Life insurance is used as a solution to create instant capital
for families and businesses that would otherwise face serious capital shortages.
Life insurance benefits are paid tax-free to create an income for families
when a breadwinner dies, or pay off liabilities in a business, such as estate
taxes, when a business-owner dies.
Creating Wealth - The Various Uses of Life Insurance
Some of the situations where life insurance is used to create capital are
here summarized:
- To create enough money to fund a buy-sell agreement. This
allows business partners to buy a company from the surviving shareholders
of a deceased owner.
- To create cash to pay off estate tax liabilities to enable the transfer
of personal assets such as a cottage or a business succession to children.
- To secure repayment of a loan or a mortgage at a financial institution.
- To create cash to pay off personal and business debts.
- To create special capital bequests to heirs.
- To equalize the value of bequests to children and other heirs, for example,
when a usiness is passed on to one child, where other children would receive
less.
- To enable a business's key person, who dies or becomes disabled, to be replaced.
- To fund a charitable bequest of the owner's choosing.
- To create enough capital, from which to invest and create a replacement
income, to provide for a young family.
Though
wealth is immediately created, the modus operandi of these strategic uses
of life insurance, is to protect the future financial stability of the associated
businesses or heirs.
The Multi-Generational Legacy
Life insurance can solve a myriad of problems. In addition, there
are advanced uses of life insurance such as: tax-preferred treatment on large
sums of investment growth; the creation of large sums of new capital; and
a method of transferring wealth tax-free, from one generation to the other.
By virtue of utilizing the guidelines of our tax laws, the Multi-Generational
Legacy (MGL) integrates all these advantages.
Tax Preferred Treatment of Investment Growth
This strategy takes advantage of a life insurance policy called Universal
Life (UL). You can invest money inside term deposits of a UL that allow the
ongoing growth of the investments to remain untaxed as long as they are not
withdrawn from the policy. The future cost of the insurance (including any
related admin fees) is paid from the pre-taxed cash element accumulating in
the policy. Upon the death of the insured, all monies the life insurance face
amount plus the tax-deferred growth, is paid out entirely as a tax-free cash
benefit to the beneficiaries.
The tactic of investing money in this tax shelter works well
for investors who have maximized their RRSP, and are on target to sustain
their retirement income needs, and/or those who are financially independent.
For example, such an investor may have just received an inheritance, and is
looking for a tax-advantaged investment opportunity. Using the MGL, you can
pass investment wealth on to the next generation without the hassle of probate,
free of taxation, and in many cases creditor proof. In the meantime, one can
achieve cash accumulation, and retain control of those investments while alive.
In addition, the invested funds can be accessed for emergency uses.
All life insurance guarantees to create a large sum of money
upon an insured's death, after the payment of the first premium. With most
UL policies, this death benefit can be composed of both the life insurance
element and the tax-preferred investment portion. Once the investments have
accrued considerably, in many cases, no more premiums need to be paid. The
insurance is effectively pre-paid from the ongoing investments growing tax-deferred.
Over time, the UL can continue to grow like any other investment (net of the
insurance costs paid annually).
Note: Some of the invested monies can be withdrawn tax-free
in relation to the amount of the adjusted cost base (ACB) of the policy.
Tax-Preferred Transfer of MGL Wealth
There is a unique method to pass the tax-preferred investment growth from
one generation to the second, and finally to a third generation. We will use
an example. Bob is a successful businessman who is financially independent.
In addition, he has just received an inheritance from his father in the amount
of $250,000. He has maximized his RRSP contributions annually to an accumulation
of $625,000 and owns $1 million in non-registered mutual funds. What can he
do with this extra $250,000? He decided to create a Multi-Generational Legacy.
His only daughter Sarah, age 40, has four children living at home.
The Multi-Generational Legacy Strategy
Bob who is now 75, has faced heavy taxation all his life, so he wants to invest
this money with minimal future tax concern. He also wants to ensure that Sarah
will eventually have access to the cash investments, and that the money will
eventually flow to his beloved grandchildren without any hassle or probate.
How Does He Achieve This?
