Rediscover the tax-saving ability of life insurance.

piggy bank wearing sun glasses

Over the past couple of weeks, a lot has been written about Finance Minister Bill Morneau’s proposal to fix the perceived unfairness in the way that private-business owners, family businesses, and incorporated professionals pay tax. While the proposal was not a surprise, it was the scope of the changes that many found alarming. In the days after the proposal became public, doctors’ associations, farmers, and small and medium-sized businesses have let the Minister and his government know that these changes will have a significant and negative effect on practicing doctors, the economy, and on the future of the family farm in Canada. Tax, financial and estate planners, as well as accountants have also responded by readying themselves and their clients for the impact of the changes which, if passed into legislation, will take effect in 2018.

With the prospect of higher tax rates, we want to remind business owners and all those potentially impacted by these proposed changes of the inherent value of life insurance.

A few valuable reminders about the tax-saving ability of life insurance!

Life insurance is tax-exempt by its very nature.

Any investment growth (i.e., passive investment), during the tax year, is not taxed. Therefore, if the proposed tax rates do increase on passive investments, tax-exempt permanent life insurance cash values become more valuable.

Life insurance is a unique tax-saving strategy for a business.

Instead of a corporation distributing investment capital to a shareholder and then paying the tax on those distributions, a shareholder can personally borrow from a corporately-owned life insurance policy. In this case, the shareholder can invest the corporate capital personally without having to go through a personal tax cycle.

This type of strategy is unique to life insurance. It’s only through tax-free life insurance proceeds and capital dividend account (CDA) credits upon death that allows the strategy to be unwound without onerous tax consequences. While this is relatively common practice today, if the proposed tax rules become law, this option will become even more attractive.

Life insurance to protect your effective tax rate.

One of the most common tax-planning strategies for an estate is to use a series of transactions to end-up with capital gains tax. But, based on projections of the new tax proposals and, if this common tax-planning strategy is used, the capital gains tax would be significantly higher than the alternative dividend tax.

A possible opportunity to preserve your effective tax rate (equal to the current capital gains tax rate) is to use life insurance and the 50% solution. This strategy protects the effective tax rate payable by the estate at a rate equal to 50% of the current dividend tax rate, which is approximately equal to the current capital gains tax rate.

A final word.

Whether or not the latest tax proposals become legislation, the government’s actions put us all on notice that changes will be coming. Will life insurance be immune to these changes? Thus far, the proposal has been silent on life insurance.