Legacy planning using life insurance strategies

1. Purchase of life insurance by the corporation

The core of this strategy involves using corporate funds to purchase a permanent life insurance policy, such as whole life or universal life insurance, on the life of the shareholder or shareholders. The corporation owns and is the beneficiary of the policy. The policy offers both a death benefit and a cash value component that can grow over time.

2. Premium payments and cash value growth

The corporation funds the life insurance policy with premium payments, which can be made from surplus cash flow or reallocated investments. In many policies, premium deposits can exceed the minimum required amount, allowing for additional funds to be invested within the policy. These excess deposits grow tax-deferred within the policy, providing an opportunity to accumulate wealth without incurring annual tax on investment income.

3. Tax-exempt growth and death benefit

The investment portion of the life insurance policy is structured to qualify as a tax-exempt policy under Canadian tax rules. This means that the growth within the policy is not subject to current taxation. Upon the death of the insured, the corporation receives the death benefit tax-free. The death benefit amount is generally much larger than the accumulated cash value or the premiums paid, making this an effective way to maximize the transfer of wealth.

4. Life Insurance and the Capital Dividend Account (CDA)

Upon receiving the death benefit, the corporation gets a credit to its Capital Dividend Account (CDA) for the amount of the life insurance proceeds, less the adjusted cost basis of the policy. Dividends paid out of the CDA can be distributed tax-free to the shareholders or their estate, allowing the funds to be passed on without triggering additional tax liabilities.

1. Tax efficiency

By replacing taxable corporate investments with a tax-exempt life insurance policy, business owners can reduce their corporation's tax liability on investment income and offset capital gains tax. The death benefit is received tax-free, and the proceeds can be distributed tax-free to the estate through the CDA, avoiding double taxation that often occurs when corporate assets are passed on to heirs. Using life insurance as an investment or sometimes referred to as an alternative asset class, provides unique advantages not available with other investments.

2. Increased estate value

This strategy typically results in a larger estate value due to the tax-deferred growth of the policy's cash value and the tax-free death benefit payout. This ensures that more of the business owner's hard-earned assets are preserved for their beneficiaries.

3.  Mitigation of new tax rules

With the 2019 changes to the tax treatment of passive investment income for CCPC's, which phase out the small business deduction when passive investment income exceeds $50,000, moving corporate funds into an exempt life insurance policy offers a way to preserve access to the small business tax rate. Investment income earned within these policies does not count as passive income for tax purposes, providing a potential solution to avoid the punitive tax measures for corporations with significant passive investments.

4. Flexibility in accessing capital

Although the primary purpose of the strategy is long-term wealth transfer, the policy's cash value can be accessed during the insured's lifetime, either by withdrawing funds (which may have tax consequences) or by borrowing against the policy's cash value. This provides liquidity if the business or the owner needs access to cash before death.

1. Business owners with surplus corporate cash

Owners of Canadian-controlled private corporations (CCPCs) who have accumulated surplus cash or retained earnings that they do not need for personal income or business reinvestment, may benefit from a corporate estate transfer strategy. These funds are often earmarked for heirs or charitable donations upon the owner's death.

2. Those seeking long-term wealth transfer

This strategy can help Individuals who want to leave a financial legacy and are concerned about the tax erosion of their corporate assets. It is ideal for those with a strong desire to maximize the amount passed on to beneficiaries by reducing tax liabilities on corporate investments.

3. Business owners affected by passive investment income rules

Corporations earning more than $50,000 in passive investment income could lose their small business tax rate under the new rules. By investing in a tax-exempt life insurance policy, business owners can preserve access to the small business deduction.

4. Those concerned with estate taxes

The strategy is also beneficial for individuals who anticipate a large estate tax liability upon death and want to ensure that their heirs receive a larger portion of their estate. The strategy is a great way to offset capital gains tax in Canada.

Overall, this strategy offers a tax-efficient way for business owners to transfer wealth to their heirs or charitable causes. By repositioning corporate assets from taxable investments to a tax-exempt life insurance policy, business owners can minimize taxes, increase the value of their estate, and help ensure that more of their hard-earned money benefits their loved ones.

1. Asset valuation

The first step in estate equalization is determining the value of the estate, especially the business and other major assets. Business owners may hire a chartered business valuator to accurately assess the value of their company, which helps in deciding the life insurance coverage required to balance the estate.

2. Distribution plan

Next, the business owner creates a distribution plan that outlines how assets will be divided among heirs. For example, if a business is worth $5 million and one child is set to inherit the business, the other heirs could receive assets, life insurance, or a combination worth an equivalent amount.

