Achieving More Together Tips and Traps. Achieving More Together Some important considerations …...

Achieving More Together

Tips and Traps


Some important considerations …

This material is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible.

All comments related to taxation are general in nature and are based on current Canadian tax legislation for Canadian residents, which is subject to change. Persons who are not residents in Canada or who are resident in Canada but are citizens of another country, may be subject to different tax rules in Canada and may also be subject to taxes levied by jurisdictions other than Canada.

For individual circumstances, consult with legal or tax professionals. This information is current as of September 27, 2005.


Have you ever wondered …

Why clients ask their CA for advice on insurance and other financial products?– Gatekeeper– Financial “quarterback”– Comprehensive knowledge of affairs– Trustworthy – Unbiased– CA knows everything (including life insurance!?)



What does the CA do in a particular case? – Reviews proposal– Analyzes illustrations/projections for reasonableness– Identifies obvious errors / omissions– Considers alternative solutions– Gives their opinion (formal or informal) on whether the

proposal is appropriate given the client’s specific circumstances



What happens if the CA catches an error?– By its nature, advice can turns out to be (or be

perceived to be) misleading, inaccurate, or incomplete (especially tax advice!)

– CA will report the error to the client – This may impact your credibility– This may impact the sale– Worst case, the client asks the CA for a referral!



How to best protect yourself (from yourself)?– Become a CA, too??– Errors & omissions insurance??– Continuing professional development– Keep up on your reading– Attend courses / seminars / conferences– Participate in a study group– Develop CAs as centres (and sources of information)– Listen to me for the next hour or so


Tips and TrapsTop 10 Errors In The Insurance Marketplace

Tips and TrapsTop 10 Errors In The Insurance Marketplace


# 1# 1Premium DeductibilityPremium Deductibility


Insurance planning errors # 1

Life insurance premiums are tax deductible if the policy is corporate-owned!– Generally life insurance premiums are not deductible– Exception: collateral insurance – paragraph 20(1)(e.2)

Assigned to a financial institution as collateral for loan Interest on the loan is deductible Assignment is a requirement of the institution Borrower is also the policyowner Deduction limited to lesser of premiums payable and

NCPI (net cost of pure insurance)


# 2# 2Premium DeductibilityPremium Deductibility



Premiums paid for “grouped” individual DI / CI coverage are tax deductible by the corporation!

– When one or more shareholders are included in the plan, must consider in what capacity the shareholder receives the coverage … Employee or Shareholder

– If coverage on shareholder consistent with coverage on other employees, premiums should be deductible

– If premiums not deductible – result is BAD – no deduction for corporation but taxable benefit to shareholder


# 3# 3Ownership TransfersOwnership Transfers



There are no tax implications when a life insurance policy is transferred to a shareholder or executive from the corporation!

– A transfer is a disposition for tax purposes– Transferor (corporation) deemed to receive proceeds

equal to the “value” of the policy - value usually = CSV– If CSV > policy ACB, result is a policy gain– Policy gain fully included in income– And the transferee (shareholder or executive) is taxed

on greater of CSV and FMV of policy, less payments



Example:– A corporation owns an permanent policy on a

business owner – The business owner plans to sell the business and

wants to transfer the policy from the corporation to him/herself

– At the time of the transfer … AV = $250,000 CSV = $150,000 ACB = $100,000

– What are the tax implications?



Example:– Answer:

To the transferor (corporation)– Deemed disposition under subsection 148(7) of ITA– Proceeds of disposition = $150,000 (CSV)– Policy ACB = $100,000– Policy gain = CSV – ACB = $ 50,000– Policy gain is T5 income– Policy gain is not a capital gain



Example:– Answer:

To the transferee (shareholder)– Deemed acquisition under subsection 148(7) of ITA– New policy ACB = CSV = $150,000– Shareholder benefit = CSV = $150,000– Shareholder benefit reduced by any amount paid by the

shareholder– However, additional shareholder benefit if FMV > CSV– So, what is the FMV of an insurance policy??


# 4# 4Beneficiary DesignationsBeneficiary Designations



Of course you can name your spouse as beneficiary on this corporate-owned policy!

