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Use of Life Insurance in Tax Planning

7th Tax Planning for the Wealthy Family Workshop – June 15-16, 2010

Presented by: Mimi C. Tang, CFP CLU CHFC

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Mimi Tang Wealth Mgmt. & Consulting Ltd. Mimi C. Tang, CFP CLU CHFCPresident

Mimi Tang offers financial planning and insurance services as an independent Representative, under Mimi Tang Wealth Mgmt. & Consulting Ltd. These services are offered independently of Peak Securities.

Mimi Tang is an Investment Advisor for Peak Securities Inc. Peak Securities Inc. is registered with IIROC (formerly known as IDA) and a member of the Canadian Investor Protection Fund. It is a full service investment broker and its’ responsibilities is limited to investment products such as stocks, bonds, and mutual funds.

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Dying Rich Old Man

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Primary Purpose of Life Insurance To provide cash on death: Pay off personal debts Funeral and last expenses Payment of capital gains Probate fees Charitable bequests Business owners: Funding the purchase of shares under shareholders

agreements key person insurance collateral insurance to cover bank loans

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Types of Life Insurance • Term:

– Five, Ten, Twenty Year– Can usually be converted to permanent insurance without evidence of

insurability– Cheapest form of insurance, premiums increase by term period– Not permanent, usually expires at age 65 or 70

• Permanent:– Term to 100– Whole Life – Participating or Non-Participating– Universal Life

• Living Benefits:– Critical Illness, Disability, Long Term Care

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Other Types of Insurance:

• Annuities:– Prescribed– Non-Prescribed

• Segregated Funds:– A Segregated Fund (Seg Fund) is a type of

investment fund administered by Canadian insurance companies in the form of individual, variable life insurance contracts offering certain guarantees to the policyholder such as reimbursement of capital upon death

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Estate and Tax Planning Strategies with Life Insurance

• Permanent Insurance:– Term to 100• Premiums are set and payable till age 100• No cash value until age 100 (cash value usually equals

the face amount of insurance)• Usually the cheapest type of permanent insurance • Riders can be added to the main policy:

– Waiver of premium on disability– Guaranteed insurability option– Term insurance (5, 10 or 20)

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Participating Whole Life Policies:

• Premiums are higher than cost of insurance• Excess deposits are invested and dividends (in

effect return of premiums) are paid by the insurer to be used by policyholder:– in cash– Deposit in an interest-bearing account (tax-

sheltered)– To apply against next policy premium– To purchase paid-up additions (additional

insurance with no further premiums)– To purchase term insurance– Dividends not guaranteed and insurer are

extremely conservative in their assumptions

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Universal Life (UL)

• Introduced in the 1980’s when interest rates were higher

• Unlike participating whole life policies, UL policies allow policyholders wider range of investment options to choose from like fixed term deposits or investments tied to stock market indices

• Flexibility as premiums can be increased , decreased or stopped

• Greater death benefits like “face plus fund value”

• Death benefit option to increase by specified rate each year (convenient for estate and tax planning like for example exposure to capital gains increases)

• Potential risks and rewards greater with UL than Whole Life

• Investment growth is tax sheltered

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Exempt Life Insurance Policies

• Policy accumulating cash reserves are not subject to taxation as long as they do not exceed the “exemption test policy”

• It is usually the contractual responsibility of the insurer to ensure that a policy is and remains exempt

• The tax free mortality gain is the most attractive feature of life insurance

• Under Section 148 of the Income Tax Act, properly arranged and planned, a large pool of tax- free dollars will be available to fund obligations arising from death. The death of the life insured under an exempt policy is not a disposition for income tax purpose and the proceeds payable are not subject to tax.

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Calculation of Adjusted Cost Base (ACB) of Life Insurance Policies

• Factors that increase the ACB:– Premiums paid to the policy– Policy gains included in income (example: from

withdrawals or policy loans)– Repayment of policy loans which were subject to

tax• Factors that decrease the ACB:– Proceeds of disposition – The net cost of pure insurance (NCPI)– Participating whole life policies, policy dividends

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Tax Tip • For Corporation with Holding Company– Have beneficiary be the Holdco• Full proceeds (ACB and the cash value) tax free

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Tax and Estate Planning with Life Insurance

• Taxation of Property Held at Death:– Canada does not have estate taxes– Canadian resident is generally deemed to have

disposed of his/her property for fair market value (FMV) immediately before death.

– Deceased is taxed on his/her terminal return any gains/losses at year of death

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Exception: Transfers of Property to Spouses or Spouse Trust at death

• “rollover” occurs for income tax purposes to the surviving spouse or spousal trust.

• is deemed to be disposed of for its’ ACB, resulting in no capital gain or loss.

