Top 5 ways wealthy Canadians use insurance

Canadians are painfully aware that taxes are a necessity, but you shouldn’t pay a penny more than what’s legally required.

Successful and high-income Canadians need to know that many taxes and related expenses—whether on investment income, capital gains, or on death—can be legally minimized or eliminated entirely with proper planning.

Insurance can be the most versatile and reliable financial product in your entire portfolio, but many readers don’t know how to use it to preserve their hard-earned money and achieve desirable tax outcomes. Nor do they know that it’s available to everyone.

Life insurance, which enjoys special treatment under our Income Tax Act, can be used to reduce or eliminate your taxes and leave more tax-free funds to your family and the causes you care about.

Here are 5 ways to use insurance products to your benefit:

1. Life insurance as an alternative investment

If you are like every person we meet, you want to leave as much as possible to your family (and hopefully your favourite charities) and as little as possible—ideally nothing—to the government.  Canadians who die without a spouse or financially dependent child or grandchild, unwittingly leave the government up to 54 per cent (in Ontario) of the value of their registered retirement savings plans and registered retirement income funds.

A further tax of 26 per cent is levied on the growth of your non-registered holdings like stock portfolios, investment real estate and private business equity. And there are still estate costs that must be paid. Life insurance can mitigate those losses and preserve your estate for your beneficiaries.

2. Estate preservation

The main goal of estate preservation is to minimize the tax burden at death. To do this properly, you need to develop a robust financial plan with an experienced financial advisor who will ask you, among other things, what you want to do in retirement and where you want your money to go after you die. Now that people are living longer, you may be retired for several decades.

If you own shares in a private holding company or investment corporation, proper planning now can reduce or eliminate the double taxation that will result from the deemed disposition of the shares at death and the tax liability on the final distribution of the assets out of the corporation.

3. Wealth transfer

While many people believe they can only buy life insurance for themselves or as part of a joint last-to-die policy, it’s also possible to transfer wealth by buying a life insurance policy on a child or grandchild.

As the owner of the policy, you pay the premiums and create a tax-exempt cash value within the policy. When the policy is transferred to the child in the future, there’s no taxable disposition, as it will qualify as a tax-free rollover, and the child will have access to the cash value.

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If you transfer the policy to the child once he or she is 18 and there is a policy gain, that income is attributed to the child, not you. The ‘wealth cascade’ strategy is particularly appropriate for grandparents.

4. Immediate financing arrangements (IFA)

A leveraging strategy can allow you to acquire the life insurance you need for estate planning and investment without tying up your own money to pay the premiums. You can enjoy all the tax benefits of ownership and vastly increase the value of your estate while your own money continues working for you in your investment portfolio, business, real estate or elsewhere.

IFA policyholders pay only the interest cost on the borrowed premiums for a permanent or whole life insurance policy. The loan gets paid off from the ultimate death benefit payout.

Along the way, all the interest paid is tax-deductible and the tax savings can be used to reduce the outstanding balance on the line of credit. The after-tax interest cost on premiums for a $100,000 insurance policy is usually just a few thousand dollars in the current rate environment.

5. Charitable planned giving

You probably have favourite charities near and dear to your heart, whether it’s an organization devoted to an illness that afflicted a family member or a school that helped you get to where you are today.

As a parent, grandparent, or great-grandparent, you can use a strategy that will provide ongoing giving through an endowment in the form of an irrevocable gift to either a private foundation or a donor-advised fund (DAF) within a public foundation.

A DAF requires that a board of directors be set up to distribute the funds. Often, adult children or grandchildren join the board to keep the family name alive and aligned with a specific cause.

Funding a charity using life insurance is the most cost-effective and tax-effective way to give. Proceeds are usually many times greater than the premiums paid, and you will be remembered for leaving a large charitable gift, and not for leaving a pile of money for the tax department.

It’s also a great way to instil a love of philanthropy in your family, especially by involving young family members in the process.