Insurance can lower death tax

Often used in estate plans for affluent clients, an estate bond is a tax-efficient strategy that creates a large and immediate estate value.

An estate-bond strategy is also a wealth accelerator that allows assets to pass on to heirs or shareholders, tax-free. Typical clients for this strategy are business owners with excess liquidities and retirees who have more income or assets than they need to sustain their lifestyles. The strategy provides both a tax-free death benefit and investment component.

The benefits are many

An estate bond creates a large and immediate estate value that is far greater than what assets might earn in a taxable investment portfolio. Because the strategy uses permanent life insurance products, cash values are also tax-sheltered. If proper beneficiary designations are in place, the assets are nearly creditor-proof and the amounts invested are available if you require liquidity during your lifetime.

Making it work

Setting up an estate bond is simple. Using a universal life or whole life insurance policy, you can begin to move their money from open savings accounts into an exempt life insurance contract. As shown in the example below, a couple who transfers $50,000 per year for 10 years (a $500,000 investment) would create an immediate death benefit worth over $1.1 million. Cash account growth in a universal life policy pushes the death benefit over $2.8 million if the client lives until age 85. If the client lives until 95, the total death benefit number nearly doubles.

For a corporate client, the death benefit could be paid into the company’s capital dividend account, which tracks the tax-free amounts a company receives from various sources. These funds can in turn be paid out to shareholders tax-free.

The next step is to determine what investments to use inside of the permanent insurance policy. Universal life and whole life products have gone in and out of favour, depending on market conditions and people’s willingness to accept and manage risk.

But they can bring peace of mind, especially when they are being used in a strategy like this one, so people will often choose conservative investments. Usually, they have a separate cash account with a wealth manager for buying stocks and implementing riskier investment strategies. In their insurance policy, the investment choices are more conservative investments, since a death benefit will be paid out at some point.

The safest route is to invest in GICs inside of a universal life policy. Whole life policies tend to offer relatively fair yields through their dividend scale.

The estate bond strategy also offers creditor protection if certain conditions are met. Properly naming the beneficiaries is one of them. If the estate is the named beneficiary, the investment won’t be creditor-proof.

To make an individual policy creditor-proof, the beneficiary must either be irrevocable or the beneficiary must be your legal spouse, children, grandchildren, parents or grandparents. Stepchildren are not considered in this vertical line.

The five-year test is another rough guideline that will be applied when considering the protected status of a policy in bankruptcy proceedings. If you declare bankruptcy within five years of the policy being established, the assets will likely not be protected and your intentions will come under scrutiny. If it’s shown that you intended to shelter money from creditors, courts will likely cancel that protection.

Finally, if you’re concerned you may need asset liquidity, the cash values that build up in the policy create a cash surrender value. Depending on the product, you can either borrow money from the policy or can pledge the policy as collateral and borrow money from a bank. In both cases, you can pay the money back, simply pay the interest, or let both ride, arranging for the loan to come due when you die, at which time the loan will be paid and the balance of the policy’s proceeds will be paid out to the named beneficiaries or your estate.

The estate bond can multiply your savings and help provide a larger tax-free legacy for those they care about most.

André L’Espérance is Director of the Wealth & Estate Planning Team at Richardson GMP.

This team of in-house experts and professionals provides coordinated support to advisors to ensure clients have complete and comprehensive wealth plans in place. The information provided in this publication is intended for informational purposes only and is not intended to constitute investment, financial, legal or tax advice. This material does not take into account your particular situation and is not intended as a recommendation. It is for general purposes only and you should seek advice regarding your particular circumstance from your personal tax and/or legal advisors This material is based upon information considered to be reliable, but neither Richardson GMP nor its affiliates warrants its completeness or accuracy, and it should not be relied upon as such. Insurance services are offered through Richardson GMP Insurance Services Limited in BC, AB, SK, MB, NWT, ON, QC and PEI.