– Life insurance premiums are not tax deductible– Usually advantageous having corporation pay

insurance premiums with its low-tax dollars– However, if a family member is named beneficiary

under a corporate-owned policy – result is BAD – no deduction to corporation but is taxable benefit to shareholder

– Avoid by naming corporation as the beneficiary


# 5# 5Principal ResidencePrincipal Residence

ExemptionExemption



You can always claim the principal residence exemption on your cottage!

– Taxpayers can only designate one property as their principal residence for a particular tax year

– For taxation years after 1981, only one property per family unit can be designated as a principal residence

– If husband and wife own a house and a cottage, one of the properties may have a taxable capital gain on disposition


# 6# 6Beneficiary DesignationsBeneficiary Designations



You should always name a beneficiary on your RRSP to avoid probate fees!

– Usually true, but consider this example: Taxpayer is widowed and has the following assets: RRIF: $300,000 GICs: $300,000 Taxpayer designates Son as beneficiary of the RRIF and

leaves the GIC to Daughter through the Will The result: Son gets the $300,000 from RRIF, Daughter

gets $300,000 from GIC LESS tax on the RRIF Oops!


# 7# 7Tax-Free RolloversTax-Free Rollovers



You can transfer this policy to your son tax-free!

– Tax-free rollover is available for transfers between spouses and between a policyowner and a child of the policyowner, but only if a child of the policyowner or the transferee is the life insured

– Otherwise, the transfer is treated as a disposition to a non-arm’s length party (not a tax-free rollover!)


# 8# 8Taxation of Policy GainsTaxation of Policy Gains



A capital gain is only 50% taxable, and a policy gain on a disposition of your life insurance policy is treated the same way!– A policy gain is reported on a T5 and is fully included

in income in the year it is reported– A policy gain may occur in the event of:

Policy loan (loan exceeds policy ACB) Partial or full surrenders (if accrued policy gain) Transfers of ownership (other than tax-free rollovers)


# 9# 9Capital Dividend AccountCapital Dividend Account



Proceeds from a corporate-owned life insurance policy pass through the corporation to your heirs tax-free!

– Insurance proceeds received by a private corporation on the death of the life insured are credited to the capital dividend account (CDA) only to the extent the proceeds exceed the policy ACB immediately before death

– The corporation can distribute tax-free capital dividends to its shareholders to the extent of the balance in the CDA


# 10# 10ProjectionsProjections



Your capital gains tax liability will grow at 10% per year to be at least $12,000,000 at life expectancy!

Capital Gains Tax Exposure

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45


Tips and TrapsTop 10 Opportunities Using Exempt Insurance

Tips and TrapsTop 10 Opportunities Using Exempt Insurance


# 10# 10Risk ManagementRisk Management


Insurance planning opportunity # 10

Financial planningPlanning Pyramid

Investment management Education Retirement Estate

Risk management Contingency fund Insurance (life, health, DI, CI, home, auto) Wills, POAs

WEALTH

PROTECTION



Financial planning– Insurance to fund basic estate liquidity needs

For example …– Final expenses– Estate administration– Debt repayment– Professional fees– Income continuation– Matrimonial obligations– Charitable bequests– Education trusts



Financial planning– Insurance to fund basic estate liquidity needs

What to look for …– Married couple or single parent with dependent children– Have not yet achieved financial independence


# 9# 9Funding Business NeedsFunding Business Needs



Business planning– Business owners often have a significant amount of

their net worth tied up in their business– The death of a business owner or key executive can

impair the value of the business and create financial hardship for the deceased’s family and the surviving shareholders



Business planning– Protect the business against the loss of an owner or

key executive with insurance For example …

– Funding shareholder agreements– Keyperson insurance protection– Collateral insurance



Business planning– Protect the business against the loss of an owner or

key executive with insurance What to look for …

– Businesses with more than one shareholder– Businesses with loans– Owners or other key executives whose death would have a

significant financial impact on the business– Needs may differ at different stages in business life cycle


