4 – TAX STRATEGIES USING LIFE INSURANCE

4.1 Estate planning
4.2 Leveraging to make an investment
4.3 Using insurance products for long-term income
4.4 Charitable donations

4.1 Estate planning

At death, a person is deemed to have disposed of all assets at their fair market value.
This can trigger:

Capital gains tax
Income inclusion for registered plans
Potential probate and estate settlement costs

💡 For married or common-law couples, certain assets—especially RRSPs and RRIFs—can roll over tax-free to the surviving spouse, deferring taxation until the second death or withdrawal.

4.1.1 Capital gains

Life insurance is commonly used to fund the tax bill created by capital gains at death, especially when families want to keep assets such as:

Cottages
Family businesses
Investment properties
Corporate shares

🎯 Goal: Preserve the asset instead of forcing a sale to pay taxes.

Typical uses

Provide cash to pay capital gains on real estate
Fund buy-sell agreements among business owners
Equalize inheritances among children

🧠 Key idea
Without insurance, heirs may need to sell the asset just to pay the tax.

4.1.2 Income tax payable on the death of a registered plan owner

For individuals without a spouse, the full value of:

RRSP
RRIF

➡ becomes taxable income in the year of death

This can push the estate into the highest marginal tax bracket.

🚨 Risk

Large RRIF balances can create a major tax bill
Beneficiaries may receive far less than expected

💡 Strategy
Life insurance can:

Replace the taxes lost to CRA
Protect the intended inheritance
Provide immediate liquidity for the estate

Why this matters

Registered plans are often the largest asset
Tax can consume 40–50%+ depending on province
Insurance creates certainty and fairness among heirs

4.1.3 Estate taxes and probate fees

Estate taxes

Canada does not impose a formal “estate tax”
Taxes arise from:
- Deemed disposition of assets
- RRSP/RRIF income inclusion

⚠ Cross-border note

U.S. property may be subject to U.S. estate taxes
Professional tax and legal advice is essential in such cases

Probate fees

✔ Life insurance advantages

Death benefits with named beneficiaries bypass probate
Segregated funds and annuities with named beneficiaries also bypass probate
Proceeds go directly to beneficiaries

❌ Assets subject to probate

Mutual funds
Bank GICs
Estate-designated policies

👉 Result: Insurance can reduce:

Probate costs
Settlement delays
Creditor exposure

🧩 Practical Estate Planning Roles of Life Insurance

💰 Pay capital gains tax on cottages or investments
🏢 Fund shareholder buy-outs
🧾 Cover RRSP/RRIF tax at death
⚖ Create inheritance equalization
⏱ Provide instant estate liquidity
🛡 Avoid probate and protect privacy

🔎 Professional Insight

Life insurance is not just about income replacement—it is a core estate planning tool that:

Preserves family assets
Prevents forced liquidation
Ensures beneficiaries receive intended value
Simplifies estate administration

4.2 Leveraging to make an investment

Borrowing to invest—known as leveraging—is a strategy designed to:

Increase potential returns
Grow wealth faster than investing only personal capital
Use tax-deductible interest to improve after-tax results

⚠ However, leverage magnifies losses as well as gains.
The investor must repay the loan and interest even if the investment declines in value.

💼 Advisors must:

Follow insurer and dealer leverage guidelines
Assess client risk tolerance
Consider age, income stability, and investment horizon

4.2.1 Borrowing to contribute to a registered retirement savings plan (RRSP)

Many clients wish to maximize RRSP contributions but lack immediate cash.
A common approach:

Borrow funds before the contribution deadline
Make the RRSP deposit
Use the resulting tax refund to repay part of the loan
Repay the balance from regular income

❗ Key tax rule
➡ Interest on money borrowed to contribute to an RRSP is NOT deductible

🧭 This strategy relies on:

Discipline to repay quickly
Confidence that tax savings outweigh borrowing costs

4.2.2 Borrowing to buy a non-registered investment

Different rules apply when borrowing to invest outside registered plans.

✅ Interest IS deductible when:

The loan is used to earn investment income
The investment is non-registered
The purpose is to generate taxable income

📌 Québec limitation

Deduction is generally limited to income received during the year.

Margin accounts

Investment dealers often allow borrowing against portfolio equity.

Debt-to-equity ratios must stay within limits
Falling markets can trigger a margin call
Assets may be sold if the investor cannot add cash

Leveraging with segregated funds

Some investors borrow to purchase segregated funds.

✔ Potential advantages

Interest may be deductible
Growth can exceed borrowing cost
Insurance features (maturity & death guarantees)

⚠ Important cautions

Redemptions to pay interest reduce guarantees
Market downturns can erode equity
Strategy must be long-term

After-tax cost example

🧮 If:

Interest paid = $500
Marginal tax rate = 46%

Tax savings = 46% × $500 = $230
After-tax cost = $500 − $230 = $270

⚠ Risks of leverage

Leverage should be approached conservatively:

Markets move in cycles
Large declines have occurred historically
Higher interest rates reduce benefits
Investor must handle cash flow during downturns

🚨 Unsuitable when client:

Has limited income
Is near retirement
Cannot tolerate volatility
Lacks emergency liquidity

🧠 Advisor Responsibilities

Before recommending leverage, confirm:

Client understands full risk
Cash flow can service debt
Tax bracket supports deductibility
Time horizon is long-term
Strategy matches risk tolerance

✅ Key Takeaways

Leverage can enhance returns but increases risk
Interest is deductible only for non-registered investments
RRSP-related borrowing interest is not deductible
Segregated fund guarantees can be reduced by withdrawals
Suitability assessment is essential

