Advocis Banff School 2007

Understanding Triple Back-to-Backs Florence Marino, LLB, TEPAVP Tax & Estate Planning Group

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Important information

Goals of this presentation

lTruly understand who the right client is for TBTBlDistinguishing TBTB sale from other HNW insurance planning opportunities

Agenda

l Overview Insured annuity basics and Corporate Insured

Annuity case studyl Triple back-to-back

Structure Case example Strategies Benefits Issues Client

l Distinguishing TBTB from other HNW insurance planning opportunities

Insured Annuity basics

Investment vehicle for seniorsA marriage of two contracts

1. A life annuity2. A life insurance policy

The Annuity

Invest a capital sum into an annuity Provides a regular payment stream until

death Non-commutable Taxable portion of annuity payment

Prescribed Annuities vs. Non-Prescribed Annuities

l Defined in Regulation 304 – prescribed annuity cannot be corporate owned

l Taxation

TaxPayable Prescribed

Annuity

Non–PrescribedAnnuity

Life Expectancy

Age

The Life Insurance

Purchase a life insurance policy Replaces the capital invested in the annuity Premiums paid with cash from annuity Permanent insurance with guaranteed

premiums Often T-100 but not always

Corporate Insured Annuity – Case Study: Harry Client

l M 75 NS, no spousel Has holding company which:

Has liquid capital that would be taxed if withdrawn Has accrued gains on its shares that will be taxable

on death

l Receives dividend income from corporate investment income

l Conservative liquid corporate investment portfolio

l Wants to reduce tax

Corporate Insured Annuity Case Study

HoldcoHoldco

Liquid Assets$1 millionLiquid Assets$1 million

HarryHarryFMV = $1 millionACB = NIL

FMV = $1 millionACB = NIL

Life InsuranceFace = $1 millionPremium = $58k/yr

Life InsuranceFace = $1 millionPremium = $58k/yr

LI

$112,000/yr$112,000/yr

AnnuityAnnuityAnnuity

Corporate Insured Annuity (Illustration of Flow of Funds (yr 3)

HoldcoHoldco

Life InsuranceFace = $1 millionLife InsuranceFace = $1 million

112K112K

Annuity

LI Premium58K

LI Premium58K

Cash35K

Cash35K

Taxes18,600Taxes18,600

AnnuityAnnuity

Comparison to Term Deposit – Corporate cash flow

Comparison to Term Deposit – Shareholder Cash flow

Comparison to Term Deposit – Net Estate Value to Shareholder

Capital Gains on Holdco?

l When Harry dies, what is the value of Holdco? Does initial capital of $1 million disappear? Insurance policy value Annuity value?

Corporate Insured Annuity Client Issues

l Older aged individual: Locked in for life Insurability of the client

l Initial capital is redundant Client does not want/need access to the

capital Capital will go to estate/heirs

l Increasing shareholder income with capital replacement - the goal

Corporate Insured Annuity Client Profile

l Shareholder of private Canadian corporationl Affluent, with capital that exceeds lifestyle

requirementsl Age 65 +l In good healthl Company’s investment portfolio includes

conservative investments (e.g. GIC’s, bonds, bank accounts)

l Large capital gains tax exposure at death re: company shares

l Interest income from investments is currently used to enhance shareholder’s lifestyle

l Wants to leave a legacy at deathl Open to long-term planning – passive/locked-in

Triple back-to-back

l Structuresl Strategiesl Benefitsl Issuesl Client

TBTB Structures

ActivecoActiveco

Annuity

Bank

AnnuityAnnuity

Life InsuranceLife Insurance

LoanLoanWorking capital orWorking capital orinvestmentsinvestments

TBTB Structures

HoldcoHoldco

Bank

AnnuityAnnuity

Life InsuranceLife Insurance

LoanLoan

Working capital orWorking capital orinvestmentsinvestments

ActivecoActiveco

Case Study – What’s different about Harry

75 Male NS, no spouse: Shareholder who is willing to take on more complex

planning/risk Large capital gains tax exposure on death Company with:

Significant continuing income – can use deductions Wants to leave corporate assets + growth

Goal: Not about increasing income to shareholder Not about replacing fixed amount of capital to heirs,

rather leaving corporate assets + growth and CDA

Case Study: Corporate Cash Flows (yr. 3)

ActivecoActiveco

Life InsuranceFace = $1MLife InsuranceFace = $1M

111,924111,924

Annuity

LI Premium58,512

LI Premium58,512

Pre-tax Cash

(26,588)

Pre-tax Cash

(26,588)

Interest80,000

Interest80,000

(18,686)Tax on annuity payment

+27,280Tax savings intTax savings int

+19,638Tax savings NCPI

= 1,644After- tax

(18,686)Tax on annuity payment

+27,280Tax savings intTax savings int

+19,638Tax savings NCPI

= 1,644After- tax

AnnuityAnnuity

Strategies

l Increasing annuity payments Shop around Impaired annuities

l Reducing taxable portion of annuityl Increasing deductions – interpretations/issues

Interest deductibility technical details NCPI interpretation variation across carriers

l Product choices T-100 or UL Special quotes

Benefits of the Triple Back-to-Back Strategy

Increased corporate cash flow today

Provide access to tax-free corporate funds in the future

Potentially reduce capital gains tax liability on shares at death

Maintain company’s working capital and investments

Issues

Can the corporation realize tax savings? Sufficient corporate taxable income in

excess of deductions Requirements for deductibility have been

met

Issues

Impact of economic uncertainties Loan renewal not guaranteed Interest rate on loan may change at renewal Death during term of loan – prepayment

penalties may arise Tax rates may change

Issues

Client fit Locked-in strategy Cash flows are not intended to enhance

shareholder income

Issues

Risk that capital gain is not reduced by as much as anticipated Valuation of the company

Issues

Structural tax risks Characterization as one contract? Denial of

CDA credit? GAAR? Tax shelter rules?

Practical Issues

Underwriting older agesl Medical underwriting l Financial underwriting

Insured must have personal net worth to qualify for amount of insurance

Must be a shareholder

Complex planning with seniors

Is this strategy the right fit? Is your client…. Age 65+ and in good health? The shareholder of a corporation,

with substantial taxable income, that will continue to operate until his/her death?

Comfortable with long term debt? Comfortable with a strategy that is

locked-in for life? Willing to implement complex tax planning to realize the benefits of

this strategy? Willing to seek professional advice?

Profile Corporate Insured Annuity Triple Back-to-Back

Objectives Increase income to shareholderLeave capital from life insurance proceeds to estate/heirs at deathReduce capital gains

CDAReduce capital gainsMaintain and increase corporate cash flow“Keep doing what I’m doing”

Tax Corporation may not have other taxable incomeTax is NOT driving factor

Large amounts of taxable incomeWants/needs tax deductions

Risk Profile Low-risk toleranceConservative and “hands-off” investor

High-risk toleranceWants to actively manage investmentComfortable with complexity, leverage and tax risks

Educating your client

Illustration output: Description page Checklist Numerical analysis

Summary of cash flows

Tax information Disclosure page Interest sensitivity

analysis

Educating your client

Educating your client

Additional client resources

Consumer guide

Advisor resources Client profile Tax Topics Canadian Taxation of

Life Insurance

Advocis Banff School 2007

Understanding Triple Back-to-Backs Florence Marino, LLB, TEPAVP Tax & Estate Planning Group