Michael A. GoldbergPartner
Minden Gross LLP
Tax Strategies for Life Insurance & Estate Planning
Presented by:
Joel Cuperfain Estate Planning Specialist
RBC Dominion Securities
Moderated byJoan E. Jung
Partner Minden Gross LLP
&
Life Insurance and Death Taxes A Primer
Michael Goldberg, Partner Minden Gross LLP
Uses of Life Insurance
• Estate liquidity• Asset protection• Estate creation• Investment opportunities, etc.
Estate Liquidity
• Income replacement• Final expenses and debts• Estate creation• Charitable giving• Business continuance (key-person)• Buy-outs• Death taxes
Types of Death Taxes
• Income tax due to deemed dispositions on death• Probate fees• US estate taxes and other foreign taxes and fees
The Life Insurance Tax Regime
• Exempt policies– Permit tax-sheltered growth in CSV and investment
portion of policies• Premiums generally non-deductible• Special rules re: transfers and dispositions
– Life insurance – not capital property– Disposition on death – tax free death benefit
Deductibility of Premiums Paragraph 20(1)(e.2)
• Conditions for deductibility:– policy collaterally assigned to a “restricted financial
institution” (bank, trust company, etc.) for a loan– assignment a condition of the loan– interest on loan deductible
Deductibility of Premiums Paragraph 20(1)(e.2)
• Deduction limited to the lesser of:– Premiums payable– Net cost of pure insurance (NCPI)
• Actual deduction must reasonably relate to the balance owing on the loan during the year
Benefits of Life Insurance for Incorporated Owner-Managers
• Premium funding cheaper using corporate dollars• Reduction in death taxes
– Valuation of life insurance on death– CDA
Life Insurance Policy Valuation on Death – Subsection 70(5.3)
• Non-arm’s length policies– Tax value on death = CSV– Can result in a reduction in death tax– Usually no impact in freeze situations
• Not applicable to arm’s length policies• Applicable for purposes of subsection 104(4) deemed
disposition rules and section 128.1 emigration tax rules
Corporate Life Insurance Benefits of CDA
• On death CDA created to the extent that:– Corporation is a private corporation – Life insurance proceeds > adjusted cost basis of policy
• Business planning side effects can include maximizing CDA benefits
Illustrations of The Benefits of Corporate Owned life Insurance
Basic Facts and Assumptions
Mr. Wise
Wiseco
Children
Common Shares $10 million - Freeze SharesACB/PUC - Nominal
$10 M life insurance
Ontario Tax Rates:
Capital gains - 23.2%Dividend - 32.57% (ineligible)/26.57% (eligible)
Personal Illustration
• Capital Gain on death = $10 million• Tax on death = $2,320,000• Life insurance impact on death
– Liquidity but no tax benefit
Corporate Illustration The Good Old Days
• New Assumptions:– Wiseco owns a $10 million policy
• Adjusted cost basis of policy = nominal• CDA created on death = $10 million
Corporate Illustration The Good Old Days
• Post-mortem redemption of Wiseco shares– Elect to treat deemed dividend as paid out of CDA tax free
Corporate Illustration The Good Old Days
• Post-mortem redemption of Wiseco shares– Elect to treat deemed dividend as paid out of CDA tax free– Capital loss to estate of:
ACB on death $10 millionLess Deemed proceeds $ 0Total Capital loss $10 million
Corporate Illustration The Good Old Days
• Post-mortem redemption of Wiseco shares– Elect to treat deemed dividend as paid out of CDA tax free– Capital loss to estate of $10 million– Subsection 164(6) election to carry loss back to Mr. Wise’s
terminal tax return– Set-off $10 million capital loss against the $10 million of
capital gains realized on death• No Tax on death
Corporate Illustration Let The Good Times Roll
• Grandfathered shares– Rule 1
• Shares subject to an agreement of repurchase entered into prior to April 27, 1995
Corporate Illustration Let The Good Times Roll