• A spousal trust will be disqualified if, for example, the spouse’s entitlement will end if he/she remarries or other conditions to spouse’s right to capital or income.

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Types of Property that can be “rollover”

• Real Estate as an investment or cottage that is not the deceased’s principal residence

• RRSP’s and RRIF’s if surviving spouse is named as beneficiary

• Shares of public traded and private companies

• Mutual and segregated funds

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Joint Last to Die (JLTD) Policy

• Tax burden realized on the surviving spouse could be satisfied through a JTLD policy (payable on second death). A great advantage of being paid when needed:– The premiums are generally very inexpensive

compared to a single life policy– Least expensive way to fund estate liabilities–More cost effective than:• Taking a loan• Liquidating assets• Self-insuring

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Premium MatchmakerFace Amount $250,000 , Non-Smoker

Age 10-year Term Term to 100 Life Provider (UL)

Male 50 $ 475 $ 3,290.00 $ 2,811.22*Female 360 2,690.00 2,153.06*Male 60 1,345 5,787.50 5,622.45*Female 950 4,587.50 4,433.67*Male 70 10,265 10,265.00 12,043.37*Female 2,735 8,605.00 8,977.04*JLTDMale 50 1,242.48*Female 50 (combined age Male 39 N/S)(First year maximum annual deposit $11,392.50)Male 60 2,701.53*Female 60 (First year maximum annual deposit $16,787.50) Male 70Female 70 (combined age Male 59 N/S) 5,055.00*(First year maximum annual deposit $28,652.50)*Pls. Refer to page 11 for disclosure

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Disclosure

• * For Universal Life (UL) insurance, the premium amount is the annual minimum Level cost of insurance premium for the selected province of issue. The Death Benefit of all UL plans is based on Sum Insured Plus Fund Value option .

• Premium rates may or may not change at time of purchase

• NOTE: This is an illustration and not a contract. Every effort has been made to ensure accuracy, but accuracy is not guaranteed. In the event of discrepancy, your insurance policy governs.

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Cost of Insurance for age 60 N/S Single Life Premium Joint Last to Die

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M $5,787.50 F$4,587.50* $2,701.53*

*Rates provided by BMO Insurance Total cost for M/F $10,375.00

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Life Annuity

• Insured gives the Insurance Company a lump sum of money

• Insurance Company provides an income stream for the rest of your life– Each payment is part repayment of capital and

part interest• Once contract is issued, it cannot be changed

or cancelled• The older you are, the higher your payment

(opposite to life insurance) 20www.mimitang.ca Mimi Tang Wealth Mgmt. & Consulting Ltd.

Types of Annuities

• Life versus Term Certain– Life annuity pays until the annuitant dies. • Payments can be guaranteed for a number of years or

as long as the insured lives• If death occurs before the guaranteed period,

payments would continue to the beneficiary• If death occurs after the guaranteed period, there is no

residual value

– Term Certain Annuity pays for a fixed period like 5, 10, 15 years. Stops at the end of the fixed period

• Prescribed versus Non-prescribed– Prescribed could be registered (payments are fully

taxable) or non-registered (only the interest portion is taxable)

– Non-prescribed: taxable amounts are different, usually higher during the early years like a mortgage

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Life Annuities

• Can be issued as single life or joint life• Smaller income payments on a joint life versus

single life• Income payments can change upon first death

if issued jointly• Immediate Annuities:– Income payments starts

• Deferred Annuities:– Income payments are deferred for certain

situations where income must start at a certain date in the future

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Insured AnnuityCurrent GIC Investments• Despite the low interest rate environment in Canada

over the last 15 years, currently over $800 Million of wealth in Canada is still placed in GICs earning low after-tax returns.

• The problem with this investment strategy is:– Low rates of return for many years– Interest income is 100% taxable– Increasing your income decreases your capital

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Source: BMO Insurance

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The Insured Annuity Solution

• This solution combines two financial instruments:– Prescribed Life Annuity– Life Insurance policy

• This combination creates an extraordinary opportunity to increase income, lower taxation and guarantee the investment capital is returned at death to the beneficiaries.

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+

Source: BMO Insurance

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9/22/10 www.mimitang.ca Mimi Tang Wealth Mgmt. & Consulting Ltd.

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That’s a difference of $3,517 per year! A GIC pre-tax equivalent would have to be 7.3% per year...every year!

Insured Annuity vs. GIC:

Gross annual income generated from Annuity = $ 12,268less taxes paid on income (assuming 45% tax rate) = $ 1,191less premiums for Term to 100 insurance plan = $ 5,085Total net annual income from Annuity = $ 5,992

Gross annual income generated from the GIC = $ 4,500less taxes paid on income (assuming 45% tax rate) = $ 2,025Total net annual income from GIC = $ 2,475

Insured Annuity Case Study

Source: BMO Insurance

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That’s a difference of $3,517 per year, an increase of 142%!