# 8# 8Funding FamilyFunding Family

Business SuccessionBusiness Succession



Business planning– Over 75% of current family businesses will have to

deal with a change in leadership over next 15 years– Only one-third of family businesses survive the

transition to the 2nd generation primarily because of a lack of planning, no qualified successors, and a lack of liquidity



Business planning– Facilitate family business succession plans with

insurance For example …

– Fund capital gains taxes on the parent’s shares– Fund a redemption of the parent’s shares– Equalize the estate amongst the heirs



Business planning– Facilitate family business succession plans with

insurance What to look for …

– Successful family-owned businesses– Business owner within 1 - 5 years of planned retirement– Business owner has a desire for an orderly transition


# 7# 7Creating TaxCreating TaxAdvantagesAdvantages



Tax planning– Life insurance is a unique financial instrument– It is possible to split the ownership of a universal life

policy into the pure death benefit and the fund account – The growth in fund account values is tax-advantaged

Account Value

Death Benefit

Owner A

Owner B



Tax planning– Create a tax-advantaged investment account for

business owners and executives by using a split-ownership arrangement

For example …– Opco owns death benefit (buy-sell, keyperson protection)

and business owner (or executive) owns fund account– Opco owns death benefit and Holdco owns fund account– Opco owns death benefit and RCA trust owns fund account– Parent owns fund account and adult child owns death

benefit



Tax planning– Create a tax-advantaged fund account for business

owners and executives by using a split-ownership arrangement

What to look for …– Need for insurance by one party and excess cash/capital

for investment by another party


# 6# 6Funding RetirementFunding Retirement



Retirement planning– The demographics in Canada indicate that boomers

will be retiring from active employment in ever increasing numbers over the next two decades

– Retirement planning and retirement income are becoming an increasing priority in the minds of your clients



Retirement planning– Provide supplemental retirement income to a business

owner or executive For example …

– Leveraged life insurance– Insured retirement compensation arrangement (RCA)



Retirement planning– Provide supplemental retirement income to a business

owner or executive What to look for …

– Client over age 40– Mortgage paid down– Maxed out on RRSPs/RPPs– Excess cash available for funding


# 5# 5Creating A GuaranteedCreating A Guaranteed

Lifetime IncomeLifetime Income



Retirement planning– Fixed income investment returns have declined over

the past two decades– Older clients looking for ways to increase returns while

maintaining their estate for their heirs



Retirement planning– Guarantee a lifetime retirement income while

preserving the estate for the heirs For example …

– Insured annuity– Corporate insured annuity– Leveraged corporate insured annuity



Retirement planning– Guarantee a lifetime retirement income while

preserving the estate for the heirs What to look for …

– Clients age 65 – 75– Personal investment assets being used as a source of

retirement income– Want to preserve their estate for their heirs– Corporate investment holding company


# 4# 4Creating A CharitableCreating A Charitable

GiftGift



Charitable gift planning– There are approximately 350,000 Canadian

households with at least $1 million in household financial assets

– Nine-in-ten (87%) of these millionaire households expect to make a financial contribution to a charity or local community organization in the next year



Charitable gift planning– Fund a charitable gift with insurance

For example …– Gift of life insurance to charity– Fund a charitable bequest with life insurance– Name a charity the beneficiary of a policy– Estate replacement insurance funded using the donation

tax benefits– Insured share redemption of private company shares gifted

to charity following death



Charitable gift planning– Fund a charitable gift with insurance

What to look for …– Client is over age 50– Client has a desire to support a charitable organization– Client wants to magnify or multiply their bequest or

minimize the impact of the donation on family wealth


# 3# 3Transfer Wealth To TheTransfer Wealth To The

Next GenerationNext Generation



Estate planning– Demographics in Canada suggest a significant

transfer of wealth will occur over the next 25 years– Clients are looking for effective ways to initiate

transfers of wealth



Estate planning– Initiate a transfer of wealth to the next generation

using life insurance For example …

– Parent purchases insurance on life of child (or grandchild), transfers ownership (tax-free) following death of parents



