Capital Squared

The “Capital Squared Strategy” provides you with permanent coverage, and significantly reduces net cash flow.  This is achieved by applying key features of the policy that enable easy access to capital, and guaranteed/growing estate benefit and cash value.  The following is a detailed explanation of the strategy as it applies to your client’s situation, as well as highlights of the policy features.  Attached to this letter you will also find net cost and wind-up summaries for $5M of single life coverage.

KEY POLICY FEATURES

Capital Squared utilizes several benefits unique to whole life insurance, as well as tax savings that reduce the net cash flow for the coverage.  Some of these key whole life policy features include:

• Loan Option:  Contractual right to borrow money against the cash value of the policy.
• Cash Value:  Guaranteed cash value in addition to policy dividend growth.
• Death Benefit:  Guaranteed death benefit which grows over time based on policy dividends.
• Non-forfeiture Option:  Cash value can be used to fund premiums.
• Policy Dividends:  Based on mortality, interest and expenses of the participating fund.

The combination of these features allows for a strategy that is simple to implement and manage, and flexible based on your preferences throughout your lifetime.

CAPITAL SQUARED DESIGN

Capital Squared utilizes three of the aforementioned policy features (cash value, loan option, death benefit) to enhance overall net wealth and reduce the cost of funding annual premiums.  This strategy also enables borrowed funds to be tax-deductible within the scope of subsection 20(1)(c) of the Income Tax Act – Canada.

The Loan Option in the insurance contract allows for a policy owner to borrow money from the whole life policy to the extent that there is sufficient cash value to secure the loan (minus any interest in the year and any outstanding loans).  The loan does not have a specified repayment schedule and you may elect to pay none, a portion, or the whole loan at your discretion. At death, if the loan has not been repaid the outstanding principal and accrued interest (if any) is deducted from the payout to the beneficiaries.

This feature provides enhanced flexibility since it mitigates the risks and concerns of obtaining a third party loan.  In addition, a policy loan provides the following unique benefits:

• No loan application process, the loan is available upon acceptance of the policy.
• No credit approval process once the policy is in place.
• No additional collateral assignment required other than the policy itself.
• Market rate interest charges.
• Provided there is sufficient policy collateral security (i.e. cash value), interest need not be paid.
• The loan is not secured against any other asset. Should the borrower default on the loan, the lending institution cannot force payment, BUT may use the policy cash value to retire the accumulated loan.

Provided the borrowed funds are used by the corporation for an income earning purpose, the interest expense on the policy loan will be deductible against any such income.  Thus, the policy loan is being used not only to fund the annual premiums, but also to generate an additional source of income reducing the overall net cost of insurance coverage.

With a whole life policy, both the Cash Value and Death Benefit are initially guaranteed, and grow over the life of the policy based on the dividends declared from the participating fund[1].  The policy uses paid up additions which are a dividend option from the whole life participating fund[2] that buys additional insurance annually and at the same time increases the cash value. While dividends are not guaranteed, they have been paid since the inception of these policies. Once credited to the policy, dividends cannot be reduced or retracted, and accumulate in the policy on a tax-free basis. Thus, reducing investment risk in policy as  Capital Squared ensures that the policy collateral will never reduce.

As with any strategy involving leverage there are risks to consider.  Borrowing heavily against the cash value of the policy can create estate planning consequences that could significantly reduce the net benefit to the estate. The loan interest rate is set by the insurer and is subject to change[3].  In addition, a policy loan may result in a taxable capital gain should the loan exceed the adjusted cost basis of the policy at any point in time.