Building Insurance into Your Clients Estate Plan

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Building Insurance into Your Clients Estate Plan

• Kevin Wark, LLB, CFP

CIFPS Annual National Conference
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Case Study

• Your client, Ron is 65 years old
• Married to Lisa (62) second marriage
• Ron has two children, Mary (32) and Richard (27)
  both from first marriage
• Currently 2 grandchildren uncertain if there
  will be more in the future

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Case Study

• Ron started a manufacturing company 20 years ago,
  currently valued at 3 million and drawing
  salary/bonus of 200,000 per year
• Mary is involved in the business as VP Marketing
• Richard currently traveling in Europe
• Commercial property acquired for 400,000 in
  1996, currently valued at 600,000 rented to
  business for 40,000 pa. and has UCC of 200,000

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Case Study

• Rons other main assets consist of personal
  residence, 300,000 in RRSPs, 200,000 in
  shareholder loans
• Ron has personally guaranteed 1 million loan to
  business
• Ron is President of local hospital board
• Home (valued at 400,000) has no mortgage and no
  other major debts

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Rons Estate Objectives

• Ensure Lisa has income of at least 200,000 per
  year (before-tax) if he predeceases her
• Pass on business to daughter (Mary)
• Treat son (Richard) fairly on his death
• Minimize impact of taxes on his estate

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Rons Estate Objectives

• Provide gifts to grandchildren for post secondary
  education and other significant obligations
• Creditor protect his estate
• Large gift to the hospital on death

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Some Observations

• Value of estate assets (before tax) is
  approximately 4.5 million
• Taxes could reduce estate by approx. 20
  (900,000)
• Major asset (representing almost 75 of aggregate
  estate) going to daughter

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Conflicting Demands on the Estate Plan

• Ron wants major estate asset to go to the
  daughter impact on income to Lisa and ability
  to be fair to Richard
• Significant tax and other liabilities may impact
  viability of estate plan
• How to fund gifts to grandchildren and charity
  from estate??
• Family law implications

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Planning Idea 1 Collateral Insurance

• Corporation acquires 1 million term or permanent
  policy on Rons life
• Corporation assigns or hypothecates policy to
  bank as collateral for loan
• Corporation can deduct lesser of premium and net
  cost of pure insurance

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Planning Idea 1 Collateral Insurance

• Insurance proceeds would repay loan on Rons
  death and corporation would receive credit to its
  capital dividend account (CDA)
• CDA could be used to flow tax-free dividends to
  Lisa to provide required level of income (subject
  to availability of cash in the corporation) or
  convert to secured shareholder loan
• Removes significant liability from corporation
  and Rons estate

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Planning Idea 2 Creditor Protection/Capital
Growth

• Ron has significant wealth tied up in his
  business
• Ron also has 200,000 shareholder loan account
  subject to business risks
• Corporation could repay shareholder loan and
  replace with conventional bank debt
• Split dollar arrangement between corporation and
  Ron for 1 million exempt UL contract

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Planning Idea 2 Creditor Protection/Capital
Growth

• Under a split dollar arrangement the Corporation
  owns death benefit and pays term costs of policy
• Ron owns the cash value and funds with proceeds
  from the repaid shareholder loan
• Corporation assigns its interest to the bank and
  can deduct lesser of premium and net cost of
  insurance
• On Rons death the corporate debt is repaid by
  insurance proceeds and cash values flow to Lisa
  on tax-free basis outside of estate

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Planning Idea 2 Creditor Protection/Capital
Growth

• Corporation pays 31,000 per year for insurance
  coverage of 1 million
• Ron pays 24,000 per year for 10 years and owns
  tax-deferred cash values
• Assuming death at age 85, corporation receives 1
  million (full credit to CDA) and Rons estate
  receives over 700,000
• Represents a total return of 5.5 (after-tax) and
  10 (before-tax) on Rons deposits

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Planning Idea 3 Estate Freeze/ Buy-Sell with
Mary

• Ron converts common shares into two classes of
  shares redeemable for 500,000 and 2.5 million
  respectively (total of 3 million)
• As part of this transaction Ron also completes an
  estate freeze and increases cost base of first
  class of preference shares to 500,000
• Deferred tax liability on shares of approximately
  600,000
• New common shares issued to Mary

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Planning Idea 3 Estate Freeze/Buy-Sell with
Mary

• Buy-sell agreement between Ron, Lisa, Richard
  and Mary funded by corporate owned insurance
• Corporation acquires 3 million permanent
  insurance policy on Rons life
• Under Rons will 2.5 million low ACB shares are
  transferred to Lisa and 500,000 high ACB shares
  to Richard
• Lisas shares are redeemed by the Corporation
  no gain or loss on redemption as funded by
  capital dividend arising from insurance proceeds

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Planning Idea 3 Estate Freeze/Buy-Sell with
Mary

• Mary buys Richards shares for 500,000 with a
  promissory note
• Remainder of insurance proceeds flowed out to
  Mary to repay promissory note
• Lisa receives 2.5 million tax-free, Richard
  500,000 tax-free and Mary has all common shares
  (worth at least 3 million) with 500,000 ACB

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Planning Idea 4 - Estate Equalization

• Ron wants to ensure Richard and Mary are treated
  equitably on his death
• Mary will be sole owner of a corporation worth
  between 3-4 million
• Assume Richard has received 500,000 tax-free on
  sale of preferred shares to Mary
• Still significant disparity in values being
  received by children upon Rons death

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Planning Idea 4 Estate Equalization

• Simplest and most cost effective approach would
  be to purchase joint second to die insurance on
  lives of Ron and Lisa
• Make Richard beneficiary of policy
• On death of surviving parent Richard will receive
  a tax-free gift outside of the estate
• Cost of 500,000 UL policy - 6,600 p.a.

