Life Insurance for High-Net-Worth Individuals and Corporate Business Owners - Podcast and Blog

I was recently a panelist on a video podcast titled Life Insurance for High-Net-Worth individuals (“HNW”) and Business Owners. The link to the podcast can be found here. 

The panel was moderated by Simon Kay of IPS Insurance. Simon specializes in Life Insurance for HNW individuals and corporate business owners and is the pioneer of Private Underwriting.

Private Underwriting is a very exhaustive process, but in simple terms, it allows people with underlying health and lifestyle concerns to have all underwriting requirements collected independent of any insurance company. IPS can then identify any areas that might place upward pressure on premiums and work with the client and their doctors to clarify or address any areas of concern. IPS can then set forth a position and advocate solely for their client with the insurers on a no names basis, protecting their clients' privacy. Simon can be contacted at this email: simon.kay@ipsinsurance.ca

The other panelist was Jay Hershfield. Jay is a highly regarded tax and estate specialist with an insurance expertise (which you will undoubtedly agree with once you watch the podcast) and is currently a director with Scotia Wealth Management. Jay has a wide range of experience from working with the Tax Policy Branch with the Federal Department of Finance, a Life Insurance company and with several large Financial Institutions.
 

The title of the podcast is self-descriptive and discusses in fairly simple terms why you as a HNW individual or corporate business owner would want to consider permanent insurance even if you have no need for insurance based on your financial resources.

Simon is in the midst of editing a second podcast on some of the hard questions to ask when you are considering entering into a life insurance policy. I will post that podcast in the near future. I think it is excellent and a must watch if you are considering purchasing a permanent life insurance policy, if I do say so myself :)

As the podcast focuses on permanent insurance, I below provide a brief written summary on what is permanent insurance, some of the reasons to use it and where permanent insurance is typically used by HNW individuals and corporate business owners.

What is Permanent Insurance?

Unlike term insurance which typically covers temporary needs, permanent insurance provides lifelong insurance and is often used for longer term needs. The two most common types of permanent insurance are Whole Life and Universal Life, and most policies combine a death benefit and savings component to the policies.

Why Use Permanent Insurance?

Permanent insurance can provide liquidity and efficiency for an estate. This liquidity and efficiency together with the ability to equalize an estate, can help facilitate family harmony after the passing of a parent.

Where a corporation is the beneficiary of permanent insurance, the Return on Investment is in many cases greater using insurance than where you create your own investment or sinking fund; because the insurance proceeds are credited to the capital dividend account (see this prior blog post on the capital dividend account) and can typically be paid out tax-free (subject to certain tax rules discussed in the second podcast).

Uses of Permanent Insurance?

The following are some potential uses of permanent insurance:

1. Estate planning – On death (typically upon the last spouse to pass-away), the value of your estate will be allocated in some combination to the CRA in taxes, your family or charity. Permanent insurance can be used to provide the liquidity for paying your estate tax liability, estate equalization with your family, charitable purposes or simply estate growth/maximization by leaving a larger estate to your family from the insurance pay-out.

2. Business or partnership agreements – Permanent insurance can be a very tax effective way to buy out a deceased partner or shareholder under the terms of a partnership or shareholder agreement, especially for corporate shareholders by utilizing the capital dividend account.

3. Legacy Assets – For HNW individuals, insuring the tax liability related to legacy assets such as residential or commercial real estate, cottages or a small business seems somewhat counter intuitive, as you would assume the estate can just sell those assets or others to pay the tax liability related to the legacy assets. However, on numerous occasions I have had parents express a desire to have their estate keep legacy assets after they pass away, for sentimental reasons or because they think the future appreciation will be significant. They therefore purchase permanent insurance to cover the legacy asset tax liability, to alleviate the income tax pressure on the estate.

4. Passive Income rules- Permanent insurance can shelter income tax-free within a policy, which effectively reduces taxable passive income for a corporation and therefore can potentially reduce the small business claw back for corporations.

5. Charitable – You can name a charity as beneficiary of a policy or make a bequest of the death benefit from a permanent policy to a charity of your choice and your estate will receive a charitable tax credit upon your death. You can also purchase or transfer a policy (this may result in a taxable deemed disposition, so speak to your accountant first) to a charity and you would receive a tax credit on the yearly premium payments.

