Share wealth without the tax burden

Life insurance can be an effective way to transfer wealth from one generation to another. Here are some strategies to help affluent clients provide for their family members’ financial future, while allowing flexibility to meet unforeseen circumstances.

Option 1: Client insures own life. Grandchildren are named beneficiaries.

John Armstrong, Vice President of Armstrong & Quaile, says the advisor must understand the client’s intention. “If they are only trying to fund the grandchildren’s post-secondary education, a RESP can accomplish the same goal.”

Pros: When a beneficiary is named on an insurance policy, payout is immediate upon death of the insured, avoiding the delay and cost of probate. Rona Birenbaum, CFP, of Caring for Clients adds “a wealth transfer can occur without other family members or the public knowing. Designations in a will become public when the will is probated.”

Cons: Client must be insurable. If the beneficiary has not reached the provincial age of majority when the insured dies, the proceeds may be paid into a trust rather than directly to the beneficiary – that may not be what the client intends.

Option 2: Client invests in segregated funds with a named beneficiary.

Armstrong says using the beneficiary designation on segregated funds provides a good solution for wealth accumulation to pass on to the family.

Pros: If a segregated fund contract has a family class beneficiary, the funds may be exempt from seizure from creditors.

Cons: Investment growth is taxed to the owner annually, unless the plan is a registered investment. Individual Variable Insurance Contracts (IVIC) vary widely in terms of maturity and death benefit guarantee amounts, and clients may not understand what they are buying.

Option 3: Client takes out life insurance on each child with grandchildren as beneficiaries. Child is the measuring life and client is the owner of the policy.

Birenbaum suggests a client purchase a Universal Life (UL) Insurance Policy that they overfund to build up the cash value. “The parent can maintain control of the plan for as long as they feel it necessary and transfer it to the child when they are confident of their ability to handle the money.”

Rob Salvucci, Director of Insurance and Estate Planning at The Williamson Group, advises purchasing the paid-up policy with funds that won’t be required for future living expenses or estate costs. “Clients think they’re okay, unexpected illness hits and they need the money back. Cashing in the policy can incur surrender charges, unexpected tax implications and family ill-will.”

Pros: Owner can transfer ownership and change the beneficiary at any time. The client can name the children as successor owner so that the policy changes ownership only at the death of the client.

Salvucci advises naming an irrevocable beneficiary if the client has concerns about the fate of the policy after a transfer of ownership. The beneficiary would have to approve any change of ownership or attempts to withdraw cash from the policy. However, the beneficiary must be old enough to have contractual capacity (usually, beyond the age of majority).

Cons: The new owner has full control of the policy; he could cash it in, change the beneficiary or take out a policy loan. The successor owner may not have the ability or the desire to pay the premium. The cash value of the policy may be used to fund the premium, but if that is insufficient, the policy may lapse.

If a successor owner has not reached the required age of majority, he does not have contractual capacity and cannot take ownership of the policy.

To meet the requirements of tax-free rollover under section 148 (8) of the Income Tax Act, a successor owner cannot be designated in the client’s will. A policy with a successor owner named in the will rather than the policy will pass to the estate first, and will be considered a taxable disposition.

Option 4: Client buys life insurance on children with grandchildren as named beneficiaries. Client pays premium initially, and then transfers ownership to the children. The client then purchases an annuity to fund the premium.

Pros: Subsequent owner of policy does not have to fund premium.

Cons: If client dies before annuity is put in place, anticipated funding of the premium will not occur.

Calculating the amount of the annuity to fund the premium indefinitely would be a challenge. If the term of the annuity is insufficient, the owner will have to assume the premium payments, the policy’s cash value will be depleted paying the premium, or the policy will lapse.

When structured and funded properly, life insurance policies can be an effective financial strategy for intergenerational wealth transfer.