Building Insurance into Your Client’s Estate Plan
Kevin Wark, LLB, CFP
CIFPS Annual
National Conference
Your client, Ron is 65 years old Married to Lisa (62) – second marriage Ron has two children, Mary (32) and
Richard (27) both from first marriage Currently 2 grandchildren – uncertain if
there will be more in the future
Case Study
Case Study
Ron started a manufacturing company 20 years ago, currently valued at $3 million and drawing salary/bonus of $200,000 per year
Mary is involved in the business as VP Marketing
Richard currently traveling in Europe Commercial property acquired for
$400,000 in 1996, currently valued at $600,000 – rented to business for $40,000 pa. and has UCC of $200,000
Case Study
Ron’s other main assets consist of personal residence, $300,000 in RRSPs, $200,000 in shareholder loans
Ron has personally guaranteed $1 million loan to business
Ron is President of local hospital board Home (valued at $400,000) has no
mortgage and no other major debts
Ron’s Estate Objectives
Ensure Lisa has income of at least $200,000 per year (before-tax) if he predeceases her
Pass on business to daughter (Mary) Treat son (Richard) “fairly” on his death Minimize impact of taxes on his estate
Ron’s Estate Objectives
Provide gifts to grandchildren for post secondary education and other significant obligations
Creditor protect his estate Large gift to the hospital on death
Some Observations
Value of estate assets (before tax) is approximately $4.5 million
Taxes could reduce estate by approx. 20% ($900,000)
Major asset (representing almost 75% of aggregate estate) going to daughter
Conflicting Demands on the Estate Plan
Ron wants major estate asset to go to the daughter – impact on income to Lisa and ability to be “fair” to Richard
Significant tax and other liabilities may impact viability of estate plan
How to fund gifts to grandchildren and charity from estate??
Family law implications
Planning Idea #1– Collateral Insurance
Corporation acquires $1 million term or permanent policy on Ron’s life
Corporation assigns or hypothecates policy to bank as collateral for loan
Corporation can deduct lesser of premium and “net cost of pure insurance”
Planning Idea #1 – Collateral Insurance
Insurance proceeds would repay loan on Ron’s death and corporation would receive credit to its capital dividend account (CDA)
CDA could be used to flow tax-free dividends to Lisa to provide required level of income (subject to availability of cash in the corporation) or convert to secured shareholder loan
Removes significant liability from corporation and Ron’s estate
Planning Idea #2 – Creditor Protection/Capital Growth
Ron has significant wealth tied up in his business
Ron also has $200,000 shareholder loan account subject to business risks
Corporation could repay shareholder loan and replace with conventional bank debt
Split dollar arrangement between corporation and Ron for $1 million exempt UL contract
Planning Idea #2 – Creditor Protection/Capital Growth
Under a split dollar arrangement the Corporation owns death benefit and pays term costs of policy
Ron owns the cash value and funds with proceeds from the repaid shareholder loan
Corporation assigns its interest to the bank and can deduct lesser of premium and net cost of insurance
On Ron’s death the corporate debt is repaid by insurance proceeds and cash values flow to Lisa on tax-free basis outside of estate
Planning Idea #2 – Creditor Protection/Capital Growth
Corporation pays $31,000 per year for insurance coverage of $1 million
Ron pays $24,000 per year for 10 years and owns tax-deferred cash values
Assuming death at age 85, corporation receives $1 million (full credit to CDA) and Ron’s estate receives over $700,000
Represents a total return of 5.5% (after-tax) and 10% (before-tax) on Ron’s deposits
Planning Idea #3 – Estate Freeze/ Buy-Sell with Mary
Ron converts common shares into two classes of shares redeemable for $500,000 and $2.5 million respectively (total of $3 million)
As part of this transaction Ron also completes an estate freeze and increases cost base of first class of preference shares to $500,000
Deferred tax liability on shares of approximately $600,000
New common shares issued to Mary
Planning Idea #3 – Estate Freeze/Buy-Sell with Mary
Buy-sell agreement between Ron, Lisa, Richard and Mary funded by corporate owned insurance
Corporation acquires $3 million permanent insurance policy on Ron’s life
Under Ron’s will $2.5 million low ACB shares are transferred to Lisa and $500,000 high ACB shares to Richard
Lisa’s shares are redeemed by the Corporation – no gain or loss on redemption as funded by capital dividend arising from insurance proceeds
Planning Idea #3 – Estate Freeze/Buy-Sell with Mary
Mary buys Richard’s shares for $500,000 with a promissory note
Remainder of insurance proceeds flowed out to Mary to repay promissory note
Lisa receives $2.5 million tax-free, Richard $500,000 tax-free and Mary has all common shares (worth at least $3 million) with $500,000 ACB
Planning Idea #4 - Estate Equalization
Ron wants to ensure Richard and Mary are treated “equitably” on his death
Mary will be sole owner of a corporation worth between $3-4 million
Assume Richard has received $500,000 tax-free on sale of preferred shares to Mary
Still significant disparity in values being received by children upon Ron’s death
Planning Idea #4 – Estate Equalization
Simplest and most cost effective approach would be to purchase joint second to die insurance on lives of Ron and Lisa
Make Richard beneficiary of policy On death of surviving parent Richard will
receive a tax-free gift outside of the estate
Cost of $500,000 UL policy - $6,600 p.a.