This is my last blog post of 2022, so Merry Christmas and/or a Happy Holiday and a Happy New Year to you and your family.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Basics and Uses of Term and Permanent Life Insurance

I am back after a summer of R&R, which proved more golf does not mean you will play better golf. 😊 I hope everyone had a good summer and had a chance to decompress from the stress of the last year and a half.

With the ability to finally get together with friends and family (socially distanced) this summer, there was lots to catch-up on and discuss. I guess because of COVID contemplation, the topic of insurance surprisingly came up a couple times during these get togethers and I noted some confusion on the topic.

So, I thought today, I would post on the basics and uses of insurance and discuss the two main types of insurance: term insurance and permanent insurance.

Term Insurance

In its most basic form, term insurance covers you if you die during the term of the insurance; but there is no cash value, guarantee or payment if you die once your term insurance has lapsed. Term insurance is often limited to a certain age (75-85) and becomes very expensive as you age (for example, my term insurance increased substantially when it renewed at the end of the 10-year term when I turned 60 years old). Thus, many term policies are either cancelled as your need for term insurance diminishes (see discussion below) or people allow them to lapse due to the age/premium cost constraints. It should be noted there are variations on term insurance and certain polices allow you to convert the term policy to permanent insurance.

On an overly simplistic level, term insurance can be compared to renting versus buying a home. When you pay rent on your apartment, condominium, or home, you have a place to live, but the rent paid does not build any equity and the monthly rent paid is cash forgone. The same holds with term insurance. If you are healthy throughout the term of the policy, you do not build any cash value/equity and the monthly insurance cost paid is forgone (although obviously, if you die while owing term insurance, your estate is paid the insurance).

As term insurance is temporary and has no cash value, it is the most cost-effective type of insurance available and is generally used to insure a specific need or a couple needs, such as one or two of the following:

1. Income replacement – term insurance can be used as a "replacement" of income for the deceased person. This is particularly important where one spouse/partner is the breadwinner, but is still often, a very good idea even when both spouses work. The objective of the term insurance in this situation is to allow your family to live in the manner they are accustomed to even if you or your spouse/partner passes away.

2. Financial security for dependents – this is really just a subset of #1, but term insurance ensures your spouse/partner is taken care of the rest of their life, and your dependents are financially covered until they are ready to join the workforce.

3. Debt and Mortgage protection - insurance can be used to pay off debt, typically the mortgage on your home when you pass away so that your family is relived of the debt burden.

4. Funding of University - many parents want to ensure their children are educated and use insurance to backstop that goal in case they were to pass away.

Permanent Insurance

The two main types of permanent insurance (although there are several variations and permutations) are:

1. Whole Life

2. Universal Life (“UL”)

These policies provide insurance coverage for life, so your estate is guaranteed an insurance payout of some quantum. I provide some brief comments on whole and UL insurance below:

Whole Life

With a whole life policy, the risk is typically shared between you and the insurance company. The insurance payments are generally fixed, have a cash surrender value (that can be borrowed against during the life of the policy or withdrawn if the policy is surrendered) but the premiums growth of the cash and death benefit can be affected by a calculation called the dividend scale. If the dividend scale drops too low, there will be less cash value and potentially require further premium payments by the policyholder to ensure the policy does not lapse. So, when looking at a whole life policy, you should ensure your advisor provides different dividend scale scenarios in their proposals, so you have an expected scenario and a worse case scenario to compare.

Universal Life

The premiums for a UL policy are typically more flexible and generally do not provide a significant cash surrender value and the risk of the policy typically falls to the insurance company. There is an insurance component and a tax sheltered “savings” component.

There are various opinions on whether whole life or UL are better choices, but really, they are dependent upon your personal risk and insurance needs. In all honesty, both whole life and UL are complex to understand. I plan in the future, to have a guest post to discuss in greater detail the differences, advantages and disadvantages of whole life and UL.

Where to use Permanent Insurance

Whether you purchase whole or UL, permanent insurance usually makes sense for the following situations: It should be noted that because insurance proceeds are credited to the capital dividend account (see this prior blog post on the capital dividend account) permanent insurance if very often used by corporations, which can make the policies tax effective.