• Grandfathered shares– Rule2
• Corporation a beneficiary of a life insurance policy on April 26, 1995
• Shares owned on April 26, 1995• Reasonable to conclude that one of the main purposes of the
insurance was to fund the repurchase of the shares– Beware trips and traps
Corporate Illustration Let The Good Times Roll
• Grandfathered shares• Surviving spouse
– Tax free rollover to spouse or spouse trust– Repurchase by spouse or spouse trust – Elect to treat deemed dividend as paid out of CDA tax free– No capital gains or capital losses – No tax on repurchase
Corporate Illustration Stop-Loss Rules
• If a capital dividend is paid on a share held by an estate– Subject to the payment of taxable dividends on the shares
owned by the estate– Capital loss to estate on share repurchase is reduced
(stopped) by 50% of the lesser of: • Capital gain on death; and• Capital loss otherwise determined
(See subsection 112(3.2))
Corporate Illustration Stop-Loss Rules
• Post-mortem redemption of Wiseco shares– Elect to treat deemed dividend as paid out of CDA tax free– Capital loss to estate restricted to $5 million– Subsection 164(6) election to carry loss back to Mr. Wise’s
terminal tax return– Set-off $5 million capital loss against the $10 million of
capital gains realized on death• Total tax on death of deceased/estate:
– $1,160,000 on $5 million of capital gains
Corporate Illustration 50% Solution
• Limit the capital dividends paid on the shares to 50% of the lesser of:– Terminal period capital gains; and– The capital loss otherwise determined
• Result:– More tax but– Preserve CDA for survivors
Corporate Illustration 50% Solution
• Limit the capital dividends paid on the Wiseco Shares to 50% of the lesser of:– $10 million of terminal period capital gains; and– $10 million of capital loss otherwise determined
• CDA dividend not to exceed $5 million
Corporate Illustration 50% Solution
• Technical issue– $10 million Deemed dividend on redemption– CDA election must be made on “the full amount of the
dividend”– Stop-loss rules apply on each “share”– Therefore – planning required to limit CDA dividend on
the shares
Corporate Illustration 50% Solution
• Technical issue - a solution – $5 million deemed dividend on paid-up capital increase on
the Wiseco shares• Elect to treat deemed dividend as paid out of CDA tax free
Corporate Illustration 50% Solution
• Technical issue - a solution (Cont’d)– $5 million taxable deemed dividend on redemption of all
$10 million of Wiseco shares• If 2010 ineligible dividend = $1,628,500• If 2010 eligible dividend = $1,328,500• If 2012+ eligible dividend = $1,477,000 (proposed)
Corporate Illustration 50% Solution
• How much is the estate’s capital loss?
– ACB on death $10 million– Plus ACB from PUC increase $ 5 million– Total ACB $15 million– Less Deemed proceeds $ 5 million– Total Capital loss $10 million
Corporate Illustration 50% Solution
• No stop-loss– Capital loss to estate of $10 million– Section 164(6) election to carry loss back to Mr. Wise’s
terminal tax return– Set-off $10 million capital loss against the $10 million of
capital gains realized on death– No Tax on death to deceased
• Total tax on death of deceased/estate: – $1,628,500(ineligible) / $1,328,500(eligible)
on redemption of Wiseco shares
Corporate Planning and
Life Insurance
Joel Cuperfain, Estate Planning Specialist RBC Dominion Securities
Corporate Tax Planning Trifecta
• Tax sheltered growth• Tax free proceeds• Ability to distribute proceeds tax free through CDA
34 | WEALTH MANAGEMENT SOLUTIONS
Insurance as another asset pool
Real Estate
Business
RRSP
Holdco investmentsInsurance
Benefits of Corporate Owned InsuranceTax free money comes out Cheaper dollars go in
Assume $1,000 insurance premiumPersonal ownership:
At 46% tax rate corporation needs to pay salary of $1,852 for owner manager to net $1,000
