Rest in peace, 10/8

The 2013 Budget has killed the 10/8 arrangement, and people who invested in these insurance strategies will need to unwind them before 2014 and readjust their plans.

These arrangements essentially let investors borrow money from their insurance companies at 10% to purchase policies guaranteed to pay 8%. Since the loan was considered investment-related, the after-tax cost of borrowing fell to 5.5% and the policyholder netted a 2.5% return.

My associate George Weinberger and I were concerned about the structural and tax features of such plans. It worried us that some advisors used them indiscriminately without explaining some of the inherent risks.

And, even though the plans were widely promoted, we advised our clients not to get involved. Although the technical basics seemed sound, we were worried that the CRA would attack the arrangements.

Turns out we were prescient about the pitfalls—and the challenges that would emerge when trying to unwind them. Further, the insurance industry has known for some time that the strategy was under scrutiny.

How to get out of 10/8s

If clients don’t have the capital to wind up their loans, they’ll have to withdraw the funds from the cash values of the policies. CRA will allow this until January 1, 2014 without tax consequence by not deeming the cash withdrawn as part of their incomes.

Insurance expert Byren Innes says cash values can generally be accessed three ways. Clients can:

• Cancel their policies and collect the proceeds after all costs are deducted.

• Make withdrawals based on what’s accrued in their accounts.

• Take out policy loans.

Cash value withdrawals come at a cost, however, and are only permitted under universal and whole life policies. Clients will have to lower their death benefits or raise their premiums to keep the same benefits levels.

Under the proposed Budget provisions, for taxation years ending on or after March 21, 2013, the new measures will deny the following benefits of a 10/8 type program:

• The deductibility of interest paid, or payable, on any borrowing that relates to a period after 2013;
• The collateral insurance deduction that might’ve been available for premiums under the policy for periods after 2013; and
• Any increase in the capital dividend account by the amount of death benefit that becomes payable after 2013 under the policy and that is associated with the borrowing.

These changes eliminate the strategic advantages of 10/8s. There are no grandfathering rules for existing arrangements. But in order not to punish those who invested in the strategy, the Budget provides an escape by alleviating the income tax on those unwinding the program before January 1, 2014.

In its parting words, the Finance Department left a warning for advisors. If new structures are created by financial professionals in an effort to undermine the new measures, they will consider future action, and may apply that action retroactively. The government’s attack on the 10/8 serves as a reminder to aggressive advisors and clients alike. If the plan sounds too good to be true, it’s probably not going to last.

There are provisions within the Income Tax Act that allow clients to plan for future needs in a tax efficient manner. So don’t risk getting clients into situations that might be difficult, or costly, to unwind.

Warning

Budget 2013 eliminates the strategic advantages of 10/8s