MARY’S STORY – PRESERVING LIFE INSURANCE TAX SAVINGS OF $1.4M
Mary and her husband operated a successful family business, which is now in the capable hands of their children and grandchildren. But with Mary in her 90s and failing health, her advisors wanted to review her corporate life insurance policies purchased in the early 1980s.
It was not an easy task considering the actual sales agent of the policies had since died, the policies had not been reviewed in over 30 years, and both the client and insurer held insufficient paperwork. Our advisors were asked to confirm the Adjusted Cost Basis (ACB) of the policies and therefore the capital dividend account (CDA) credit allowing for tax-free dividends to be paid.
CDA Credit = Insurance proceeds less ACB
Mary’s accountants expected the ACB to be $0, providing the maximum tax-free capital dividend account (CDA) credit. The shareholders expected the full $5 million death benefit to be distributed out of the company as a $5 million tax-free capital dividend.
Here is where the problem arose. According to the insurance company, the policy was classified as G1 (refers to policies issued or last acquired before December 2, 1982), which meant the ACB was not $0 but the sum of the premiums paid of $3 million. In contrast, under a G2 classification, the ACB would be reduced by the net cost of pure insurance and result in a $0 ACB.
Could the original purpose of the life insurance be achieved?
Our advisors began sorting through the 40-year-old documentation and found that Mary’s medical insurance application was completed after the G1 date. This information was critical to our argument that the ACB should be $0, because it meant the policy was not in force before the G1 date. On this basis, we contested the ACB amount—going back to the insurer multiple times and requesting they reconsider the policy’s classification. Months passed without a favorable resolution, during which time Mary passed away and Canada Revenue Agency (CRA) requested an audit on the policies to verify the ACB.
Tax savings of $1.4 Million Achieved!
After a year of contesting the insurer’s decision, the file was referred to their legal department. After months of deliberations, the insurer agreed with our G2 classification and confirmed an ACB of $0. Mary’s beneficiaries had just saved $1,440,000 in tax.
We can help protect your capital.
Applying our knowledge of the technical elements of insurance contracts as well as financial and insurance expertise, we were successful in achieving the desired result for our client—tax savings of $1.44M. However, this outcome was only achieved after a prolonged struggle with the insurer and their legal department, and a CRA audit of the ACB of the policies.
There were many lessons learned in this situation.
- It is critical to document the purpose of the insurance, what are we doing and why.
- Clients need complete records and documentation. Do not rely upon the insurer.
- Ensure there is a successor in the event your agent passes.
- Regular review of your insurance policies is critical to protecting capital.
- Insurance companies are not always correct.
- Ensure you are receiving impartial and competent advice.
Our clients receive a comprehensive completion package which includes all memorandums, planning documentation, policy summary and illustrations, and policies. These documents ensure that the purpose is achieved and provide the basis for future reviews and planning.
By reviewing current life insurance needs and in-force policies, our business insurance specialists can help establish the best protection for wealth and cash flow.
Warren Campbell, CFP, TEP, CLU
Jim Dehoney, BBA, LLQP