Corporate ownership (small business deduction)With tax rate of 15.5%, corporation only needs to earn $1,184.00 to net $1,000 – an absolute savings of over 1/3
PLUS: Post mortem planning with CDA allows us to reduce the tax liability
Corporate OwnedInsuranceIn Action
The Situation
Investco
MomDad
50% 50%
FMV = $10,000,000ACB = $0PUC = $0
The Situation
• Dad and Mom both 45 years old• Shares are not grandfathered for purposes of Stop-loss
provisions• No tax liability triggered on death of first spouse• Capital gains tax liability of $2,300,000 on death of second
spouse
Insurance for protection
Insurance as a tax shelter
Cost for $2,300,000joint-last-to-die:
Cost for $2,300,000joint-last-to-die:
$8,188
Cost for $2,300,000joint-last-to-die:
$8,188
After tax rate of return to age 85: 7.75%
Insurance as a Tax Shelter
• move excess cash to tax sheltered environment• provide more to second generation family members• maxi-fund Universal Life plan
– increase annual funding from $8,188 to $94,061
Let’s Compare
GIC at 4.5%GIC at 4.5%45 85 45 85
Overfunded Universal LifeOverfunded Universal Life(policy interest rate 3.5%)(policy interest rate 3.5%)
Net estate value at death – age 85 (before redemption):
$5,106,135$5,106,135
$12,642,233$12,642,233
Overfunded Universal Life
• At life expectancy of age 85, death benefit is $12,974,822
• CDA credit is $11,901,955• Can use proceeds to pay tax liability and/or redeem shares• CDA credit not used is available for future distributions to
next generation
Another twist …
• Redeem shares of Investco prior to death of second spouse to avoid stop-loss
• Universal Life plan:• $2,300,000 joint last-to-die on Mom and Dad• Death benefit type is “Account value on first death”• Annual premium is $94,061
(assume freeze implemented at $10,000,000)
Account Value on First Death
Upon death of Dad (age 85), shares rollover to MomInvestco receives death benefit of $10,674,822 (i.e. policy account value)Investco’s CDA credit = $9,601,955(account value minus ACB of policy)
Account Value on First Death
• Investco uses proceeds to:– redeem Mom’s shares and/or– deposit back into Universal Life plan to build up values
for next generation– Without this planning, mom could not access corporate
funds without incurring 32% tax hit PLUS mom would face $2,300,000 tax liability at her deathTotal tax to Mom: approx. $130,000
What have we accomplished
• Funded personal liability with corporate dollars– Savings of 1/3 in active business context
• Tax sheltered growth inside policy– Investment income normally taxed at approx. 50% in private corporation
• Tax free proceeds• Accessed death benefit on first death instead of last death
– Putting tax free dollars in hands of surviving spouse• Liberated corporate dollars through CDA eliminating tax on distribution
– Additional savings of approx. 30%• Eliminated tax otherwise payable by mom and dad
– Deferred to next generation but taxes deferred are taxes saved!
Valuation IssuesTrips and Traps
Valuation and Life Insurance
Valuation depends on whether or not a specific provision in the Income Tax Act applies!!!
Canada Revenue Agency (CRA)
• Specific provision: Look to the details of the provision• No specific provision: Look to general provisions, case law,
CRA’s administrative guidelines, policy statements, technical interpretations, round table responses, accepted valuation principles, etc.
Rollovers
• Spouse– Inter vivos – Testamentary
• No rollover to Spouse Trust– Inter-vivos
or– At death
Intergenerational Rollover
Rollover available where:• (a) an interest of an owner in a life insurance policy (other than
an annuity contract) has been transferred to the owner’s child for no consideration, and
• (b) a child of the owner or a child of the transferee is the person whose life is insured under the policy.