Insured Annuity vs. GIC

Insured Annuity Case Study

Source: BMO Insurance

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Taxation

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Source: BMO Insurance

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Case Study on Segregated Fund and Life Annuity

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• Client, 65 yrs. Old, diagnosed with cancer • Disabled nephew• Client wants to leave a monthly income to

nephew for the rest of his life should she die• Solution:– $100,000 in a Segregated Fund– Beneficiary, her nephew with condition • Proceeds to buy a 10 year life annuity for her

nephew

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Corporate- Owned Life Insurance

• Capital Dividend Account (CDA)– Is the vehicle through which insurance proceeds

received by a private corporate and may in turn be distributed tax-free to its’ shareholders.

– Purpose of the CDA:• Originates from the “integration theory” – is the

fundamental basis on which the Canadian corporate tax system orginates.• Integration theory holds that income tax should

be the same (no more no less) as income earned by the corporation or earned directly

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Capital Dividend Account (CDA)• CDA is a notional tax account which includes

certain tax-free amounts received by a corporation

• Outstanding credit in the CDA can be distributed tax-free to the shareholders

• Amounts credited to the CDA:– Tax-free portion of capital gains (currently 50%)– Capital dividends received by the corporation – Certain tax-free amounts which the corporation

receives from the sale of “eligible capital property” like goodwill of a business

– Amount of any life insurance proceeds received by the corporation from a policy under which it was beneficiary, less ACB of the policy to the corporation

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Purposes of Corporate-Owned Life Insurance

• Availability of the CDA• Buy/Sell Funding• Key Person Insurance• Collateral Insurance• Charitable Giving• Pay Estate Liabilities

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The Corporate Asset Transfer Plan…it’s simple!

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Source: BMO Insurance

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• The Jim Pattison Group began on May 8, 1961 when Mr. Pattison purchased a General Motors automobile dealership by borrowing $40,000 from the Royal Bank of Canada, and placing his home and life insurance policy with the bank as collateral. Acquisitions in subsequent years included the following:

• 1965 - Awarded license to operate Vancouver AM radio station CJOR • 1967 - Acquired Neon Products (Vancouver) & Seaboard Outdoor Advertising • 1968 - Acquired Overwaitea Foods (Vancouver) • 1969 - Acquired Provincial News (Edmonton)

– Employees: 2,500 Sales: $100 million • 1980 - Started Jim Pattison Real Estate Group

– Employees: 6,000 Sales: $500 million • Purchased Beautiful British Columbia Magazine • 1984 - Acquired Canadian Fishing Company

Jim Pattison Story

34Source: Wikipedia, the free encyclopedia Jim Pattison, June, 2007

Jim Pattison Story• 1985 - Acquired Ripley's Believe It or Not!

– Employees: 6,000 Sales: $1 billion • 1990 - Acquired the Foodservice Packaging Group

– Acquired the Flexible Packaging Group – Acquired Coroplast and Montebello Packaging – Employees: 10,000 Sales: $2 billion

• 1991 - Started Jim Pattison Trade Group – Started Financial Services division

• 1994 - Acquired Westshore Terminals, a BC-based coal-export terminal facility – Employees: 15,000 Sales: $3 billion

• 1995 - Acquired Buy-Low Foods • 1997 - Started Select Media Services

– Opened Ripley's Aquarium, Myrtle Beach, SC • 1999 - Acquired Cooper's Foods

– Employees: 20,000 Sales: $4.4 billion • 2000 - Opened Ripley's Aquarium of The Smokies, Gatlinburg, TN

– Employees: 22,000 Sales: $4.6 billion • 2001 - Acquired Monarch Broadcasting

– Acquired Van-Whole Produce – Employees: 24,000 Sales: $5 billion

35Source: Wikipedia, the free encyclopedia

Jim Pattison Story• 2002 - Started ProLogix Distribution Services and AccuLogix Distribution Services

– Acquired Ever Corp. – Employees: 25,000 Sales: $5.2 billion

• 2003 - Acquired LIN PAC Inc. – Employees: 26,000 Sales: $5.5 billion

• 2004 - Acquired Classic Attractions (Texas) – Acquired St. Augustine Sightseeing Trains (Florida) – Acquired Maltese Signs (Norcross, GA) – Acquired auto lease business of Cross-Canada Car Leasing Limited (Toronto, ON) – Acquired periodical distribution companies in San Jose and Chico, CA – Employees: 27,000 Sales: $5.7 billion

• 2005 - Acquired control of Icicle Seafoods (B.C.) Inc. – Acquired Freeway Dodge Chrysler – Acquired Spartech Corporation’s corrugated plastic sheet business – Started the Vancouver edition of 24 Hours (in partnership with Quebecor Media) – Formed or purchased interests in several US and Canadian joint ventures in the periodical industry – Employees: 28,000 Sales: $6.1 billion

