The Blunt Bean Counter

Monday, March 28, 2016

The 2016 Federal Budget

Last Tuesday, the Minister of Finance, Bill Morneau, delivered the Liberal governments much anticipated 2016 Federal budget.

While much of the budget had been floated and/or proposed during the election and confirmed in part on December 7th (the middle-class tax cut and 4% increase in tax rates for high income earners) by Mr. Morneau, there were some still some surprises.

In January, I wrote a blog post on how the "Top 1%, are not Happy Campers". I would suggest they are still not (see my CBC National News interview on this topic here and the story of this high earner leaving Canada). Yet, I think between all the trial balloons and rumours, from raising the small business tax rate to 26.5%, to a possible increase in the capital gains rate from 50% to 75%, many of the "Top 1%" felt they escaped tax Armageddon to some extent. However, if you are a small business owner or professional, there were many under the radar changes that may significantly impact your future tax planning and depending upon your fact situation, potentially result in even more income taxes. If planned, it was an excellent job of misdirection from the government in respect of high income earners.

The "middle-class"are the winners here. However, I still want to reserve judgment as to how big a win certain people had. The "middle-class" has lost the family tax cut worth $2,000 to some people. In addition, much of the "middle-class" gain revolves around children, so if you are single or do not have children or only say one child, your benefit is not quite as large. Finally, the new Canada Child Benefit ("CCB") starts to phase out on adjusted family income in excess of $30,000, so many families will have a reduction in their child tax benefit. So while most people will be net winners, some middle-class people may not benefit as much as they anticipate. This Toronto Star article
presents some interesting numbers on how the federal budget affects everyday Canadian families.

Business Changes

The budget contains several proposals that will close down many popular tax planning techniques used by high income earners. These include:

a) The transfer of personal life insurance policies to private corporations that allow the shareholder to extract tax-free funds. New measures will reduce or eliminate these transfers effective March 22, 2016. For those who transferred policies prior to the budget date and took back tax-free shareholder loans, essentially the new proposal will cause the tax-free capital dividend received by the corporation upon your death, to be reduced by the tax-free loans you took from your company while alive.

b) Many partnerships created structures whereby the partners had corporations that provided services to the partnership allowing them to potentially access the $500,000 small business exemption. For taxation years that begin after March 21, 2016, the budget will change the rules to catch this type of service income. I am surprised it took this long to eliminate this type of planning.

c) It is somewhat common for the spouse of a high income earner to incorporate a company that provides services to their spouse's corporation. This planning can often allow both spouses corporations to access the $500k small business deduction. Also applicable on or after March 22, 2016, the budget will deem the service income to not be eligible for the SBD where the shareholders or a person does not deal at arm's length (such as spouses). Thus, combined, the two related corporations can only claim $500k SBD in total.

Other Business Changes

The small business tax rate reductions legislated by the Conservative government will be frozen at 10.5% for 2016 and beyond.

The Eligible Capital Property regime (such as goodwill, customer lists and licences) will now be replaced with a new capital cost allowance class (Class 14.1) with a 5% declining balance. The CEC balances will be transferred effective January 1, 2017. This is very complex, but will be less beneficial than the current regime in many cases as active income is now being turned into investment/property income.

There will be significant changes to transfer pricing and anti-surplus stripping and various foreign transactions which are beyond the scope of this post (meaning, way too complicated for me and you need a non-resident specialist).

Miscellaneous Personal Changes

1. The budget proposes the elimination of the children's fitness tax credit, arts tax credit and education and textbook tax credits as of January 1, 2017. The children's fitness tax credit and arts tax credit will be halved for 2016 and you can continue to carry forward unused education and textbooks credits. The Federal tuition credit is unchanged.

2. The family tax cut will be eliminated for 2016 and subsequent years.

3. The child tax benefit and universal child benefit will be combined into one non-taxable Canada Child Benefit ("CCB"). The CCB will provide annual benefits of up to $6,400 per child under six years old and up to $5,400 per child six through seventeen. On the portion of adjusted family net income between $30,000 and $65,000, the benefit will be phased out at a rate of 7 per cent for a one-child family, 13.5 per cent for a two child family, 19 per cent for a three-child family and 23 per cent for larger families. Where adjusted family net income exceeds $65,000, remaining benefits will be phased out at rates of 3.2 per cent for a one-child family, 5.7 per cent for a two-child family, 8 per cent for a three-child family and 9.5 per cent for larger families, on the portion of income above $65,000.

