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How to Maximize Intergenerational Wealth

October 12, 2022

By Rosanna Palmieri, Partner at Momentum Financial Services Inc.

 

The Challenge

When my husband and I were planning our retirement from our manufacturing business several years ago, we were looking for ways that would protect our hard-earned wealth from taxes while also providing financial security for our adult children and grandchildren. So, we started reviewing options that we could use that not only achieved tax-efficient wealth transfer but also bolstered our own financial needs in retirement. Spoiler alert: I ended up pivoting into wealth planning and management, joining Momentum Financial. I still haven’t set that retirement date, but my husband and I did find a strategy to meet our intergenerational wealth challenge.

At Momentum Financial, we found that a number of clients are looking to achieve the same thing that my husband and I were: financial security for their younger generations throughout their life.    Parents and grandparents are looking for strategies to accumulate wealth on a tax-deferred basis, and then transfer it without tax consequence to their child or grandchild as a gift to use throughout their lifetime.

With one of the most complex and rigorous tax regimes in the world, Canadians have limited options for achieving tax-efficient wealth transfer. Obvious solutions of gifting money or setting up joint accounts come with their own challenges: ‘Kiddie’ taxes, income attribution rules on investment income, premature loss of control, and exposure to the child’s own liabilities or relationship breakdowns, often make these options not the ideal strategy.

 

The Solution

The transfer of wealth through a tax-exempt permanent life insurance policy is one option that we’ve used with our families as well as recommended to our clients over the years, having been used by affluent families for decades. There are many different variations that can be tailored to a family’s cashflow needs and estate goals.

In this arrangement, a “child” is defined as the adults’ child, grandchild, son or daughter-in-law, their spouse’s child from a previous marriage, their adopted child, or their child from a common-law relationship.  The term “child” is not restricted to a particular age. 

 

How it Works

The parent/grandparent (owner) purchases a tax-exempt permanent life insurance policy on the life of the child and contributes to it for typically ten to twenty years (this can be shorter or longer, depending on the policy set up).  The policy grows and is transferred to the child’s ownership at no cost.  The child then becomes the new policy owner without any immediate tax consequences.

 

The Benefits

•         The transferred insurance policy does not become part of the child’s family assets if properly structured and therefore typically not at risk in case of a child’s marital breakdown or insolvency
•         Any funds withdrawn from the policy, after it transfers to the child, is taxed in the child’s hands (not the parent/grandparent)
•        The parent/grandparent can retain some control of the policy after the transfer, if the policy is structured correctly
•        The policy can be used as collateral for borrowing against
•         A trusted individual can control use of the funds
•        Avoids probate fees and maintains privacy of parent/grandparent
•        By keeping the policy in force, the child will avoid possible insurability issues as they get older

 

Case Study

Grandparents buy their 4 year old grandchild Madeline a birthday gift of a permanent life insurance policy, investing $5,000.00 per year for 10 years.  Alternatively, Madeline’s grandparents could invest the same amount of money in a non-registered account, and either liquidate the holdings and gift the proceeds or pass them along at death.  Here’s how the strategies compare:

	Non-registered Investment	Permanent Life Insurance
Total Invested	$50,000.00	$50,000.00
Assumed Rate of Return	6.00%	6.00%
Value in 10th Year	$62,043	Death Benefit: $451,929 Cash Value: $27,634
Value at Child’s Age 30	$117,778	Death Benefit: $599,040 Cash Value: $100,817
Value at Child’s Age 50	$279,208	Death Benefit: $1,154,292 Cash Value: $368,467
Value at Child’s Age 65	$555,640	Death Benefit: $1,624,726 Cash Value: $813,492
Value at Death (age 95)	$2,409,445	Death Benefit: $3,115,691 Cash Value: $2,865,618
Other Considerations
Annual Growth Taxable	Yes - Interest, dividends and realized capital gains	No
Creditor Protected	No	Yes – if set up properly
Subject to Net Family Asset Calculation in Divorce	Yes – if jointly held with child	No
Subject to Income Attribution	Yes	No
Taxes when transferred during lifetime	Yes	No
Taxed at Death	Yes	No
Probate Fees at Death	Yes	No
Notes:           Non-registered investment returns assumed to be comprised of 25% dividend income, 25% interest income, 25% unrealized capital gains and 25% realized capital gains. Assumed marginal tax rate of owner is 50%, based in Ontario.           Participating insurance figures from Equitable Life policy illustration with current dividend policy rate. Cash values and death benefit values are non-guaranteed figures.

 

What can Madeline do with her policy once it has been gifted to her? There are several options for her accessing the value while it remains in force during her lifetime. By borrowing from the policy or collatorilising a portion of the death benefit, Madeline can use it for anything, whether for a down payment on a home, helping one of her children with post-secondary tuition, or supplementing her own retirement income.

As with all financial planning matters, every family’s needs are different, and there is no one-size-fits-all solution. This strategy and others should be reviewed with a qualified financial professional to ensure it meets your needs.