What the tax advantages folio says about life insurance

On Oct. 1, the Canada Revenue Agency (CRA) released its much-anticipated income tax folio explaining how the tax advantage rules will apply to RRSPs, RESPs, RRIFs, RDSPs and TFSAs.

In addition to detailing how the rules would apply to an array of aggressive tax planning, the folio also discussed how the CRA views life insurance and segregated funds.

“A registered plan might hold, or be structured as, an annuity contract,” the folio’s insurance section starts. “If that contract has a life insurance component, it is the CRA’s view that there is an advantage each year.”

It says later that “there is no advantage where the death benefit under the life insurance component is nominal, such as in a typical segregated fund annuity contract.”

That’s good news, says Kevin Wark, managing partner, Integrated Estate Solutions, and tax consultant with the Conference for Advanced Life Underwriting.

“They don’t consider the insurance component of a seg fund to be an advantage,” he says. “That would have been a shock and surprise to many.”

However, the folio specifically targets split-dollar or shared-ownership life insurance arrangements held within registered plans, saying they give rise to an advantage. These arrangements allow for a permanent insurance policy to have two owners: one party owns, and pays fair value for, the death benefit of a permanent policy, while the other owns the policy’s cash surrender value and contributes up to the exempt limit. The two parties are generally related (e.g., family members or corporate shareholders), and the arrangement works because “one party is looking for permanent insurance protection, and the other is looking for an investment vehicle,” says Wark.

Wark says it would be unusual for a registered plan to hold a split-dollar or shared ownership arrangement, adding that he and colleagues have not come across such scenarios.

“I’m not sure if [mentioning them specifically] was out of an abundance of caution on the part of CRA, or whether they have found some of these,” he says.

Nevertheless, if advisors have clients who are holding these arrangements within their registered plans, Wark says the clients may face additional taxes. He suspects the CRA would determine the amount of the advantage by looking “at the cost of insurance that would be charged if the arrangement was not put in place.”

Advantages are taxed at 100%, meaning if the CRA finds your client has received a $500 benefit, he will be taxed $500—negating the benefit altogether.

The folio also notes that the CRA will not approve a proposed registered plan if “it is clear from the terms of the [proposed] specimen plan that an advantage would arise.”

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.