The budget proposes to provide an additional amount of up to $2,730 per child eligible for the disability tax credit.

4. The retirement age for Old Age Security will be rolled back to age 65.

5. Many mutual funds have been structured to allow "switches" among the funds (known as corporate class funds) to avoid triggering tax. The budget proposes that for dispositions after September 2016, a taxable disposition will occur when you switch among mutual funds with the exception of switches between series of shares within a class (i.e.: the shares within the class are essentially the same funds).

6. There was no budget proposals in respect of stock options, a pleasant surprise, given the Liberals had discussed restrictions being implemented.

7. The Conservative governments proposal to allow the donation of real estate or private corporation shares will not proceed.

The budget contained multiple proposals, but I have only touched on a few. For many of the proposals, the devil will be in the details.

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.

Monday, March 21, 2016

Estate Planning and the Black Sheep Child

In November, Adam Mayers of The Toronto Star reviewed my book, Let’s Get Blunt About Your Financial Affairs. In his article, he discussed some of the comments I made in my book on inheritances.

123 REF-Tomas Marek

My observations elicited some very interesting emails to my inbox. Some of the emails provided tragic and sad details of children being left out of their parents' lives and consequently their wills for various reasons. One reader, who is gay, asked me if he could be left out of a will solely for that reason.

This question is far outside my area of expertise. I thus enlisted my wills, trusts and estates expert Katy Basi, to answer his question and discuss in general, the consequences from both the parents and child's perspective, of leaving a black sheep child out of the will.

Please note: Katy and I use the term "black sheep" colloquially and the term is not meant to be demeaning in any manner.

Estate Planning and the Black Sheep Child

By Katy Basi

Many families have one (or more) black sheep children, and estates lawyers commonly deal with two categories of questions regarding these shunned family members. In this blog post I will refer to our sample unfortunate as Cain (though most black sheep are not guilty of fratricide!). The two situations are as follows:

If the client is not Cain - can I cut Cain out of my will? If I do, will he be able to challenge my will?
If the client is Cain – can my family members cut me out of their wills?

The Parent is the Client

If you plan to cut Cain out of your estate plan, I typically have three pieces of advice for my clients:

(1) Explain in the will why Cain is being treated differently than other family members of the same degree of family connection. For example, if a child is being cut out of a will because they have chosen not to have contact with their parents for two decades, the will should state that very relevant fact. Otherwise, Cain could argue that the lawyer made a drafting error by leaving him out, or this omission could be used as evidence of the parents’ lack of capacity to make the will(s) in question (i.e. the argument then goes “Clearly the fact that they “forgot about me” indicates that they had lost their marbles!”).

(2) Consider leaving a set dollar value legacy to Cain, and then having a clause that takes the legacy away if Cain challenges the will for a reason other than a valid interpretation issue. This is known as an “in terrorem” clause and needs to be very carefully drafted by an estates lawyer in order to be legally effective.

(3) Arrange for a capacity assessor to interview the testator before the will is signed (though not too far in advance of signing). The capacity assessor should then write a letter or report of some kind confirming that the testator has the capacity to make the will in question (presuming that this is the case, of course). This is particularly helpful if the testator is elderly or ill, or if there are any other factors which could lend strength to a “lack of capacity” argument by a disappointed beneficiary. I have seen a capacity assessment stop estate litigation in its tracks.

Cain is the Client

When I am advising Cain, my first piece of advice is to consult an estates litigator (I am an estates solicitor, and therefore a major part of my job, in my view, is to help clients plan their estates in such a way as to discourage litigation). After that disclaimer, my counsel generally flows along these lines:

(a) We are lucky (in my view) to have testamentary freedom in Ontario, subject to certain limitations (other provinces such as British Columbia have enacted laws limiting testamentary freedom to some extent).

(b) One exception to testamentary freedom is the ability of certain family members (e.g. minor and adult children, parents and siblings) to make a support claim against the estate. For example, if Cain is an adult child who was financially supported by his parents, and was not left a sufficient inheritance by them (as determined by a court) Cain may make a support claim against the estate. Support can include providing accommodation at lower than fair market value rent.

(c) Where no financial support has been provided, Cain’s usual recourse is to try to have the will that cuts him/her out declared invalid, usually on the basis of a lack of testamentary capacity (as alluded to above) or undue influence (e.g. “my sister pressured my mom into cutting me out of her will”).