Uses of Permanent Insurance

As noted previously, unlike term insurance which typically covers temporary needs, permanent insurance if often used for longer term needs, such as the following:

1. Estate planning – Upon death, your estate will be allocated in some combination to the CRA in taxes, your family or charity. Permanent insurance can be used to provide the liquidity for paying your estate tax liability (typically in a much more tax effective manner than self-funding), estate equalization with your family or even estate growth/maximization by leaving a larger estate to your family from the insurance pay-out.

2. Business or partnership agreements – Permanent insurance can be a very tax effective way to buy out a deceased partner or shareholder under the terms of a partnership or shareholder agreement. As noted above, permanent insurance if very often utilized where corporations are involved because of the capital dividend account.

3. Passive Income rules- Permanent insurance can shelter income tax free within a policy, which effectively reduces taxable passive income for a corporation and therefore can potentially reduce the small business claw back for corporations.

4. Charitable – You can name a charity as beneficiary of a policy or make a bequest of the death benefit from a permanent policy to a charity of your choice and your estate will receive a charitable tax credit upon your death. You can also purchase or transfer a policy (this may result in a taxable deemed disposition, so speak to your accountant first) to a charity and you would receive a tax credit on the yearly premium payments.

5. Alternative for Fixed Income – I have seen some sophisticated investors use a permanent insurance policy to replace the fixed income component of their portfolio, as even when you factor in the cost of insurance, the return of a permanent policy may exceed the return from fixed income investments.

When you use the word insurance most people wince and only focus on the premium costs. But as discussed above, insurance can protect you short-term or be used to assist with longer term business and estate planning needs. In addition, with permanent insurance, the after- tax returns of an insurance policy versus alternative investments are often higher even after accounting for paying the insurance premiums.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

What Small Business Owners Need to Know - Insurance as a Corporate or Estate Planning Investment Class

Last summer, I attended a  BDO SuccessCare Program that dealt with helping small business owners plan for succession (in a couple weeks I have a post on "One Day You Will Sell Your Business" that discusses how less than 40% of corporate business owners actually have a succession plan).

At the course, Brodie Mulholland, a lawyer who provides insurance and tax based estate planning strategies spoke about how small business owners can use insurance for estate planning and investing purposes even where there is no specific need for life insurance in the traditional sense. I was very impressed with his talk and afterwards started speaking to him about some of the points he made. Brodie volunteered to write a blog post on using insurance as a corporate or estate planning investment class and today I am posting his blog.

Note: over the years I have had several clients purchase insurance in their corporation for estate planning and/or investment purposes. While for certain small business owners, such insurance clearly provides a substantial increase in value to their estate at death, please be aware, that neither Mark Goodfield, The Blunt Bean Counter blog nor the firm I work for is endorsing Brodie or the purchase of insurance for the purposes discussed below. You must obtain independent insurance advice and speak to your accountant on whether purchasing an insurance policy makes economic, estate and income tax sense in your own circumstances.

All the examples, numbers and discussion below are Brodie's solely and I make no representation as to their accuracy. Finally, Brodie's examples below reflect a whole life policy. Before considering any corporate funded insurance policy, you should discuss the advantages and disadvantages of Universal Life ("UL") vs Whole Life or any other alternative insurance product. Many estate and insurance advisors feel UL is a better product, while others feel a whole life policy is the way to go. You need to understand which product best suits your needs.

With all these caveats out of the way, I will leave it to Brodie to discuss the use of insurance as an investment class.

Insurance as a Corporate or Estate Planning Investment Class

By Brodie Mulholland

Today I will review how life insurance may be used, either personally or in a corporation, as vehicle for investments to grow and pay out tax free. It is important to understand that insurance facilitates the investment and in many cases, the person purchasing the policy may feel they already have sufficient life insurance in the traditional sense. As reflected in the examples below, compared to a GIC earning 3% per year after tax, the effective after tax rate of return with an insurance policy is substantially higher, if the policy is owned personally, the returns are even more compelling if owned by a private corporation. 

In general, you would typically only consider funding a life insurance policy as an investment where you anticipate having more funds than you will need to live and you want to leave this money to your estate.

An Example

Let’s take a couple, Thom and Sophie who are, respectively, 66 and 64, who have $100,000 to invest each year (while I am using an investment of $100,000 a year for this example, until the year in which the survivor of Thom and Sophie die, for many small business owners, the investment is often $25,000-$50,000 for say ten years). One option would be for Thom and Sophie to invest in a GIC. In Ontario, if you are paying tax at the highest marginal rate; 53.53% of the income earned each year on the GIC goes to pay income tax. How do you shelter that income from tax?

