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Life Insurance as an Estate Strategy

Written by Jack Rotsztain

Life insurance is an often overlooked but powerful tool to consider in one’s estate planning. The utility of life insurance is not limited to helping surviving family members pay for funeral and related expenses, but life insurance can also be used strategically to attain certain financial objectives. Two important outcomes that can be achieved through the strategic use of life insurance are liquidity and estate maximization.

Life Insurance Creates Liquidity

If the estate is the named beneficiary of a life insurance policy, then the proceeds paid to the estate will be subject to probate taxes just like any other asset of the estate and will not be accessible until probate has been obtained; however, if a third party is named as beneficiary, then the proceeds paid to the benficiary will bypass the estate and will not be subject to such taxes or tied up in the probate process, which can be lengthy.

The availability of liquid funds and quick access to cash after the death of a loved one can be crucial for the family to pay after-death expenses, and even more so if most of the assets of the estate are tied up in a business or real estate holdings. Tax laws in Canada stipulate that there is a deemed disposition of capital assets, stocks, and bonds upon the death of an individual subject to certain exceptions (for example, inheritance by a spouse). This means that such property owned by the deceased will be subject to capital gains tax or income tax. Having access to cash can allow the family of the deceased to meet this tax burden without having to sell off property to create funds.

The liquidity created by proceeds of life insurance can also be used strategically for business succession plans. Buy-sell agreements among shareholders or business partners are triggered upon the death of one of the shareholders or partners and can be financed through the proceeds of life insurance. Holding a life insurance policy can provide the surviving parties with the cash to redeem the deceased party’s interest in the business from the decedent’s family.

There may also be a scenario where an individual would like to pass on his business only to a child who is actively engaged in the business. If the business comprises the majority of the value of the estate, the remaining children may feel as though they have been treated unfairly. The individual may consider obtaining a life insurance policy in order to financially equalize all the children.

Life insurance proceeds do not only create liquidity for the beneficiaries, but life insurance policies can maintain a certain amount of liquidity for the policyholder as well. Some insurance policies have a cash surrender value, which is the amount of money the insurance company will pay the policyholder if the contract of insurance is voluntarily terminated before death occurs. The cash surrender value is available to the policyholder during his lifetime, and depending on the policy, policyholders may be able to borrow money from the policy or pledge the policy as collateral to borrow money from a bank.

Life Insurance Can Maximize One’s Estate

Another financial objctive which can be obtained by strategic use of life insurance is estate maximization. Maximizing one’s estate involves ensuring that one’s intentions are carried out in the most efficient manner. One common intention is to leave as much money and assets as possible to one’s heirs. This can be accomplished in part by taking advantage of the positive tax implications of life insurance policies.

The first way that life insurance policies maximize one’s estate is accomplished by bypassing the estate and avoiding probate. As previously mentioned, if the estate is named as beneficiary, then the proceeds of the policy are subject to probate, but if a third party or parties are named as beneficiaries, probate taxes are not payable.

Secondly, a beneficiary is not required to pay income tax on the proceeds of a life insurance policy. Because of this, and because permanent life insurance policies have a savings component which, pursuant to the Income Tax Act, allows financial resources to grow in a tax-sheltered environment, the long-term value created by holding such a policy can be significantly greater than value created through regular investing. This represents an opportunity to diversivy one’s portfolio to include tax-exempt life insurance as an asset allocation strategy.

Tax strategies utilizing life insurance can also be implemented through one’s privately held company as well. One way to do this is for the corporation to purchase a life insurance policy on the life of the owner and name the corporation as beneficiary. Upon death, the proceeds will be paid into the corporation’s capital dividend account and can subsequently be declared as tax-free dividends to shareholders who are beneficiaries of an estate.

Devising the Proper Plan

Using life insurance strategically as an estate planning tool can be very effective for the right person, especially for those people who earn more income than they need or use. Nevertheless, careful planning is necessary in order to determine the best way to execute this strategy. In addition to his own financial position and estate maximization, one needs to be mindful of how the proceeds will be distrubuted to his loved ones or favourite charities. Is it best to name a beneficiary on the insurance policy or use an insurance trust to distribute proceeds? Should a policy be purchased in one’s own name or through a corporation? These, along with other intricacies, should be addressed by seeking advice from a lawyer and financial planner when creating an estate plan.

Jack Rotsztain

Barrister & Solicitor at Kronis, Rotsztain, Margles, Cappel LLP

Practising under Rotsztain Law Professional Corporation

25 Sheppard Avenue West, Suite 1100

Toronto, Ontario

M2N 6S6

Tel: (416) 225-8750

Fax: (416) 225-7214

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