(d) Either of these claims will require solid evidence to be successful in court.

(e) A successful will challenge is not helpful if the prior will also cuts out the challenger, presuming that the prior will is valid.

(f) While in the old days most of the costs associated with estate litigation were borne by the estate in question, the courts have shifted their approach in recent years. These days, courts do not hesitate to order an unsuccessful will challenger to pay, not only their own costs, but also the costs of the estate relating to the challenge. Litigation is very, very expensive and time-consuming, so launching a will challenge due to feeling left out, without a good evidentiary case, is just not a good idea.

(g) However, if the will challenger has been cut out of the will for a reason that is against public policy, then litigation may be successful even if the testator had capacity and was not unduly influenced. If Cain can prove in court that he/she was cut out of an estate plan due to discrimination on a basis not permitted under the Charter of Rights and Freedoms, for example due to their sexuality, or because they married outside of his/her race/religion etc., then Cain may have a valid claim. The evidentiary mountain here can be steep to climb, but in a recent case the claimant was successful in overturning her father’s will on the basis that her father had cut her out as she had a mixed-race child. She was successful despite the fact that there was no reference to this discrimination under the terms of the will. There was, however, substantial external evidence as to the discriminatory reason behind her father’s estate plan.[Note: Just prior to the publication of this blog post, the decision of the lower court was overturned by the Ontario Court of Appeal, reinstating the father's original estate plan. It would be very helpful to have guidance from the Supreme Court of Canada regarding this issue if the daughter decides to ask for leave to appeal].

My discussions with clients about cutting out, or being, the black sheep tend to be fraught with sadness, anger and frustration. My experience is that clients do not cut out a black sheep lightly, and in many cases would usually be overjoyed to reconcile, knowing that there will need to be apologies and compromise on both sides. By the time I am counselling a black sheep about being cut out, it’s clear that no amount of litigation will heal the hurt feelings.

Bloggers Note: Katy has written numerous guest posts for this blog. Many of her articles have proven to be very popular with readers. If you want to read more from Katy, the best way to review her previous blog posts is: go to the search function on the top right hand side of the blog and type in her name.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estates, and income tax law (including incorporation's and corporate restructurings). Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@basilaw.com. More articles by Katy can be found at her website, basilaw.com.

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

Monday, March 14, 2016

What Small Business Owners Need to Know - One Day You Will Sell Your Business

Last summer, I attended a four-day course on family business succession planning, put on by The BDO SuccessCare Program. The course dealt with the usual financial issues accountants love to delve into when a business owner is undertaking succession planning, such as valuations and tax planning. But what I found fascinating was; that the meat of the course dealt with the many psychological issues and hurdles that an advisor must consider when dealing with family succession planning.

One of the slides utilized in the course, was a "One Day You Will Sell" flow-chart (see below). I was struck by the simplicity and frankness of this message. If you are a small business owner, the slide bluntly states, that if you do not plan for the succession of your business voluntarily, you unfortunately will likely have that decision made involuntarily for you. Jeff Noble, a Director & Practice Leader of SuccessCare notes that the involuntarily side of the chart can also include disagreement and disenchantment.

You Should Voluntarily Plan the Sale of Your Business

It is prudent for business owners to plan for a voluntary sale to someone inside the family or to a company insider, as this strategy also accommodates a change in direction to a third party sale. (If all preparation is geared towards an external sale, it is much more difficult to later switch to an internal sale.) This way the business decreases dependency on current management, leadership and ultimately current ownership. The by-product is a business that is also better prepared for and attractive to an external buyer.

Why Would Anyone not Plan for a Voluntary Sale?

When you review the left side of the above diagram and see the words death, ill health and bankruptcy, one would have to wonder why any small business owner would ever allow their "baby" to be subject to an involuntary disposition. It is not unusual where there is an involuntary disposition, that the ill business owner or their estate (if deceased) receive only cents on the dollar for the business.

Yet business owners do not plan for their succession in astoundingly huge numbers. In 2015, U.S. Trust undertook an extensive Wealth and Worth survey.

The survey reflected that an astonishing 61% of small business owners do not have a formal plan for the orderly succession of their business. Since in most cases, informal plans are not worth the piece of paper they are written on (although, most informal plans are verbal), these business owners are flirting with involuntary business dispositions.