3. Purchase of the life insurance policy

The business owner then purchases a life insurance policy that provides a payout equivalent to the value of the other assets. If the business is worth $5 million, the owner might purchase a life insurance policy that would provide them with the additional money they need to ensure that all children receive an equitable inheritance.

In some cases, business owners may opt for a corporate-owned life insurance policy. This type of policy is owned and paid for by the company but insures the owners or key shareholders. When the insured person dies, the company receives the payout, which can then be used to buy out shareholders or distribute funds to heirs.

4. Buy-sell agreements

To further help ensure smooth business succession, the owner may establish buy-sell agreements funded by life insurance. These agreements outline the terms for buying out shareholders in the event of death, disability, or retirement. In the case of death, the life insurance proceeds provide the necessary liquidity to execute the buyout, helping to ensure that business operations continue without disruption.

One of the significant advantages of using life insurance for estate equalization is tax efficiency. Life insurance payouts in Canada are typically tax-free, which means that the proceeds can be distributed to heirs without tax liabilities. If the life insurance is corporate-owned, the policy's death benefit over the policy's cost basis can be paid out as a tax-free capital dividend.

Estate equalization using life insurance is particularly beneficial for:

1. Business owners with family-owned businesses or closely-held corporations are prime candidates for this strategy. It allows them to pass on the business to heirs who are interested in running it while helping to ensure that other heirs receive an equal share of the estate. This can help prevent family disputes and help ensure the continuity of the business.
    
2. Families with illiquid assets such as real estate, art, or collectibles also benefit from estate equalization. If one heir wants to keep the family cottage, for example, life insurance can provide the liquidity to ensure other heirs receive an equivalent inheritance without forcing the sale of the property.
    
3. Families with complex dynamics where heirs have different levels of involvement in the family business or varying financial needs may benefit from estate equalization to help ensure fairness. For instance, life insurance payouts can prevent potential conflicts over perceived favouritism.
    
4. High-net-worth individuals with substantial estates often face significant estate taxes and challenges in dividing their wealth equitably among heirs. Life insurance can provide the liquidity needed to pay estate taxes and ensure that all heirs receive a fair share of the estate, without the need to sell off valuable assets.

By providing liquidity through life insurance payouts, this strategy ensures that all heirs are treated equitably, avoiding family disputes, and preserving the integrity of the estate.  It offers flexibility in estate planning, allowing business owners to pass on their companies to those who will continue running them while providing for other heirs who may not want to be involved.

The annuity settlement option transforms the lump-sum death benefit of an insurance contract into a stream of periodic payments.  Upon the policyholder's death, the proceeds from their insurance policy, segregated fund contract, or guaranteed interest account are automatically transferred to an annuity.  The resulting annuity then pays out regular income to the beneficiaries according to the terms specified by the policyholder.

Policyholders can choose the length of time over which the payments will be made, which can range from a specific number of years to the lifetime of the beneficiary.  Additionally, guarantee options can be added to ensure that a minimum amount is paid out, even if the beneficiary dies before the full annuity is disbursed.  This flexibility allows policyholders to tailor the annuity to their specific needs and the needs of their beneficiaries.

For those with multiple beneficiaries, the annuity settlement option provides the ability to differentiate between them, offering a lump sum to some and others an annuity, depending on their personal situations.  If a policyholder wishes to change the terms or beneficiaries, they can do so by simply completing a new annuity settlement option form – without the need for legal fees or the complexity of amending a trust.

1. Gradual wealth transfer

The annuity settlement option replaces a potentially overwhelming lump sum with smaller, scheduled payments. This can help protect beneficiaries who may struggle with managing large sums of money or who have limited financial experience.

2. Cost-effective

Unlike setting up a trust, which can incur significant legal and administrative costs, the annuity settlement option has no fees for setup or ongoing management. It eliminates the need for contract preparation costs, trustee fees, and accounting expenses associated with trusts.

3. Increased privacy

As with all beneficiary designations on insurance contracts, estate settlements through the annuity settlement option are private. The distribution arrangements are known only to the beneficiary, protecting the family's financial matters from public scrutiny.

4. Flexibility

Policyholders retain control over the terms of the annuity, including the length of the payment period and the addition of guarantees. Changes to beneficiaries and terms can be made at any time, without fees.

5. Simplified estate planning

The annuity settlement option streamlines the estate planning process. It is easier to implement than a formal trust and does not require ongoing management or legal intervention after the initial setup.

