they will be leaving behind. Life insurance is a great tool for this because the policy’s death benefit provides immediate liquidity upon death through a death benefit that is paid out tax free to your named beneficiaries, such as your spouse, kids, charities, etc.
It doesn’t matter how big the death benefit may be – $10,000 or $100 million – your beneficiaries won’t ever have to worry about paying a single cent of tax on that money. What other asset class does that?
If used appropriately and in the correct circumstances life insurance is also a very powerful living benefit tool in an overall tax and estate plan. Generally this type of planning is geared towards high-net worth individuals, business owners that are growing their company very quickly or that have idle retained earnings that they are not investing back into their business and investors that have maximized registered tax shelters like RRSPs and TFSAs that are now looking for a low risk tax efficient asset class to park their money as an alternative to fixed income assets like bonds, mortgages and preferred shares.
Life Insurance as an Asset Class
One of the main benefits of proper insurance planning is that it creates immediate cash that is growing tax deferred, which can be accessed directly, via a policy loan or collateralized with a bank. The money inside the policy grows in a reliable and predictable fashion creating safe, stable and conservative returns. In instances where this is a significant amount of wealth inside the policy collateralizing the policy can be a very attractive way to receive supplementary tax-free retirement income (under current tax legislation), while the interest portion can potentially be capitalized and repaid upon death by automatically being deducted from the final death benefit. If you’re already familiar with how a reverse mortgage works you will notice some similarities in the two strategies.
How business owners can use life insurance as a planning tool
Drawing funds out of your corporation or investing the capital within your holding company is a high-tax scenario. In this instance life insurance can also be an effective tax tool to pay substantially less tax. If you want to get money out of your company in a tax efficient manner and you’re a business owner in your early 50s or younger, this may be the right strategy for you.
By shifting some of the passive investments from your holding company into a corporately owned life insurance policy you can take advantage of this tax shelter. Younger business owners can also benefit from the ability to withdraw funds efficiently for the company during the owner’s lifetime.
If you are an older individual or business owner, life insurance can be used to save significant tax on estate planning and will effectively outperform the after-tax rates of return of other traditional investments. It is a highly attractive tool in an estate plan compared to other more traditional asset classes.
For example, let’s say we have a 70-year-old couple that owns a successful company, with life expectancies of 85 and 87, respectively. They purchase a life insurance policy that will pay out a death benefit after the last spouse passes away of which the vast majority of this payout can be paid tax free to the other shareholders in the company through something called the capital dividend account. In this example, in 15 years the corporation would have had to earn more than a 20 per cent year return to equal the after-tax amounts from the insurance payout.
The right type of insurance planning can create substantial value in an overall tax and estate plan both while you are alive and after you die. It’s important that this tool is used appropriately and that the overall planning is done in conjunction and in a collaborative fashion with your existing legal and accounting teams. Having multiple advisory professionals involved in the overall planning will ensure that the proper life insurance is strategy is not only appropriate in light of your circumstances but also ensures that significant value is created to your overall tax and estate planning.
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