Trust to Beneficiary
• Potential conflict– 148(7) – non-arm’s length disposition
vs– 107(2) – tax free rollover of trust capital
• CRA says: Although life insurance is not capital property for tax purposes, it is trust capital for trust law purposes. 107(2) applies
Deemed Proceeds of Disposition
• SS 148(7): deemed proceeds equal to the “value of the interest” when:
• Gift• Distribution from corporation• Transfer to non-arms’ length person
•SS 148(9): Value is cash surrender value•Other situations: actual proceeds or fair market value
Opco
Transfers: In, Out and Between Companies
Transfers Between• May want to transfer the policy between two
companies• Non-arm’s length relationship: 148(7) deems
proceeds equal to CSV• If transferee is a shareholder, will be a shareholder
benefit to the extent the FMV of policy exceeds CSV
• Transfer policy as dividend in kind
Transfers: In, Out and Between Companies
Transfers Out:• If corporation is dealing non-arms’ length
with the shareholder, deemed proceeds equal CSV
• Shareholder must pay to the corporation FMV if this amount is greater than CSV
Opco
No specific provisions:– CRA’s guidelines and technical views:
• IT-140R3 - Buy-sell agreements• IT-416R3 - Valuation of shares • IC 89-3 - Business equity valuations
CRA’s view
• Factors considered in determining “fair market value” of an insurance policy:– CSV of the policy at the particular time– premiums– face amount of coverage– the state of health of the life insured(s)– the life expectancy of the life insured(s)– conversion privileges– replacement value
Value of Policy
Paterson v. Remedios (1999) 29 E.T.R (2d) 279 (Sask. Q.B.).Case Facts
– Family law case re: division of property– Does term insurance policy have value?– Insured was terminally ill– Changed beneficiary from
soon-to-be ex-wife
• Court said policy has value
Valuation of Term Insurance
How to value a Policy?
• Discounted death benefit– Discount rate?– Future premium obligations
• Replacement value– How much would a new policy cost?
• Special factors – certain features or riders or even policies may not be
available• E.g. how to value a participating whole life policy that’s no longer
available for sale?
Transfer of InsurancePolicies to Corporations
Transfers of Insurance Policies
• Mr. X. is 65 year old, moderate health• High cholesterol, high blood pressure• Mr. X is sole owner of Xco• Bought a $1,000,000 T-100 policy 12 years ago (personal
ownership)
Transfers of Insurance Policies
• Mr. X heard it’s more tax efficient to have his corporation pay the insurance premium (after tax corporate dollars being less expensive after tax personal dollars)
• Mr. X wants to transfer the insurance policy to XCo• What are the tax consequences?
Transfers of Insurance Policies
• Life insurance is not capital property• Section 85 rollover not available• Subsection 148(7) defines proceeds of disposition to be equal
to “value” of policy• Subsection 148(9) defines “value” to mean “cash surrender
value”
Transfer of Life Insurance
• T-100 has no cash value• Deemed proceeds equal nil• Subsection 148(7) also deems XCo’s new ACB to be nil• (Important for CDA purposes)
Transfers of Life Insurance
• But what if the policy actually has a fair market value of $200,000?
• What if XCo actually pays $200,000 fair market value?• Deemed proceeds still nil• See CRA technical letter 2003-0040145
Transfers of Life Insurance
Practical applications:• Older clients with level cost personally held life insurance• Professionals who have recently incorporated
– Now have the opportunity to have corporate owned life insurance
Insured Annuities1. Personal Back to Back2. Corporate Back to Back
The problem
• Your client is mature/retired individual who:• Has non-registered GIC investments,• Wants high guaranteed returns,• Wants to minimize taxes and maximize after-tax income,• Wishes to preserve capital for children, a charity, or others• BUT, only earning 3-4% and the interest income is fully
taxed...
Life Annuities
• Pro - Enhanced Cash Flow
• Con - Capital Encroachment
A combination of two tax-efficient products:
A prescribed annuity contract with payments guaranteed for life.