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Planning Idea 5 - Estate Equalization

• Another option would be for Ron to transfer the
  commercial property to his Corporation on a
  rollover basis
• Ron would take back redeemable preference shares
  with redemption value of 600,000 and ACB of
  200,000
• Mary would enter into agreement with Ron to
  purchase shares on Rons death

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Planning Idea 5 - Estate Equalization

• Mary would acquire a 600,000 policy on Rons
  life to fund purchase of shares
• Taxable gain in Rons estate on shares
• Rons will would provide for after-tax sale
  proceeds to flow to Richard
• Mary would own preference shares with full cost
  base

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Charitable Gifting

• Number of ways to cost effectively structure
  major gifts on death
• Can be funded through personal or corporate
  dollars
• Can structure to receive tax credit for premium
  payments or death benefit

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Planning Idea 6 Personal Charitable Gift while
Alive

• Ron could purchase 200,000 insurance policy and
  gift to the hospital
• Ron would be able to claim a tax credit for
  premiums paid on policy after transfer
• 10 Year Direction to hold would exclude gift from
  charitys disbursement quota

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Planning Idea 7 Personal Charitable Gift on
Death

• Ron acquires 200,000 insurance policy and
  designates hospital as beneficiary
• No charitable credit for premiums paid
• On Rons death estate can claim entire death
  benefit as charitable gift
• Gift bypasses estate and potential creditors
• Tax credit available to offset gains on death
  (i.e. from sale of preference shares to Mary)

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Planning Idea 8 Corporate Charitable Gift

• Rons Corporation could purchase 200,000 policy
  on his life
• On Rons death life insurance proceeds could be
  gifted to the hospital (cannot designate hospital
  as direct beneficiary)
• Corporation can claim deduction for donation
• Corporation also receives 200,000 credit to the
  capital dividend account tax free dividends

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Planning Idea 9 Gifts to Grandchildren

• Complicated by fact these are not natural
  grandchildren of Rons wife
• Ron will want to take steps to protect their
  inheritance
• Purchase insurance to provide gifts on death
• Could establish life insurance trusts to hold
  benefits for grandchildren
• Benefits include bypassing the estate and
  management of funds while grand children are
  minors

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Three years later

• Ron has incorporated a holding company, sold the
  operating business and invested after-tax
  proceeds in the holding company

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Planning Idea 10 Corporate Insured Annuities

• Objectives of Program
• Increase corporate investment yield and cash flow
• Increase value of estate by reducing taxes
• Facilitate distribution of corporate assets on
  tax effective basis

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Corporate Insured Annuities - Process

• Corporation applies for 4 million joint first to
  die UL on Ron and Lisas life
• Corporation liquidates 4 million of investments
  to purchase a life 0 annuity with payments to
  the first death of Ron and Lisa
• Corporation borrows 4 million to replace
  investment portfolio
• Corporation assigns both contracts to bank as
  security for loan and pays interest annually

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Corporate Insured Annuities Cash Flow

• Annuity payments used to
• Pay insurance premium (177,500 pa)
• Pay loan interest (340,000) _at_ 8.5
• Pay taxes on annuity (non-prescribed)
• 36,600 in year 1
• 80,600 in year 2 and declines
• every year thereafter

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Corporate Insured Annuities Cash Flow

• Corporate Income Taxes Reduced by
• Loan interest expense (340,000)
• NCPI deduction (146,000 in year 1 and increases
  to equal total premium in year 3)
• Loan is repaid with insurance proceeds on Rons
  death

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Corporate Insured Annuities Cash Flow in Year 1

• Inflow
  Outflow
• Annuity 367,000
• Insurance
  177,500
• Loan Interest
  340,000
• Tax on Annuity
  36,600
• Tax Savings 243,000
• Net Cash Flow 60,000
• Assuming 50 corporate rate

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Corporate Insured Annuities Cash Flow in Year 2

• Inflow Outflow
• Annuity 367,000
• Insurance
  177,500
• Loan Interest
  340,000
• Tax on Annuity
  80,600
• Tax Savings 259,000
• Net Cash flow 30,000
• Assuming 50 corporate tax rate

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Corporate Insured Annuities Impact while Ron is
Alive

• No reduction in corporate investments (except for
  any tax payable on disposition)
• Loan fully secured (other security may be
  required)
• Positive cash flow as a result of tax deductions

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Corporate Insured Annuities Tax consequences on
Death

• Corporate shares deemed disposed of at FMV
  insured annuity has no value for tax purposes
• Corporate value reduced by bank loan of 4
  million (tax savings of up to 1 million)
• CDA credit of 4 million less ACB of policy
  (allowing corporate investments to be extracted
  on tax-free basis)

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Corporate Insured Annuity - Risks

• Liquidation of corporate assets may have tax
  consequence and/or penalties for early
  termination
• Interest rate fluctuations borrowing rates may
  rise but annuity rates are fixed
• No commutation value for annuity
• Separate insurers should be used for life
  insurance and annuity contracts

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Corporate Insured Annuities - Risks

• General anti-avoidance rule (has value of company
  really been reduced?)
• Interest deductibility (new REOP proposals
  requires annual testing)
• Financial strength of insurance companies backing
  the arrangement

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Other Planning Tips

• Joint second to die insurance if Ron is
  substandard/uninsurable or for corporate back to
  back scenario
• Use of holding companies for corporate-owned
  insurance (creditor proofing, avoids transfer on
  sale of operating business, valuation issues)
• Having other family members or business partners
  share in costs of insurance

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Discussion