• 2006 - Acquired Carthage Cup, Carthage, TX – Acquired Creative Outdoor Ads, Halifax, Nova Scotia – Acquired Island Radio Ltd.'s six FM stations on Vancouver Island – Acquired OK Radio Group Ltd.'s two FM stations in Victoria, BC – Acquired A&W Fixtures, Cocoa, Florida – Started Great Pacific Bank Limited, Warrens, Barbados

• 2007 - Disposed of interest in the Vancouver 24 Hours • 2008 - Acquired Guinness World Records from HIT Entertainment

36Source: Wikipedia, the free encyclopedia

Life Insurance

• Asset not a liability• Creditor Protection Under the Insurance Act– Each province has an Insurance Act which

provides creditor protection to life insurance policies in the legislation. The legislation is identical in every province except

Quebec. Sub-section 147(2) of the Insurance Act (BC) is an example: While a designation in favour of a spouse, child,

grandchild or parent of a person whose life is insured or any of

them, is in effect, the insurance money and the rights and interests of the insured therein and in the contract are exempt from execution or seizure.

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Case Law1. Ramgotra:

– 1996 Supreme Court of Canada decision in the case of Royal Bank vs North American Life and Balvir Singh Ramgotra.

• June of 1990, Dr. Ramgotra transferred his non-insurance RSP to a RIF through North American Life naming his wife as beneficiary. In Feb., 1992, he declared bankruptcy and was discharged in Jan., 1993 at which time his only assets were his clothing, household contents and the RIF.

• Royal Bank argued that by moving his RSP to an insurance company’s RIF, the bank’s view was that the RIF remained part of his estate and was therefore subject to seizure by the trustee in bankruptcy.

• The court ruled and made it abundantly clear that , all other legal considerations aside, the exempt status of the RIF under provincial insurance legislation was the critical factor in its’ decision.

• The transfer of non-exempt funs to insurance policies and to insurance RSPs and RIFs within one to five years prior to bankruptcy, will in most cases provide effective creditor protection. 2.

2. Sykes, Robson and Stock3. Harrison V. State Farm Mutual Automobile Insurance Co.4. Minister of National Revenue V. Moss

– The Court ruled that the taxpayer’s insurance policies were not exempt from seizure by Revenue Canada.• Case of statutory exception: The court held that, while the Bankruptcy and Insolvency Act (Canada) contains

specific language which prevents trustee in bankruptcy from seizing assets which are protected from creditors under provincial legislation, no such provisions are contained in the Income Tax Act (Canada)

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Use of Life Insurance in Tax Planning Asset

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Minimize the expense: cost of life insurance

Maximize the tax-sheltered investment

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Private Health Service Plan (PHSP)

3 Ways to Pay for Health Care Expenses:

1.Traditional Insurance2.Paying out of Pocket3.PHSP

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What is a PHSP?In 1988, the Canada Revenue Agency under IT-

339R2 under Subsection 248(1) (also paragraphs 6(1)(a), 18(1)(a), 118.2(2)(q) and 118.2(3)(b)), passed into law the Private Health Services Plan that allows you to expense your medical costs through your company as long as they are administered through a third party arms length administrator:

• 100% tax deductible to your company• 100%tax-free to the employee

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Who is Eligible?

• Incorporated business• Limited company• Sole proprietorship:– 50% of your net income for the year must be your

net income – Your net income from sources other than business

should not exceed $10,000

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What is Covered?

• Any product, procedure or service you receive from a medical practitioner. For example:– Physician, dentists, chiropractor, massage therapist,

ophthalmologist, optical service, psychiatrist, therapist etc.

• Hospital Services• Medication• Prescribed Medical Treatment

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Cost?

• One-time set up fee of $295• 10% administration fee for expenses as they

are submitted (fees are 100% tax deductible to the company)

• 100% tax-deductible for the employer• 100% tax-free for the employee• Easy to set-up

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Three Insurance salesman were sitting in a restaurant boasting about each companies service.

The first one said, "When one of our insureds died suddenly on Monday, we got the news that evening and were able to process the claim for the wife and had mailed a check on Wednesday evening."

The second one said, "When one of our insured died without warning on Monday, we learned of it in 2 hours and were able to hand-deliver a check the same evening."

The last salesman said, "That´s nothing. Our office is on the 20th floor of a tall building. One of our insureds who was washing a window on the 85th floor, slipped and fell. We handed him his check as passed our floor."

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www.mimitang.ca

• Mimi Tang Wealth Mgmt. & Consulting Ltd.• 604-926-8068• 604-926-8089 (Fax)• mtang@mimitang.ca

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