Permanent Insurance – The Most Misunderstood Tax Shelter

Today, only four tax shelters are available to Canadian tax payers. Your principal residence (for now), Tax-Free Savings Accounts(TFSA), lottery winnings, and last is life insurance.

For incorporated professionals, taxes will be the largest expense over a lifetime, so understanding these tax shelters and how to use them is beneficial.  Of these four tax shelters, the tax advantages of life insurance are the most misunderstood.

If you’re keen on paying your fair share of tax to CRA but don’t necessarily want to “leave a tip,” here’s what you should know about permanent life insurance.

Permanent Life Insurance

Permanent life insurance is an all-encompassing term for life insurance policies that do not expire, unlike term insurance which stops at the end of the term.

Permanent life insurance is designed to provide for needs that will exist permanently into the future. Think tax liabilities on death, funding a buy-sell/agreement with a business, equalizing an estate, and charitable bequests.

A unique feature of permanent insurance is that portions of the premiums often go towards an investment account within the policy. The value of this investment portion is known as the cash surrender value, which is the portion within the policy that will ultimately grow tax-free.

Two Common Types of Permanent Life Insurance

Whole Life

Whole life insurance offers coverage for the entire life time of the insured, and its investment account can grow guaranteed. Although the investment component can grow guaranteed, you have little to no control over how this cash portion gets invested and this portion is always invested extremely conservatively.  

Universal Life

Universal life offers more flexibility around premium and investment structures. You have more control over how the investment component is invested with several options to select from. Not all investment options provide guarantees, so market risk depends on the selected option.

Which type of insurance depends entirely on your current financial situation and intended goals.  A good advisory team collaborating on your behalf to structure things appropriately is critical.

Tax Exempt & Tax Free

As mentioned, only four tax shelters are available to Canadians, and life insurance is one of them.

Canadian tax law allows the investment component within permanent insurance policies to grow tax-free. This can be especially important with private corporations where tax rates on passive investments are extremely high (nearly 50%). If you remember, I referenced a conservative return when discussing whole life insurance. A numerical example is approximately 4%. Now 4% might seem low, but compared to what a corporately owned investment into a stock would produce after tax, the conservative insurance policy return is excellent. To earn 4% after-tax using stocks or bonds, you would likely need to make anywhere between 6%-8% from your investments. This 6%-8% would also not be guaranteed.

Passive investment returns also affect incorporated business owners’ ability to access the small business deduction, which allows them to pay lower tax rates (9%-12%) on their first $500,000 of active business income. The investment account within the insurance policy is NOT considered a passive investment and, as a result, does not affect access to these lower tax rates.

In addition to the tax-exempt status, with corporately owned permanent life insurance, death benefits are paid tax-free. [SL2] With corporately owned policies, the death benefit is paid to the corporation. It can be transferred tax-free [SL3] to beneficiaries using the capital dividend account­, which can easily save families hundreds of thousands and, in some instances, millions in taxes.

Enhancing Your Cash Flow

The cash surrender value (the investment account) within an insurance policy is viewed as an asset by banks and financial institutions. This means that whether a policy is personally or corporately owned, you are still able to access cash that has been deposited into the investment account while living.

We’ve seen clients access these funds to provide for lifestyle expenses in retirement. We’ve also seen clients access these funds so they could invest either back into a business, into a real estate deal, or even an investment portfolio.

Closing

To make intelligent financial decisions, you need to understand what life insurance “can do,” not what it “is.” Working with a strong financial planning team that collaborates with your other professionals will help you increase your overall net worth, maximize your family’s legacy, and do it all while leaving less of a tip to CRA. When used in the right circumstance, permanent insurance is invaluable for creating some of the best outcomes I’ve ever seen in personal finance.

- Brandt Butt, CIM® Portfolio Manager and Investment Advisor iA Private Wealth Inc. Insurance Advisor* IA Private Wealth Insurance

Brandt is an Portfolio Manager/Investment Advisor and part of an award-winning team at Endeavour Wealth Management with iA Private Wealth. Brandt’s focus is working with incorporated physicians and dentists between the ages of 35-45 who are looking to set themselves up on the right financial path in hopes of reaching a point where they are choosing to work, instead of having to.

This information has been prepared by Brandt Butt who is a Investment Advisor/Portfolio Manager for iA Private Wealth Inc. and does not necessarily reflect the opinion of iA Private Wealth. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor/Portfolio Manager can open accounts only in the provinces in which they are registered. iA Private Wealth Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. iA Private Wealth is a trademark and business name under which iA Private Wealth Inc. operates.

Disclaimer: *Insurance products are provided through iA Private Wealth Insurance, which is a tradename of PPI Management Inc. Only products and services offered through iA Private Wealth Inc. are covered by the Canadian Investor Protection Fund.