One option is to use life insurance. Under the current life expectancy tables used for income tax purposes, the statistical life expectancy of the last of Thom and Sophie to die is 25 years (for example, suppose Thom died in 20 years and Sophie in 25 years). If Thom and Sophie paid $100,000 per year into a GIC that earned 3% after tax (that’s like earning 6% before tax at a 50% marginal tax rate), after 25 years the GIC would be worth almost $3,800,000. However, the amount paid out on a tax free basis to their estate could be more than $6,300,000 if instead they acquired a “participating with paid up additions” whole life insurance contract that paid out on the last of them to die assuming current policy premiums and insurance company dividend payment rates (different types of insurance are explained below). That’s over $2,500,000 (or over 65%) more to their estate after tax.

Does this sound too good? Even if I lower the insurance company’s dividend payment rates by 1% (many experts believe they will be lower in the future given the historically low interest rates the last decade) the amount that would be paid out after tax would still be almost of $5,700,000. Still some risk you say? If they used a T-100 insurance policy that pays out on the last of them to die and where the annual premiums and payout amount are guaranteed for life, the tax free payout could be almost $6,000,000 – that is almost $2,200,000 (or 58%) more than the GIC after tax.

Which Investment or Type of Insurance to Choose?

 

Year	GIC 3% After Tax Rate of Return	Whole Life Insurance - Current Dividend Scale	Whole Life Insurance - Current Dividend Minus 1%	T-100 Life Insurance
10	$1,180,780	$2,922,055	$2,840,120	$5,940,856
20	$2,767,649	$4,980,042	$4,541,546	$5,940,856
25	$3,755,304	$6,315,893	$5,588,146	$5,940,856
30	$4,900,268	$7,787,482	$6,682,200	$5,940,856

Based on information obtained on or before November 26, 2015, assuming:
- Thom and Sophie are non-smokers in standard health
- $100,000 payments are made annually at the start of each year until the year in which the survivor of Thom and Sophie die

There are pros and cons to each option. The biggest “con” to using life insurance versus a GIC, is that life insurance does not pay out until death and so the insurance benefits your estate or the beneficiaries you designate, not you directly. When choosing between life insurance products, the advantage of a T-100 life insurance policy is that the amount that you pay and that will be paid out on death are guaranteed. With universal and whole life policies, generally there will be certain guaranteed minimum payout amounts, but the actual tax free payout amount will vary depending upon, in the case of universal life, investment performance and for whole life, dividend rates.

There are ways to borrow against, or in some cases, withdraw, amounts you have paid into certain permanent insurance policies, although I do not recommend planning to use life insurance in this way as an investment unless you are quite certain that you will never need to use it during your lifetime. With T-100 policies, generally borrowing or withdrawing from the policy is not possible.

Funds in a Corporation

What if the funds to be invested are inside your corporation? Using corporate dollars to pay the insurance premiums is often better because, generally, corporate dollars have not been taxed as much. More importantly, because life insurance proceeds are credited to a special account called the Capital Dividend Account (“CDA”), depending upon the type of life insurance and how long the policy has been in effect, most, if not all, of the insurance proceeds may be paid out of your corporation to you/your estate tax free. See Mark's post on Capital Dividends - A Tax-Free Withdrawal from your Company for more information on the CDA account.

Thom and Sophie’s Corporation

So to carry on with our example, let’s suppose that Thom and Sophie had a corporation with $100,000 per year to invest and that their estate will need these funds and the accrued growth from the corporation to pay taxes on the death of the survivor of Thom and Sophie.

Again, let’s compare what would happen if Thom and Sophie used that $100,000 per year to have the corporation fund a GIC versus funding a life insurance policy with premiums of that amount. Let’s further suppose that the survivor of Thom and Sophie dies 25 years from now so their estate would need funds to pay its tax liability then. If the corporation earned 3% per year after tax on the GIC, as above, in 25 years that would amount to almost $3,800,000. Now how does the estate get the funds out of the corporation? Usually the corporation would pay a dividend on the shares formerly held by Thom and Sophie’s to their estate, assuming that their estate now holds their shares in the corporation. However, at current tax rates, if these funds were paid to the estate by dividend, the estate would have to pay tax of about 1/3 (or much higher after the Liberal tax changes - the accountants may use various tax planning techniques to lower the tax rate on removing the funds) of the dividend amount, leaving the estate with about $2,500,000 after tax.

