By Rosanna Palmieri, CEA
Financial Advisor & Certified Executor Advisor, Momentum Financial Services Inc.
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.
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:
|
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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.