Planning Idea #5 - Estate Equalization
Another option would be for Ron to transfer the commercial property to his Corporation on a rollover basis
Ron would take back redeemable preference shares with redemption value of $600,000 and ACB of $200,000
Mary would enter into agreement with Ron to purchase shares on Ron’s death
Planning Idea #5 - Estate Equalization
Mary would acquire a $600,000 policy on Ron’s life to fund purchase of shares
Taxable gain in Ron’s estate on shares Ron’s will would provide for after-tax sale
proceeds to flow to Richard Mary would own preference shares with
full cost base
Charitable Gifting
Number of ways to cost effectively structure major gifts on death
Can be funded through personal or corporate dollars
Can structure to receive tax credit for premium payments or death benefit
Planning Idea #6 – Personal Charitable Gift while Alive
Ron could purchase $200,000 insurance policy and gift to the hospital
Ron would be able to claim a tax credit for premiums paid on policy after transfer
10 Year Direction to hold would exclude gift from charity’s disbursement quota
Planning Idea #7 – Personal Charitable Gift on Death
Ron acquires $200,000 insurance policy and designates hospital as beneficiary
No charitable credit for premiums paid On Ron’s death estate can claim entire
death benefit as charitable gift Gift bypasses estate and potential
creditors Tax credit available to offset gains on
death (i.e. from sale of preference shares to Mary)
Planning Idea #8 – Corporate Charitable Gift
Ron’s Corporation could purchase $200,000 policy on his life
On Ron’s death life insurance proceeds could be gifted to the hospital (cannot designate hospital as direct beneficiary)
Corporation can claim deduction for donation
Corporation also receives $200,000 credit to the capital dividend account – tax free dividends
Planning Idea #9 – Gifts to Grandchildren
Complicated by fact these are not natural grandchildren of Ron’s wife
Ron will want to take steps to “protect their inheritance”
Purchase insurance to provide gifts on death
Could establish life insurance trusts to hold benefits for grandchildren
Benefits include bypassing the estate and management of funds while grand children are minors
Three years later…
Ron has incorporated a holding company, sold the operating business and invested after-tax proceeds in the holding company
Planning Idea #10 – Corporate Insured Annuities
Objectives of Program Increase corporate investment yield
and cash flow Increase value of estate by
reducing taxes Facilitate distribution of corporate
assets on tax effective basis
Corporate Insured Annuities - Process
Corporation applies for $4 million joint first to die UL on Ron and Lisa’s life
Corporation liquidates $4 million of investments to purchase a “life 0” annuity with payments to the first death of Ron and Lisa
Corporation borrows $4 million to replace investment portfolio
Corporation assigns both contracts to bank as security for loan and pays interest annually
Corporate Insured Annuities – Cash Flow
Annuity payments used to: Pay insurance premium ($177,500 pa) Pay loan interest ($340,000) @ 8.5% Pay taxes on annuity (non-prescribed)
* $36,600 in year 1
* $80,600 in year 2 and declines
every year thereafter
Corporate Insured Annuities – Cash Flow
Corporate Income Taxes Reduced by: Loan interest expense ($340,000) NCPI deduction ($146,000 in year 1 and
increases to equal total premium in year 3)
Loan is repaid with insurance proceeds on Ron’s death
Corporate Insured Annuities – Cash Flow in Year 1
Inflow Outflow
Annuity $367,000
Insurance $177,500
Loan Interest 340,000
Tax on Annuity* 36,600
Tax Savings* $243,000
Net Cash Flow $60,000
* Assuming 50% corporate rate
Corporate Insured Annuities – Cash Flow in Year 2
Inflow Outflow
Annuity $367,000Insurance $177,500Loan Interest 340,000Tax on Annuity* 80,600 Tax Savings* $259,000 Net Cash flow $30,000* Assuming 50% corporate tax rate
Corporate Insured Annuities –Impact while Ron is Alive
No reduction in corporate investments (except for any tax payable on disposition)
Loan fully secured (other security may be required)
Positive cash flow as a result of tax deductions
Corporate Insured Annuities – Tax consequences on Death
Corporate shares deemed disposed of at FMV – insured annuity has no value for tax purposes
Corporate value reduced by bank loan of $4 million (tax savings of up to $1 million)
CDA credit of $4 million less ACB of policy (allowing corporate investments to be extracted on tax-free basis)
Corporate Insured Annuity - Risks
Liquidation of corporate assets may have tax consequence and/or penalties for early termination
Interest rate fluctuations – borrowing rates may rise but annuity rates are fixed
No commutation value for annuity Separate insurers should be used for life
insurance and annuity contracts
Corporate Insured Annuities - Risks
General anti-avoidance rule (has value of company really been reduced?)
Interest deductibility (new REOP proposals requires annual testing)
Financial strength of insurance companies backing the arrangement
Other Planning Tips
Joint second to die insurance if Ron is substandard/uninsurable or for corporate back to back scenario
Use of holding companies for corporate-owned insurance (creditor proofing, avoids transfer on sale of operating business, valuation issues)
Having other family members or business partners share in costs of insurance
Discussion…