Solution: Insured AnnuitiesSolution: Insured Annuities
Annuity
Insurance•A life insurance contract, with a guaranteed death benefitguaranteed death benefit to preserve invested capital.
Result is lifetime income, from annuity; from annuity; and an estate for heirs, from insurancefrom insurance.
The Insured Annuity
• Maximizes income• Minimizes income taxes• Guarantees lifetime income• Guarantees estate values
Life Annuities
• Lifetime payment stream• Each payment represents a blend of interest and capital• Sometimes described as insurance against living too
long
Life Annuities
• Prescribed Annuities
• Non-prescribed Annuities
Life Annuities
• Special tax treatment for prescribed annuities:– Payments taxed as a level blend of interest and tax-free
return of capital.– Interest income is spread evenly over the life of the
annuity.
Prescribed / non-prescribed annuitiesPrescribed / nonPrescribed / non--prescribed annuitiesprescribed annuities
non-prescribedannuity
TaxableIncome
prescribedannuity
Age
The Insured Annuity
• Purchase Term-to-100 insurance policy• Purchase Prescribed Annuity• Preferred tax treatment of the annuity results in higher
after tax income - even after the payment of the insurance premium
GIC @ 3.5%
$1,000,000 Initial Capital 35,000 Annual receipt 35,000 Taxable portion 16,100 Tax (@ 46%) 18,900 After-tax income Nil Insurance premium $18,900 Net retention
GIC/Bond Portfolio vs Insured Annuity GIC/Bond Portfolio vs Insured Annuity -- A Comparison:A Comparison:
Insured Annuities Female age 70, non-smoker
Insured Annuities Female age 70, non-smoker
Insured Annuity
$1,000,000 84,643 22,566
10,380 74,326 32,020 $42,243
Insured AnnuitiesInsured Annuities
Rate of Return, Female 70
After-tax return 4.22%
Equivalent pre-tax GIC return,assuming 46% tax rate 7.81%
Insured Annuities
WHAT ARE THE RISKS?• Investment rate the annuity is earning is locked-in for life; but
a 7%+ guaranteed rate for life isn’t bad!• Lack of flexibility; • CRA has indicated the annuity and the life insurance policy
must be separate contracts:neither contract can be contingent on the othereach must have separate underwriting
Conservative Guaranteed Investment Strategy
• Guaranteed (Enhanced) lifetime income.– Higher after-tax returns than traditional guaranteed
investments.• Little or no management• Preferred income tax treatment on prescribed annuity.• Avoid OAS claw back• Invested capital preserved for heirs.• Can avoid probate fees.• Testamentary Insurance Trust
• What about corporate structures?
If personal is good, corporate must be better …
What are Corporate Insured Annuities?
• Same Basic Concept– Corporation purchases a non-prescribed annuity
• Measuring life is shareholder– Corporation acquires life insurance policy on life of
shareholder.– Corporation is beneficiary of insurance policy, and entitled
to receive annuity payments– Corporation uses annuity income to fund insurance
premium obligations
Corporate Insured Annuities
• How is this different from personal context?– Goals are:
to enhance cash flow during lifetimeAND
to reduce taxes at deathAND
to create a CDA credit
Corporate Insured Annuities
• How is this different from personal context?– Goals are:
to enhance cash flow during lifetimeAND
to reduce taxes at deathAND
to create a CDA credit– Non-prescribed annuities.– Refundable Dividend Tax on Hand (RDTOH)
implications.
Valuation Issues
MR. X MR. X100 % Common Shares 100% Common Shares ACB- Nil ACB- Nil PUC- Nil PUC- Nil
Assets- GIC Assets$1,000,000 (1) T-100 Life
Insurance(2) Life Annuity(Zero guarantee)
HOLDCO HOLDCO
Thank You
Joel Cuperfain, Estate Planning Specialist RBC Dominion [email protected]
Michael Goldberg, Partner Minden Gross [email protected]
Joan E. Jung, Partner Minden Gross [email protected]
www.cch.ca
