A Window of Opportunity
Clients hoping to use their permanent life insurance policies as vehicles for accumulating tax-sheltered savings soon will face tighter restrictions on how much tax-free cash they can hold in these policies. Until these rules take effect on January 1, 2017, everyone has the opportunity to take advantage of the existing rules which will be grandfathered at the beginning of next year and the benefits of acting now may extend far into the future, through many generations. Specifically with incorporated individuals, the opportunity to move their tax exposed surplus within a corporation/holding company into a tax sheltered vehicle, provides a means to pass along those assets tax free.
The relevant changes to the Income Tax Act set out how much of the investment earnings associated with the cash value in a life insurance policy are exempt from taxes. The exempt test rules have allowed many policyholders to shelter substantial amount of cash within their policies, a result the government did not intend. The aim of the changes is to end this practice by reducing the tax-exempt savings room in permanent life insurance policies. There also will be fewer options for clients to pay up their policies over an extremely short period of time as the amount of cash that will be allowed into these policies will be reduced by as much as 60%. This impact will be felt by both incorporated and unincorporated individuals.
The more impactful piece will be for incorporated individuals and the change to the Adjusted Cost Base (ACB), inevitably affecting the credit to the Capital Dividend Account (CDA). When a corporation owns a life insurance policy it must also be the beneficiary of that policy. The advantages that we see here in Canada are that, when a policy pays its benefit to the corporation, it creates a credit to the corporation CDA in excess of the ACB, allowing the benefit to flow through to shareholders tax free. The calculation for that credit is as follows;
[Death Benefit – Adjusted Cost Base] = Credit to CDA
Along with the reduction to the available overfunding room, the new rules are imposing a change to the calculation of the ACB. This adjustment will effectively double the time it takes for the entire benefit to come out of the corporation tax free.
Where does Permanent Life Insurance fit for you?
Estate Preservation: To provide the estate with sufficient liquidity to ensure that all taxes and other estate debts are eliminated.
- Wealth Accumulation: To provide individuals with tax deferred growth to supplement retirement income.
- Corporate Transfer: To create a tax effective way of transferring corporate assets to the next generation tax-free, while maintaining access to the cash value in your lifetime.
It is often said that where there is challenge there is opportunity. Times are changing and we have to accept that, but we have been given forewarning to the changes and the impacts of these changes. It is now up to you to act on the opportunity before the window is closed for good.
Chris joined Wise Riddell Financial Group in September 2013 after spending 8 years as a professional chef in Montreal. With his decade of business and management experience, he has been a valuable addition to the risk and estate planning team at Wise Riddell. Chris has returned to his native Oakville where he resides with his wife, Diane, and their two young sons. He is an avid golfer, skier and enjoys being outdoors with his family.