How to Take Advantage of New Rules For Life Insurance

By Mark Borkowski

The tax rules for life insurance changed on January 1, 2017. The previous regime was effect for over 34 years — from December 2, 1982. Generally, policies purchased before 2017 are grandfathered under the old rules. In this article, we review the changes and look at what you can do now. I recently conducted an interview with Canada’s best known Actuary and Life Insurance expert, Promod Sharma (PS), who is a well-known actuary and life insurance expert, working at Taxevity Insurance Advisory.

MB: The tax rules for life insurance don’t change often

PS: You’re right, Mark. Life insurance is known for stability. The industry pays lots of tax and is good at following the rules and interpreting them when there’s ambiguity.

MB: Why were the rules changed?

PS: The world has changed since 1982. Who had a personal computer? Who knew what a mutual fund was? Back in 1982, mortality tables weren’t even split between smokers and non smokers. People smoked in the office.

We weren’t using smartphones or the Internet. Technology has advanced. The public has become more sophisticated. Demands for guarantees and flexibility have grown. Insurance products became more innovative. Universal life insurance was invented. Term 100 with guaranteed level insurance costs was invented. Life insurance was used for tax-sheltered growth. The old rules couldn’t anticipate the changes. Life insurance began offering more tax advantages than Ottawa intended.

MB: What advantages?

PS: The basic advantage of life insurance is a tax-free death benefit. That’s major. The bigger advantages come with permanent cash value life insurance, mainly whole life and universal life. You get:

– Tax-sheltered growth
– Tax-free access via loans using the cash value as collateral. The death benefit repays the loan and interest. What’s left goes to your heirs tax-free.
– Tax deductions on a portion of the premium when life insurance is required as collateral for a qualifying loan
– Creditor protection when properly structured

You can’t all those advantages with TFSAs or RRSPs.

MB: Give us examples of the differences

PS: TFSAs and RRSPs have the same contribution limits for everyone. That’s considered fair. Life insurance provides much more flexibility. The maximum deposit varies year by year with your age and amount of coverage. Like your TFSA, you make contributions with your after-tax dollars but you’re allowed to invest much more. Like your RRSP, you’re allowed to take withdrawals but you’re not forced to do this.

If you’re incorporated, you’re allowed to put corporate dollars into your policy. RRSPs and TFSAs only allow personal income.

MB: What’s changed?

PS: There’s less room for tax-sheltered growth in some policies. That doesn’t affect many people. As with RRSP and TFSA limits, few Canadians were using the maximum room available.

MB: What’s the impact on small business owners?

PS: Small business owners and incorporated professionals lose the most. There’s a mechanism to access retained earnings from a private corporation tax-free. It’s called the Capital Dividend Account (CDA) and life insurance is one of the few ways to use it. The death benefit less the Adjusted Cost Basis (ACB) gets credited to the CDA.

Because we’re living longer, the mortality tables have been updated. The ACB now takes longer to drop to zero. That means that smaller capital dividends in the early years. Where a portion of the premium is tax deductible, the amount of the deduction is now lower.

MB: What hasn’t changed?

PS: The basics of life insurance remain the same. The death benefit is still tax-free. Creditor protection is available when properly structured. Tax-sheltered growth is still allowed.

MB: What can we do?

PS: There are three key things.

– Review the life insurance you already have: you may have options you’ve overlooked. For example, you might have a contractual right to invest in fixed interest investments that credit a guaranteed minimum of 4%. That’s attractive, especially when the growth is tax-sheltered. You may be able to convert term life into permanent life if you act in time. Your beneficiary designations may be out of date. You might find you have too much or too little protection.

– Understand how to benefit from the new rules: Life insurance still has tremendous tax advantages but the ideal products, companies and configurations have changed. Conscientious advisors need more time to test the options carefully before making recommendations.

– Take action: The life insurance industry has innovated in 2017. New products are easier to understand. Penalties like surrender charges have been reduced or dropped. Buying new life insurance is easier too. There’s less need to give blood or have a paramedical exam, depending on your age, health and coverage amount. There are convenient e-applications you can complete without meeting your advisor in person.

MB: What if your advisor didn’t tell you about the new rules in time?

PS: Advisors get paid much more for selling than servicing. If you weren’t told how to benefit from the old rules, it’s too late now. There may be other things your advisor didn’t tell you or do for you. Consider getting your insurance reviewed by someone with the skills and heart to help you.

MB: Is there any good news?

PS: On the plus side, there weren’t changes to the rules for disability insurance, critical illness insurance or long term care insurance. Those forms of protection are very important. You may have gaps in your coverage. Now is the best time to fill them.

MB: What happens going forward?

PS: Life goes on. The new tax rules aren’t as generous but life insurance remains valuable. There’s no other way to get a large, tax-free lump sum at a crucial time. There are still ways to get significant tax-sheltered growth under the new rules. Let’s hope the next changes aren’t until 2051.

Promod Sharma is an actuary at the Taxevity Insurance Advisory (http://taxevity.com). You can reach him by phone (416-938-3711), email (ps@taxevity.com)

Mark Borkowski is president of Mercantile Mergers & Acquisitions Corp. Mercantile is a mid-market M&A brokerage focused on selling private companies in Canada.

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