It seems that all good things either come to an end or get changed, and life insurance taxation is no exception. Deemed now to be too generous by CRA, they are changing the rules, which will impact retirement and estate planning strategies using life insurance and annuities.
Permanent life insurance plans used for the purpose of tax sheltering and distributing personal or corporate wealth will be affected, and higher taxation on annuities will reduce payouts.
Life insurance has always been one of the three allowable tax shelters, the others being principal residences and TFSAs. Overfunding of permanent policies over the base premium cost will be reduced, and the time frame to quick-pay or prepay policies will be lengthened out. These changes will have a significant impact for corporate farms or larger privately held businesses looking to maximize the tax-free cash they can withdraw from their businesses under the current rules.
Passing on the maximum estate value: Take the example of John, aged 50 and a non-smoker. When looking for help with a number of estate planning issues, it was found that permanent life insurance could be used to provide tax-sheltered growth of the significant amount of funds that are held in his holding company. Under the current rules, a $5 million dollar insurance policy owned by the holding company would allow the full $5 million of proceeds to be paid out tax-free to his children, who would be the new company shareholders on his death any time after he turned 75.
If he waits until 2017 to apply for the policy, and he was to die at age 73, only $4.175 million of the death benefit proceeds will be allowed to be paid out tax-free. The remaining $825,000 will be subject to the top marginal rate of tax at that time, well in excess of $300,000. He would have to live past age 90 for the full amount to be paid out tax-free.
Using annuities for low or no-tax income: CRA has also targeted annuities, so after 2016 the annuity payouts will be facing higher taxation. The current rates are based on 1970 mortality tables, while new rates will be based on 2000 mortality rates. Simply put, we’re now living longer, and CRA feels the tax breaks allowed under the current rules are too generous.
Annuity payouts are influenced by long-term interest rates, which means they’re higher than the 1-5 year GIC rates that most people typically focus on. Monthly annuity payments vary with age. For example, payments range from $626 at age 65 to $740 at age 75 for a male who invested $100,000 in a non-registered prescribed annuity, both with zero tax. Payments from a registered annuity (purchased with RRSP money) would be similar, but fully taxable. These amounts constantly change, and it’s a competitive marketplace, so it’s important to check the rates offered by all life companies.
If you are considering using life insurance to enhance capital tax-free withdrawals from your corporation, or build tax-sheltered cash to leverage for retirement income, or to conserve or equalize your final estate value, you need to do it this year!
As well, today’s seniors who are having difficulty generating adequate retirement income from low GIC and bond rates should look at annuities to enhance monthly income before the end of the year.
Take the time to sit down with an experienced financial advisor and discuss how to end up with more cash in your or your heir’s pockets instead of CRAs!
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