According to the Canadian Life and Health Insurance Association, about 22 million Canadians have life insurance, with total coverage amounting to $5.1 trillion. This works out to an average of $442,000 per household, or five times the average household income.
It would seem, then, that all these Canadians may be planning to use death benefits to provide for their survivors. But imagine someone whose wealth is already 10 or 20 times higher than his or her annual income – or more! – and who has few or no dependents.
What purpose would life insurance serve?
Self-insured, yes, but…
In the insurance world, these high-net-worth individuals are generally referred to as “self-insured,” since their assets are sufficient to provide for their coverage needs. But beyond this need for coverage, life insurance might still prove to be more efficient than other financial tools to help such individuals achieve certain goals, because it can provide a significant amount of cash on a tax-free basis.
Here are four examples.
Protecting net worth
At death, a person is deemed to have disposed of all assets, and the executor or liquidator is expected to pay the associated tax before making any distributions from the estate. For example, the total value of a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) would be taxable, as would any capital gains realized on non-registered investments. Moreover, since we’re talking about substantial wealth, the total would be subject to the highest tax rate.
Note that in Canada, only half of a capital gain has to be included in taxable income. However, it should be remembered that the inclusion rate was once 75% and there is no guarantee that it won’t be raised in the future. That said, as a result of the death tax, regardless of the inclusion rate, the legacy could be much smaller than the original assets, and this could be detrimental to its intended use. A life insurance policy could preserve the legacy by paying the taxes.
Ensuring business continuity
Business partners can make highly strategic use of life insurance, generally to meet two needs.
The first is to finance the share buyback clause that is usually included in the shareholder agreement. In the event of a partner’s death, the policy provides a tax-free lump sum that the remaining partners can use to buy back the late partner’s shares. Thus, the heirs receive the value of the late partner’s holdings and the remaining partners are left in a better position to ensure business continuity.
The second need is to manage the risk associated with “key employees.” The death of a key employee can disrupt operations, destabilize client relationships and jeopardize funding. The capital provided by life insurance can be used to mitigate the financial shock and to quickly recruit strategic employees.
Supporting a cause
If the individual wishes to support certain causes, life insurance could help to make even more of an impact after death than during the person’s lifetime.
Indeed, a donation in the form of a life insurance policy can provide a substantial lump sum for the organization, since the benefits received would be higher than the total premiums paid by the donor. In terms of taxes, if the organization is both the beneficiary and the policyholder, the donor would receive a tax credit equal to the premiums paid. If the donor is the policyholder, the estate would receive a tax credit after the donor’s death, with the donation then equalling the proceeds of the policy.
Finally, some life insurance policies allow for the accumulation of value that the insured can use for other needs. If the policy is simply "surrendered", the resulting income would generally be taxable in the hands of the individual. However, it might be possible to instead use the cash value as collateral to take out a loan, with the interest and principal paid off by the policy itself upon the death of the policyholder. Under current legislation, such a loan could potentially be obtained on a tax-free basis, making life insurance a tax-efficient source of leverage. Naturally, it would be important to obtain a legal opinion before proceeding.
All of these options lend themselves to scenarios that may include a spouse, business partners, an operating company, holding company, foundation or family trust… Don’t hesitate to contact your advisor for guidance on where to start.
The following sources were used to prepare this article:
Canadian Family Offices, “Life insurance offers untapped potential in high-net-worth planning.”
CLHIA, “Canadian Life & Health Insurance Facts, 2021 Edition.”
Fiscalistes.com, “L’impôt au décès.”
Government of Canada, “Inclusion rates for previous years.”
Investopedia, “Why the Wealthy Should Consider Buying Life Insurance.”
SFL, “Philanthropy: An Important Part of an Integrated Financial Plan.”
Simple Life Insure, “The Best (and Worst) Advice I’ve Ever Heard about Life Insurance.”
SunLife, “Life insurance for the wealthy.”