If the corporation instead acquired the same “participating with paid up additions” whole life insurance as stated above and assuming current dividend payment rates, the payout amount would be over $6,300,000, much of which could be paid out to the corporation to Thom and Sophie’s estate tax free. 

If Thom and Sophie were to take the most conservative approach, and had the corporation acquire the same T-100 insurance policy referred to above, the proceeds would be almost $6,000,000 and these should be able to be paid out of the corporation tax free, so the difference to Thom and Sophie’s estate compared to the GIC would be almost $3,500,000 – over double. (again, there may be additional tax savings from further tax planning involving Thom and Sophie’s shares.)

Term vs. Permanent Life Insurance

There are two basic types of life insurance: term and permanent. Term insurance is the type with which most of us are familiar – it is in effect for a specified term, for example, 20 years. Its purpose is primarily to manage the risk to the family in the event of death (i.e. income replacement) – that is, if an income earning spouse were to die prematurely, what amount of capital would produce enough income to make up for the loss to the family of the deceased’s income. If the person whose life is insured lives longer than the term (e.g. 20 years) the policy’s term will have expired. Another type of life insurance is permanent insurance: insurance that is intended to payout on the death of the life insured, and has no specified term – it is intended to be in effect permanently until the insured dies.

Participating Life Insurance and Statistical Life Expectancy

Permanent life insurance policies can be “participating” or “non-participating”. Most participating policies are ones where the insurance company pays dividends to the policy holder. Depending upon how these dividends are paid or used, they may not be taxable to the policy owner/recipient. One of the most common ways that non-taxable dividends are paid or used is by way of “paid up additions” – the dividends are used to buy extra amounts of life insurance so the insurance contract payout amount increases every year. Again, in very general terms, there are three types of permanent life insurance: universal, whole life and T-100 policies. Generally, with Universal Life, the investments inside the policy are managed by you and those in a whole life policy are managed by the insurance company. Universal and whole life policies may be participating or non-participating and T-100 policies are non-participating. A permanent life insurance policy “matures” (that is, pays out) when the life insured dies, so for the purpose of comparing life insurance to other types of investments, we use statistical life expectancy as the date to which returns are calculated.

Tax Free Investment Growth Inside an Insurance Policy

Under the Income Tax Act when you may make extra contributions to a life insurance policy they can grow tax free within certain limits (known as the MTAR rules). Generally, the larger the face amount of the insurance policy (that is, the death benefit or amount paid on death) and the older the person whose life is insured, the greater the extra contribution allowed. As mentioned, those extra contributions grow inside the policy on a tax free basis. You might be saying “yes, but I can do that in my RRSP”. True, but on death, your RRSP is fully taxable – often to the tune of almost 50%. That is not the case with the extra contributions and growth inside the insurance policy: on your death, they payout to your beneficiary’s tax free, in addition to the death benefit.

So you don’t Have a $100,000 a Year to Invest?

This type of insurance planning works for amounts less than $100,000 per year, but for various reasons, including of fixed policy fees, as amounts get smaller, the effective returns will not be as high and may not make sense for amounts less than $25,000 per year, for say at a minimum of ten years.

The Rules are Changing in 2017

The tax rules are changing for insurance policies issued after 2016, in some cases, substantially reducing the amount that may grow tax free inside an insurance policy. Thus, you may wish to consider this type of planning before 2017, especially since the process of putting such a life insurance policy in place can take several months; in other words, right now is a great time to look into it.

Brodie Mulholland is a consultant to tax and estate planning lawyers, tax accountants and investment advisors to assist their clients with insurance based tax and estate planning strategies. Brodie is a lawyer who has practised for over 30 years in the areas of trusts, wills, tax and estate planning, corporate and commercial law and corporate restructuring. He is a member of STEP (Society of Trust and Estate Practitioners) and received an Advanced Certificate in Family Business Advising (with distinction) from STEP. Please feel free to contact Brodie directly at 416-917-0058 or by email at brodie.mulholland@gmail.com.

The above blog post is for general information purposes only and does not constitute legal, insurance or estate planning or other professional advice or an opinion of any kind. Readers are advised to seek specific legal, insurance or estate planning advice regarding any specific issues.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

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