The U.S. Trust survey noted five reasons business owners do not have formal succession plans. They include (with my comments in parentheses):

1. No plan to retire anytime soon (which means: they don't want to retire)

2. The decisions have yet to be made (which often means: they are procrastinating on deciding between long-time employees, their children or an arm's length sale)

3. Others are aware of their wishes (which means: there is no formal plan and a disaster is waiting)

4. A will is in place to cover the succession plan (which means: pretty much the same as #3 above)

5. They are too busy to think about it (which means: they don't want to think about it)

I would add the following other reasons:

6. They will not face their mortality (see my blog on facing your mortality)

7. They do not want to accept the fact that if they hand over the reins to someone else, the company may function without them (which means: they can't accept they are not the company)

In June of 2014, I wrote a three-part series on estate freezes. In the third installment, I noted Tom Deans, the author of Every Families Business (the bestselling family business book of all-time) half-jokingly noted during a panel discussion we were part of that "when your parent has a heart attack at 71, twenty years ago they died. Now doctors put in a coronary stent and your parent is good for another 20 years. So when parents tell a child it will all be yours one day, that one day could be when you turn 65 and up until you obtain control of the company, your parent(s) may keep their thumb(s) on you (since they often maintain voting control as per my estate freeze discussion last week). Parents; skipping a generation is not succession planning!"

While the above quote is in reference to an estate freeze and passing the business to the next generation (Tom does not necessarily believe an estate freeze is the best succession plan), Tom's comments reflect that many business owners would rather just work till they drop.

If you are a business owner, review the seven reasons above, get over your obstacle and start planning for your business succession, or someone else may be planning your involuntary succession.

Small Business Owners - Get on my Mailing List

If you are an owner-manager and/or a shareholder in a corporation and have not signed up for my corporate mailing list, please email me at bluntbeancounter@gmail.com

I will be sending out specific mailings on matters of importance to small business owners and I am considering, depending upon the interest, holding a roundtable for small business owners who are in the Toronto area.

Thanks to the many readers who have already signed up.

Monday, March 7, 2016

The CRA’s 2016 Compliance Letter Campaign

Since 2010, the Canada Revenue Agency ("CRA") has been sending letters to specific Canadians to in their words “inform selected taxpayers about their tax obligations and to encourage them to correct any inaccuracies in their past income tax and benefit returns”. The 2016 campaign, for which the CRA estimates it will send approximately 30,000 letters, has already begun. Today I will discuss

A better caption would be "You Are Maybe Getting Audited"

these letters.

Favoured Taxpayers

The letters are sent to selected groups of individuals where the CRA feels the taxpayers may not fully grasp the technicalities regarding the deductibility of specific expenses. These groups tend to fall into the following three main categories:

1. Self-employed business owners

2. Commission employees

3. Rental property owners

Expenses That Catch the CRA's Eye

The letters tend to focus on the following type of expenses:

Self-employed and commission employees

Advertising and promotion, specifically meals and entertainment

Wages, often in relation to spouses and for commission employees, any deductions for assistants

Auto expenses, especially the quantum of business related mileage

Home office use

Rental property owners

Capital cost additions (cost of property)

Repairs and maintenance

Travel expenses

What the Letters Look Like

The typical compliance letter will say something like this:

“You have reported $XX of XX expenses in 2014 as business/employment expenses/rental expenses. The CRA is asking you to review this amount as taxpayers often make common errors with XX expenses”…….

The CRA includes an appendix with a detailed description of the expense they are reviewing and what the criteria are to qualify for deducting the expense at issue.

The letters clearly state that you are not being audited at this time, but that if changes are required you should make them within 45 days using a T1-Adjustment Form. The CRA also notes that later in the year they will be auditing taxpayers who earn a certain type of income and claim certain types of expenses. They then add that an audit may cover tax years or other items not noted in the compliance letter.

Since in cases other than misrepresentation, the CRA can audit you three years back from the date of your notice of assessment, you can be at risk for three years of audit review.

Obviously, the audit discussion scares the heck out of most people, even where they have properly claimed their expenses.

The Possibility of Being Audited

On its website, the CRA says the following regarding the possibility of an audit.

“Receiving this letter does not necessarily mean that you will be selected for an audit. We consider a number of risk factors before conducting audits.