6. Creditor protection

The annuity settlement option can offer creditor protection, preventing the beneficiaries' payments from being seized by creditors in certain circumstances.

1. Limited flexibility compared to trusts

While the annuity settlement option offers a simple solution, it may lack the flexibility of a trust in certain scenarios. Trusts can provide more control over the timing and conditions of distributions, which may be important if a policyholder wants to delay payments until certain conditions are met, such as the beneficiary reaching a specific age or milestone.

2. No tax planning benefits

Trusts can be structured for tax-planning purposes, such as income splitting or minimizing taxes for beneficiaries in higher tax brackets. The annuity settlement option does not provide these same opportunities for tax efficiency.

3. No conditional payments

Annuities are structured to provide regular payments without the ability to set specific conditions for disbursement. In contrast, a trust allows the policyholder to set conditions on the use of the funds, such as for the education or healthcare expenses.

4. Potential for reduced control over timing

Once the annuity terms are set, payments are typically fixed. In contrast, a trustee in a trust arrangement can adjust the timing of distributions based on the needs and circumstances of the beneficiary.

5. Not suitable for complex family situations

In more complex family dynamics, such as blended families or beneficiaries with unique needs, a trust may be better suited to help ensure that all family members are adequately cared for. In the case of a beneficiary receiving provincial disability support, annuity payments may disqualify them from receiving income and/or service support.

The annuity settlement option is ideal for individuals who want a simple, cost-effective way to transfer wealth gradually to their beneficiaries.  It is particularly suited for policyholders who are concerned about their beneficiaries' ability to manage a large sum of money, such as young adults, those with disabilities, or beneficiaries with a history of poor financial management.

This option is also attractive to those who want to avoid the complexities and costs associated with establishing and maintaining a trust.  This option may also be appealing to policyholders who prioritize privacy, as beneficiary designations through a life insurance policy, whether direct or via an annuity settlement, bypass probate and remain outside public records, ensuring confidentiality.

Investments in variable annuities are subject to market risk and loss of principal. The investment return and principal value will fluctuate so that accumulation units, when redeemed, may be worth more or less than their original cost. Ask your Edward Jones financial advisor which variable annuity may be right for you.

Investments in fixed annuities are subject to surrender penalties that are usually assessed if you withdraw all or a portion of your principal during the guarantee period. Such withdrawals may also be subject to a market value adjustment. Some fixed annuities provide waivers for surrender charges under special circumstances, such as a nursing home stay. Ask your Edward Jones financial advisor which fixed annuity may be right for you.

1. Purchase life insurance policy

Parents or grandparents buy a permanent life insurance policy, such as Whole Life or Universal Life insurance on the life of their child or grandchild.

2. Policy funding

The policy is funded with assets that the policyowner intends to transfer to the child or grandchild as part of their legacy.

3. Ownership transfer

Ownership of the policy is either transferred while the original owner is alive, or the life insured is named as contingent owner thereby allowing the tax-free ownership transfer to the child upon the original owner's death.

4. Intergenerational rollovers

These rollovers allow the policy to transfer ownership without triggering taxes, provided the life insured and transferee are classified as "children" of the original owner. This includes natural or adopted children, stepchildren, grandchildren and others.

5. Beneficiary designations

The beneficiary, typically the next generation, receives the death benefit tax-free, bypassing probate and any estate taxes.

1. Tax efficiency

The policy grows tax-sheltered and the death benefit is paid out tax-free. The transfer of ownership occurs without incurring taxes.

2. Wealth preservation

The policy can preserve and grow wealth for future generations, providing a legacy that is protected from creditors and taxation at death.

3. Access to cash value

The policy's cash value can be accessed by the new owner for various life events, such as education, buying a home, or retirement, through policy loans or surrenders.

4. Insurance protection

The younger generation gains life insurance protection at favourable rates, ensuring coverage even if health conditions deteriorate later in life.

5. Flexibility and control

Policyowners maintain control over the policy, and they can name irrevocable beneficiaries to help ensure that funds are used as intended.

1. Irrevocable beneficiaries

To protect the policy's purpose, irrevocable beneficiaries can be named, which prevents changes to the policy without their consent.

2. Contingent owners

Naming a contingent owner helps avoid complications if the original policyowner passes away before transferring the policy.

3. Generational continuity

The strategy allows for cascading wealth down multiple generations, offering flexibility to continue the legacy.

Cascading life insurance is a valuable tool for affluent families looking to maximize wealth transfer efficiency, reduce tax liabilities, and secure financial protection for future generations.