4.3 Using insurance products for long-term income

Prescribed annuities provide a unique tax advantage:

Interest and original capital are spread equally over all payments
This lowers taxable income in early years
Creates predictable, stable cash flow

💡 When combined with life insurance, this strategy can:

Provide lifetime income
Protect capital for heirs
Reduce annual taxes compared with traditional fixed income

4.3.1 Insured annuity

Many retirees seek:

✔ Guaranteed income
✔ Protection of principal
✔ Estate preservation
✔ Minimal market risk

The usual choice is a GIC, but it has drawbacks:

Interest fully taxable
Lower after-tax income
No estate replacement feature

The insured annuity alternative

An insured annuity combines:

Prescribed life annuity – provides tax-advantaged income
Life insurance policy – replaces capital at death

🧩 Result:

Higher after-tax cash flow
Estate value preserved through insurance
Predictable lifetime income

How it works – practical illustration

🧾 Situation

Fred, age 70
$500,000 available
Wants safe income and to leave estate to children

Option 1 – GIC

Rate: 2.5%
Income: $12,500/year
👉 Fully taxable

Option 2 – Insured annuity

Term-100 insurance premium: $20,652
Prescribed annuity income: $38,440
Taxable portion: $1,562

🧮 Net result

Income after insurance cost:
➜ $17,788 ($38,440 − $20,652)
Taxable income:
➜ only $1,562 vs $12,500 with GIC

🎯 Benefits achieved

Higher spendable income
Minimal taxable portion
$500,000 insurance benefit for heirs

⚠ Key considerations

An insured annuity is powerful but not perfect:

Risks & limits

Interest rates may rise later
Strategy is long-term and irreversible
Requires medical insurability
Insurance premiums must remain affordable

Best suited for clients who:

Want guaranteed income
Are risk-averse
Desire estate preservation
Are in higher tax brackets

🧠 Advisor Insight

When evaluating this strategy, compare:

After-tax income vs GIC
Insurance cost sustainability
Client life expectancy
Estate objectives
Liquidity needs

✅ Takeaways

Prescribed annuities spread taxable income evenly
Insured annuity = income today + estate tomorrow
Often produces better after-tax results than GICs
Ideal for conservative retirees with estate goals

4.4 Charitable donations

Many registered charities—such as hospitals, universities, and foundations—accept life insurance–based donations as part of their fundraising strategies.
This approach allows donors to:

❤️ Support causes they care about
💰 Receive federal and provincial charitable donation tax credits
🏛 Leave a meaningful legacy without reducing current cash flow

Key tax rules (at a glance)

Federal charitable donation tax credit
- 15% on the first $200
- 33% on amounts above $200 (applies when income is in the top marginal bracket)
Provincial credits vary by province
Credits are non-refundable (reduce tax payable)
Total eligible donations are generally limited to 75% of net income
Year of death: limit increases to 100% of income
Unused credits may be carried back one year in the year of death

📌 Special notes:

First-time donors (after March 20, 2013) may receive an additional federal credit on the first $1,000 of donations
Québec residents may see reduced federal savings due to federal tax abatement

4.4.1 Assigning a new insurance policy to a charity

An individual may purchase a new life insurance policy and assign it to a registered charity.

🧾 How it works:

The charity becomes policyholder and beneficiary
The donor continues paying premiums
The charity issues a charitable donation receipt equal to the premium paid
Upon death, the charity receives the full insurance benefit

✅ Advantages:

Ongoing annual tax credits
Large future gift created from modest premiums
Simple and predictable structure

4.4.2 Assigning an existing policy to a charity

An existing life insurance policy can also be donated.

📌 Tax treatment:

Charity issues a receipt for the cash surrender value (CSV) or fair market value
Additional receipts may be issued for future premiums paid
If CSV exceeds adjusted cost base (ACB), the policy gain is taxable income in the year of donation

🧠 Planning tip:

This strategy works well for unneeded permanent policies
Tax impact should be reviewed before assignment

4.4.3 Naming a charity as beneficiary

A policyholder may name a registered charity as beneficiary only, without assigning ownership.

📌 Important consequences:

The charity does not own the policy
No receipts are issued for:
- Premiums paid
- Cash surrender value (CSV)
Upon death, the charity issues a donation receipt to the estate for the benefit received

⚠️ This method is often less tax-efficient than assigning ownership during life.

4.4.4 Donating a segregated fund contract

Special and highly favorable rules apply to donating segregated funds (and other publicly traded securities).

💡 Key advantage:

Capital gains inclusion rate is reduced to zero
Donor receives a donation receipt for full market value
No tax payable on accrued capital gains

🎯 Why this matters:

Creates a larger tax benefit than redeeming first and donating cash
Particularly effective for highly appreciated investments

4.4.5 Donation program tax shelters

Some promoters market donation programs promising:

❗ Unusually large tax credits
❗ Refunds exceeding the amount donated

🚨 Major caution:

The CRA consistently warns against these schemes
Donation receipts often overstate fair market value
Such donations are frequently disallowed, sometimes retroactively
Significant penalties have been imposed on promoters and participants

🛑 Best practice:

Avoid any arrangement where the donation receipt exceeds the true economic cost
Life insurance–based charitable strategies are legitimate, but mass-marketed tax shelters are not

✅ Key takeaways

Life insurance is a powerful tool for charitable giving and legacy planning
Assigning ownership to a charity is usually more tax-efficient than naming it as beneficiary
Segregated fund donations can eliminate capital gains tax entirely
Donation limits increase significantly in the year of death
Caution is essential when evaluating donation tax shelters