Peter Boys, Boys Financial Services

Life Insurance – The Last Great Tax Shelter

life insurance

Much of what a financial advisor does is around tax deferral, tax minimization and replacing taxes on death for estate equalization or conservation. If you have considerable assets, own a farm or small business or have holding companies, you should know about the tax benefits of life insurance compared to other investment options.

I have been following with great interest all of the news relating to our new provincial and federal governments and their tax and spend pronouncements. It appears that any chance for balanced fiscal budgets is out the door for some time well into the future.

Tax-sheltered accumulation: The cash value inside a life policy can accumulate free of annual taxation, plus allow for enhanced growth in value over time when compared to some other investment options. This is similar to the tax sheltering with a principal residence, real estate, registered plans or investment growing via capital gains. Insurance is an ideal place to hold interest bearing assets that would otherwise be fully taxable.

Tax-deductible contributions: Other than investing in RRSPs, life insurance may offer some tax deductibility of the premiums if it has been assigned to cover any CRA qualified bank debt. There are rules regarding this, and also as to the percentage of the premium that is allowed to be deducted.

Potential for tax-free income: As permanent policies accumulate cash value it’s possible to borrow against this cash value for income or investment needs. There are specific rules as to the amount of cash value that can be leveraged and the type of investments that can be held in the policy.

Tax-free estate transfer: Other than on the sale of your principal residence, life insurance proceeds provide for the tax-free transfer of wealth to the next generation for estate conservation or equalization needs. This can be done in full privacy when paid out to named beneficiaries, plus it also bypasses probate in the process outside of the will.

Potential for creditor protection: Within certain guidelines there can be protection from creditors when family members are named as beneficiaries of the insurance proceeds. This also applies to insurance-based investment contracts such as segregated funds and guaranteed investment accounts.

Reliable investment returns: Most life insurance companies offer policies that generate a very consistent rate of return, paid by way of dividends on the cash balances inside the policies. The combination of low volatility and tax-free payout on death to the insured has the potential to generate very attractive internal rates of return.

Enhanced extraction of funds from a holding company: It’s common for people to accumulate significant assets inside holding companies, especially when there are multiple operating companies. But accessing these assets tax efficiently presents a challenge due to the high level of taxation on distributions from holding companies. This is where life insurance can be an effective tool to withdraw funds at low or no tax to the shareholders by way of the Capital Dividend Account, when the holding company is the beneficiary of the life insurance proceeds.

These only represent some of the tax-sheltering benefits available with creative structures using life insurance, which are more important now considering that taxes are expected to increase significantly. Without proper tax planning, your business or estate stands to lose significant value to taxes. If you have considerable assets, own a farm or small business or have holding companies, an experienced financial advisor can suggest ways to reduce or offset that loss.

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