Life Insurance

Why ? How Much ? Term Mortgage Term 100 Universal Life Whole Life Corporate Owned Life Insurance Corporation Buys an Existing Life Insurance Policy Partnership Buyout

Why ?

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Life insurance is one of the most important aspects of financial planning. It provides significant benefits such as: replacing earned income for financial dependents, eliminating outstanding loans and mortgages, paying for funeral, final expenses and paying capital gains tax on investments and recreational properties. Life Insurance benefits are typically paid out tax free.



How Much ?



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Following death there will be an immediate need for cash to cover debts, funeral expenses, income taxes, living expenses of the family and educational expenses of the children. Therefore, a logical starting point is to calculate the cumulative amount of debt and ensure that there is a sufficient sum of insurance in place to eliminate this financial burden. Secondly, you must determine how much income the surviving family members need to maintain their lifestyle. As an example if you are aiming to replace $50,000 of income you would need $1 million of capital earning at the rate of 5%. The capital requirement may be satisfied with both life insurance and your assets.



Term



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Term insurance is temporary insurance. Companies offer a range of products with guaranteed rates that escalate every 5, 10, 20 or even 30 years. Term insurance is an excellent product for those whose needs are short term, or need a large face amount of coverage at an inexpensive cost. This type of insurance, however, becomes very expensive over time and is not to be used for lifetime protection or estate planning. These policies usually expire by age 75 and have no monetary value when terminated. A common feature of Term policies is the right of conversion, whereby the owner may convert non-medically to a ‘permanent’ policy within that company’s portfolio. You would pay current age rates at the time of conversion.



Mortgage



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Most individuals insure their mortgage against premature death of either spouse. Mortgage life insurance is available as creditor insurance through the lender or may be acquired as an individually owned plan. Your mortgage likely represents your largest financial burden and as such you should be fully aware of the significant differences between a bank policy and an individually owned plan.



Term 100



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This product is the most basic form of permanent insurance. The premiums are guaranteed and level. One can pay premiums for life or purchase a shorter pay variation which can be paid up after 10 or 20 years. There is usually a guaranteed cash surrender or reserve value throughout the policy’s tenure providing value if one terminated the contract early. This insurance does not allow for tax sheltered fund accumulation. Some plans do offer paid up insurance whereby a percentage of the original face value continues without paying any further premiums. These policies are used to insure long term needs and are one of the cornerstones of effective estate and tax planning.



Universal Life



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Universal Life (UL) policies offer a great deal of planning opportunity options. The basic cost of insurance is guaranteed and may be level or annually renewable term. It offers the options of “overfunding” where extra premium may be invested in a multitude of funds or accounts that accumulate on a tax deferred basis, much like an RRSP. You also have the ability to take a premium holiday allowing the fund value to pay premiums. Alternatively you may change your monthly deposit by either increasing or decreasing it. On death, the face amount and accumulated fund value are paid out tax free. This is an effective way of transferring wealth to children – investments held outside a life policy are deemed disposed of and taxed accordingly at death – unless rolled over to spouse. Investments held inside a UL policy escape taxes on death. The applications of this product are numerous and can be creatively used to provide many estate solutions.



Whole Life



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This product is the original form of permanent insurance. The rates for traditional Whole Life are higher than Term to 100 or Universal Life. These plans may or may not participate in dividends (return of unused premium). Such dividends may be used to purchase more insurance through “paid up additions” or to enhance the cash surrender value of the policy. One may purchase a ‘non-participating’ policy for lower rates but no paid up additions or enhanced cash surrender values are available.

These products are essentially ‘hands free’ since no investment decisions are required, and may serve a particular niche in ones insurance portfolio.



Corporate Owned Life Insurance



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Today most Professionals have the right to Incorporate. A Corporation may own a life insurance policy on a shareholder which allows cheaper after-tax dollars to be used to purchase a policy. The Corporation must be the owner and beneficiary of the policy – having a spouse as beneficiary will lead to a taxable benefit being added to the life insured’s income which nullifies this advantage. At death, life insurance proceeds are paid into the corporate Capital Dividend Account (CDA) tax free. The corporation may then declare a tax-free dividend to shareholders. One of the disadvantages of this arrangement is the loss of creditor protection that personally owned policies enjoy. It is important to understand that investment earnings inside a corporation are taxed at the highest marginal tax rate. Therefore, it is wise to know that investment growth inside a corporately owned Universal or Participating policy is tax deferred allowing for some planning strategies. Clearly in most situations it would make sense to flow premiums through the corporation.

This topic is exceptionally broad and should be discussed in detail with your insurance advisor and accountant.



Corporation Buys an Existing Life Insurance Policy



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A tax strategy exists whereby a shareholder of a corporation sells their personal life insurance policy to their corporation. This strategy works best with permanent (Universal or Whole Life policies) policies where the cash surrender value is low or zero and has a relatively high sale price. This strategy requires that an Actuary prepare a Fair Market Value estimate.

The advantages that you may realize are:

  • Extract cash from your corporation tax free – (liquidity gain and tax gain)
  • Future premium are paid by corporation – lower tax rate (tax gain)
  • On death face value paid tax free to corporation less adjusted cost base
  • In many cases this is a worthwhile strategy to consider, however it is always recommended that you review this with your accountant or tax specialists to determine if this is right for you.



    Partnership Buyout



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    Commonly when two or more individuals have ownership interest in a company they will arrange a buy-sell agreement which stipulates transfer of shares for specific events. Death is a specified event where the shares of the deceased are sold to the survivor(s). Clearly having a proper funding mechanism in place is critical to solidify the agreement. Any type of the life insurance products noted above may be used as a funding mechanism. If no arrangement is made for buy-out at death, it may be impossible to find the funds or a potential purchaser for the deceased’s shares. You could even end up with the deceased partner’s spouse as your ‘New Partner’. Proper funding ensures you control of the company.