Estate planning– Initiate a transfer of wealth to the next generation

using life insurance What to look for …

– Clients over 50 who are financially independent with adult children


# 2# 2Funding EstateFunding Estate

TaxesTaxes



Estate planning– A deceased taxpayer is deemed to dispose of all

property immediately before death for proceeds equal to fair market value

– Accrued gains taxed on final tax return– Transfer to surviving spouse or spouse trust can defer

(but not eliminate) tax liability– The tax liability can have a material impact on the

value of the estate available for distribution to the heirs



Estate planning– Fund the estate tax liability with insurance to

preserve/conserve the estate for the heirs For example …

– Investments– Private company shares– Commercial real estate– Vacation property– RRSPs



Estate planning– Fund the estate tax liability with insurance to

preserve/conserve the estate for the heirs What to look for …

– Client(s) over age 50 – Investment assets with significant accrued gains– Private company shares– Registered funds


# 1# 1Maximize Family WealthMaximize Family Wealth



Estate planning– Wealthy families may have no obvious need for life

insurance protection but are interested in ways to maximize family wealth without adding significant risk



Estate planning– Maximize the estate for distribution to the heirs

For example …– Insured inheritance– Corporate estate transfer– Insurance as an alternative investment



Estate planning– Maximize the estate for distribution to the heirs

What to look for …– Client over age 50– Significant investment holdings (personal or corporate)– Investments include fixed income component generating

interest income taxed at top rates


Insurance as an alternative investmentInsurance as an alternative investment


Daily interest

1, 3, 5, 10 year simple interest GIC

Maximum First Year Excess Deposit 1, 3, 5, 10 year compound interest GIC

$269,119 Bond funds

Millennium Profile accounts

Index-linked options

Mutual funds and managed accounts

Cost of Insurance $47,400

Minimum Premium Commitment

$48,490 Premium tax (2%) $970 + 2% excess funding

Policy Fees $120

INSURANCE BENEFIT

The "Mechanics" of Millennium Universal LifeMale, Non-Smoker, 60, Standard Health and Female, Non-Smoker, 60, Standard Health

$5,000,000 Canada Life Millennium Universal Life Insurance Policy (Joint-Last)

$5,000,000

ACCOUNT VALUE


Insurance as an alternative investment

Bob and Carol, both age 60, good health $5.0-million of investment assets

– 50% fixed income– 50% equities

Assume– 3% after-tax return on fixed income– 6% after-tax return on equities– Maintain current asset allocation– Need $100,000 after-tax annual cash flow– Joint life expectancy is 30 years


TODAYTODAY

Fixed Income $2,500,000

Equities 2,500,000

Total $5,000,000



TODAYTODAY ESTATEESTATE


Equities 2,500,000

Total $5,000,000


Equities 6,000,000

Total $12,000,000



TODAYTODAY

Cash $50,000 / yr



TODAYTODAY

Cash $50,000 / yr

ESTATEESTATE

Investment $2,500,000



TODAYTODAY

Cash $50,000 / yr

Life Policy

Or…Or…



TODAYTODAY

Cash $50,000 / yr

ESTATEESTATE

Cash $5,000,000

Or…Or…


Life Policy


TODAYTODAY

Cash $50,000 / yr

ESTATEESTATE

Investment $2,500,000

Cash $5,000,000

Difference in the strategies $2,500,000

Or…Or…


Life Policy

+


Tax-free IRRTax-free IRR

2020 2525 3030 335 5

14.814.8% % 10.110.1% % 7.3 7.3% % 5.5 5.5%%

27.427.4% % 18.718.7% % 13.5 13.5% % 10.2 10.2%%

Years To Life ExpectancyYears To Life Expectancy

Pre-tax IRRPre-tax IRR **

** Assumes a 46% tax rate on interest income Assumes a 46% tax rate on interest income



Conclusions:– Insurance is an innovative financial instrument

– Insurance can be used to facilitate or enhance a client’s overall wealth management plans

– Insurance can be a viable solution even when the need for liquidity is not evident

– Insurance strategies such as Insured Inheritance and Corporate Estate Transfer are very appealing in the HNW marketplace


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