Bob proceeded to purchase a life insurance policy, and quickly funded it with
the $250,000 over six annual payments. He placed the entire $250,000 into
the insurance company's transferring, shuttle-type investment account, from
which the premiums were loaded into the UL. When prepaying a UL policy a maximum
premium per year is allowed, as a limit, to keep the policy tax exempt. Amounts
in excess of the maximum annual premium can be deposited into a taxable shuttle-type
account designed to flow the money into the plan. Once these monies are invested
in the UL, they are removed from a taxable position.
Bob purchased the insurance on Sarah's life, and made her the contingent owner
of the policy (imperative to facilitate the tax-free transfer of the investments).
His four grandchildren are equal beneficiaries. Thus, the term Multi-Generational
Legacy.
Note: The life insurance company can assure that the payments
are not so high as to cause the policy to become non-exempt.
Generation 1: Bob Retains Access to Income
Using the MGL concept, Bob will have access to his money
invested in the UL, while he lives, if the need ever arises. Though he believes
the markets will recover, it is reassuring to know he also has these funds
to fall back on if need be. He knows that his monies will accumulate on a
tax-preferred basis. Income earned within the plan is not reported on Bob's
tax return.
There is an advantage to using the MGL strategy over using
a trust to pass his $250,000 on to Sarah. A trust can be expensive to establish
and manage, with restricted control. Conversely, an exempt life insurance
policy such as UL, can be cost effective and established easily. You determine
when you want to transfer the plan's ownership (and control) to your child
or grandchild, now, later, or upon your death.
Generation 2: The Investments Transfer To Bob's Daughter
Bob chose to transfer the policy to Sarah, upon his death.
When a child or grandchild is named as a contingent owner of the UL plan,
the tax-advantaged, multi-generational transfer occurs despite the original
policy owner's death. The wealth is passed outside of the client's will to
avoid probate fees. After Bob dies, Sarah the contingent owner will have full
access to the remaining cash in the policy for income. The policy ownership
and all assets will automatically be transferred to Sarah by virtue of the
policy's contract provisions including the governance of those assets held
therein.
The tax-free transfer of ownership to a child, and the ongoing
tax sheltering, is allowed because of legislation regarding the use of life
insurance within families. Moreover, probate can be avoided, as the beneficiaries
remain the same as defined in the policy. No estate-planning directive regarding
this strategy is needed in Bob's will. If confidentiality is desired, no one
other than Sarah and her children need to know about this MGL strategy. Thus,
you minimize the risk of contestability; and protect the original intent of
the MGL wealth transfer.
Opportunities Abound
Once Sarah has ownership, she also has full control of the
investment assets, and she can choose to do several things:
- Take taxable withdrawals from the investment portion of
the policy.
- Borrow tax-free cash, collateralized by the value of the investments.
- Pass all or most of the investment portion (along with the life insurance
benefit) of the policy to her children_the beneficiaries_divided equally when
she dies. The proceeds will transfer as tax-free cash, without probate.
Generation 3: The Wealth Transfers to Bob's Grandchildren
When Sarah dies, all her children will receive not only their
portion of the death benefit. They will also receive their portion of all
of the remaining investment growth as well, all tax free. Though deceased,
Bob will have accomplished his multi-generational strategy by transferring
wealth over two successive generations without using a trust, without probate,
and without taxation on his investments (while they stayed in the UL). Bob
initially had access to the money if he needed it. Further, Sarah could spend
the funds as she deemed fit. Finally, the children received an inheritance
from mother, though indirectly from grandpa.
Sarah chose to keep enough cash in her investments to keep
the policy paying for itself in relation to the interest being paid on the
investments. Your insurance specialist can tell you more about keeping a policy
pre-paid and tax exempt.
Is this legal?
The tax laws allow an owner of a life insurance policy to
transfer the ownership to any child of their own, without taxation, where
the child is the life insured. A child includes an adopted child, a grandchild,
a stepchild, a son-in-law, or a daughter-in-law. Taxes are due only upon the
withdrawal of funds by the new owner. Clients should consult a tax specialist
to confirm the tax viability of these plans relevant to your own unique situation.
The Advantages of the MGL
The beauty of this plan is that it can be recreated from
generation to generation where there is significant wealth. It accomplishes
one or more of these tactics:
- Leaves funds to children and/or grandchildren.
- Reduces taxes on investment income.
- Lowers current taxable income.
- Retains complete control of assets.
- Avoids costly probate fees.
- Simplifies an estate transfer of wealth.
- Creates new family wealth.
- Minimizes the risk of will contestability.
