Cascading Insurance

The Rules

The cascading insurance strategy takes advantage of subsection 148(8) of Canadian tax law, which will allow you to transfer ownership of a life insurance policy to any of your children, free of tax, where a child of yours is the life that is insured under the policy – a child includes any natural or adopted child, grandchild, step-child, or a son-or daughter-in-law.

On the surface, the idea may seem crazy.  Meaning, who’s going to buy insurance on the life of a child?  Canadians who would like to pass assets to the next generation completely free of tax and probate, and then to subsequent generations in the same manner – hence the cascading effect – should consider the strategy.

The Strategy

The cascading strategy takes advantage of the fact that it’s possible to invest money inside a universal life insurance policy on a tax-sheltered basis, and that the death benefit, along with the accumulated investments in the policy, are all paid out tax-free to the beneficiaries when the insured dies.  The best way to understand cascading is to walk through an example:

Ruth is 70.  She has $200,000 of non-registered money that she doesn’t need to meet her costs of living.  She wants to minimize her tax hit on the income from the money annually.  In addition, she wants to shelter the money from tax and probate fees when she passes it to her daughter Allison, who is age 35, and ultimately to her grandson Mark, Allison’s son, who is a minor.
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Ruth purchased a Universal Life insurance policy and put the $200,000 into the policy over a five year period.  She named her daughter Allison as the contingent owner.  The insurance is placed on Allison’s life and Mark is the beneficiary.

When Ruth dies, Allison will become the owner – she will then own the accumulated investments inside the policy.  The policy will pass to Allison free of probate and tax.

What are Allison’s options?  She could make withdrawals from the accumulating investments in the policy (a taxable event), borrow money using the investments in the policy as collateral (providing her with tax-free cash flow), or she could reserve the whole policy for her son Mark.  (he will receive the insurance proceeds free of probate and tax upon her death).

The Bottom Line

A cascading life insurance strategy allows you to accomplish a few things, including:  Transferring of money to the next generation without giving up control during your lifetime, eliminating current taxes in your hands on the money invested in the policy, eliminating probate fees on the assets in the policy, and providing you with access to the funds in the policy if needed.