We rely on risk-assessment systems and research to determine which taxpayers are most likely to misunderstand their tax obligations. We also randomly select tax returns and conduct reviews to verify that taxpayers are paying their taxes in full and on time. If our review indicates that certain activities are more at risk for non-compliance than others, we may conduct more audits of taxpayers reporting these types of activities”.

Should You Be Concerned if You Receive a Letter?

I would suggest, that in the vast majority of situations, taxpayers have claimed expenses that are within the rules of the Income Tax Act ("ITA") and adjustments will typically not be required. The ITA rules can be interpreted differently and while most people attempt to stay on the straight and narrow, some people push to the grey areas. If you are one of those people, you may want to consider a possible adjustment if your grey is hinging on black. In addition, some people do not keep the best of records to support their deductions and that could be a cause for concern.

If you have an accountant, you should speak to them once you receive the letter. They can review with you, if they perceive you to have any audit risk.

If you do not have an accountant, you will need to consider if you have been “aggressive” in claiming deductions or misinterpreted the rules. If so, filing the T1 adjustment may make sense.

You are probably wondering if filing a T1 adjustment will minimize the risk of an audit? Unfortunately, I cannot answer that question, as I have no access to the rates of follow-up audits on those who have filed T1-adjustments. If I had to guess, filing an adjustment would only minimally affect a future audit (you cleaned up your affairs, but are noting they were not clean to begin with), but again, I have no substantive proof one way or another and this is just my opinion.

If you feel you have filed your return accurately and correctly, you do not need to take any action. However, there is no guarantee you will not be audited and that the CRA will not reassess you on expenses claimed (since your interpretation of what is say a deductible advertising expense may be different than the CRA’s, even if you feel it clearly meets the criteria of the ITA).

So the long and short of this; if you have filed your returns accurately, you have no need to fear these letters. However, the letter may be indicative you have claimed expenses the CRA has found are often claimed incorrectly or aggressively and you may be audited in the future.

Monday, February 29, 2016

The 2016 Ontario Budget

Last Thursday, Ontario Finance Minister Charles Sousa delivered the provinces 2016 budget. While there were some interesting programs introduced; such as the Ontario Student Grant program for children from families making less than $50,0000, there were few new tax measures.

I apologize to readers from other provinces, but Ontario is my home province, so I have a vested interest in this budget.

Personal Income Tax Rates

There were no new personal tax rate changes announced (not surprisingly given the tax rates below). For residents of Ontario who earn greater than $220,000, the combined Federal and Ontario tax rates are as follows for 2016:

Ontario-Federal Combined Top Marginal Personal Tax Rates for 2016
Salary	Capital Gains	Eligible Dividends	Non-eligible Dividends
53.53%	26.76%	39.34%	45.30%

I have written previously about how the "top 1%" of income earners are no happy with these rates, so there is no need to discuss them again.

Business Income Tax Rates

There were no changes to the corporate tax rates. For incorporated companies carrying on business in Ontario, the tax rates are as follows:

Combined Federal and Ontario Corporate Income Tax Rates for 2016
General	M&P	Small Business
26.5%	25%	15%

The access to the 15% small business rate could be "shaken-up" if the Federal Liberals follow through in next months Federal Budget with their election promise to look at restricting the ability for certain small businesses and professionals (such as doctors, lawyers and dentists) to claim the small business deduction where they do not meet certain employee thresholds.

Miscellaneous Business Changes

The government stated that the legislation for The Ontario Registered Pension Plan ("ORPP") will be implemented in the spring of 2016. Though technically not a tax, the ORPP will eventually cost businesses 1.6% to 1.9% on employee pensionable earnings up to $90,000. The impact of this substantial additional cost to employers will have to be seen; I would suggest businesses may not just happily absorb the ORPP cost and the ORPP may cost some Ontarians their jobs.
Ontario will reduce R&D credits from 4.5% to 3.5% and the Ontario Innovation Tax Credit from 10% to 8%
The Apprentice Training Tax Credit is under review as previously announced

Miscellaneous Personal Changes

Ontario will discontinue tuition and education tax credits beginning in September, 2017
The government will also discontinue the Children's Activity Tax Credit and Healthy Homes Renovation Tax Credit as of January 1, 2017
Ontario will mirror the Federal Split Income rules for minors, whereby the top marginal Ontario rate will be applied starting January 1, 2016

So as noted above, not too much to get excited about. I have a feeling the Federal Budget may create a little more excitement.

Monday, February 22, 2016

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.