Tips and Traps

1. Tips and Traps

2. Some important considerations … • This material is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. • All comments related to taxation are general in nature and are based on current Canadian tax legislation for Canadian residents, which is subject to change. Persons who are not residents in Canada or who are resident in Canada but are citizens of another country, may be subject to different tax rules in Canada and may also be subject to taxes levied by jurisdictions other than Canada. • For individual circumstances, consult with legal or tax professionals. • This information is current as of September 27, 2005.

3. Have you ever wondered … • Why clients ask their CA for advice on insurance and other financial products? • Gatekeeper • Financial “quarterback” • Comprehensive knowledge of affairs • Trustworthy • Unbiased • CA knows everything (including life insurance!?)

4. Have you ever wondered … • What does the CA do in a particular case? • Reviews proposal • Analyzes illustrations/projections for reasonableness • Identifies obvious errors / omissions • Considers alternative solutions • Gives their opinion (formal or informal) on whether the proposal is appropriate given the client’s specific circumstances

5. Have you ever wondered … • What happens if the CA catches an error? • By its nature, advice can turns out to be (or be perceived to be) misleading, inaccurate, or incomplete (especially tax advice!) • CA will report the error to the client • This may impact your credibility • This may impact the sale • Worst case, the client asks the CA for a referral!

6. Have you ever wondered … • How to best protect yourself (from yourself)? • Become a CA, too?? • Errors & omissions insurance?? • Continuing professional development • Keep up on your reading • Attend courses / seminars / conferences • Participate in a study group • Develop CAs as centres (and sources of information) • Listen to me for the next hour or so

7. Tips and Traps Top 10 Errors In The Insurance Marketplace

8. # 1 Premium Deductibility

9. Insurance planning errors # 1 • Life insurance premiums are tax deductible if the policy is corporate-owned! • Generally life insurance premiums are not deductible • Exception: collateral insurance – paragraph 20(1)(e.2) • Assigned to a financial institution as collateral for loan • Interest on the loan is deductible • Assignment is a requirement of the institution • Borrower is also the policyowner • Deduction limited to lesser of premiums payable and NCPI (net cost of pure insurance)

10. # 2 Premium Deductibility

11. Insurance planning errors # 2 • Premiums paid for “grouped” individual DI / CI coverage are tax deductible by the corporation! • When one or more shareholders are included in the plan, must consider in what capacity the shareholder receives the coverage … Employee or Shareholder • If coverage on shareholder consistent with coverage on other employees, premiums should be deductible • If premiums not deductible – result is BAD – no deduction for corporation but taxable benefit to shareholder

12. # 3 Ownership Transfers

13. Insurance planning errors # 3 • There are no tax implications when a life insurance policy is transferred to a shareholder or executive from the corporation! • A transfer is a disposition for tax purposes • Transferor (corporation) deemed to receive proceeds equal to the “value” of the policy - value usually = CSV • If CSV > policy ACB, result is a policy gain • Policy gain fully included in income • And the transferee (shareholder or executive) is taxed on greater of CSV and FMV of policy, less payments

14. Insurance planning errors # 3 • Example: • A corporation owns an permanent policy on a business owner • The business owner plans to sell the business and wants to transfer the policy from the corporation to him/herself • At the time of the transfer … • AV = $250,000 • CSV = $150,000 • ACB = $100,000 • What are the tax implications?

15. Insurance planning errors # 3 • Example: • Answer: • To the transferor (corporation) • Deemed disposition under subsection 148(7) of ITA • Proceeds of disposition = $150,000 (CSV) • Policy ACB = $100,000 • Policy gain = CSV – ACB = $ 50,000 • Policy gain is T5 income • Policy gain is not a capital gain

16. Insurance planning errors # 3 • Example: • Answer: • To the transferee (shareholder) • Deemed acquisition under subsection 148(7) of ITA • New policy ACB = CSV = $150,000 • Shareholder benefit = CSV = $150,000 • Shareholder benefit reduced by any amount paid by the shareholder • However, additional shareholder benefit if FMV > CSV • So, what is the FMV of an insurance policy??

17. # 4 Beneficiary Designations

18. Insurance planning errors # 4 • Of course you can name your spouse as beneficiary on this corporate-owned policy! • Life insurance premiums are not tax deductible • Usually advantageous having corporation pay insurance premiums with its low-tax dollars • However, if a family member is named beneficiary under a corporate-owned policy – result is BAD – no deduction to corporation but is taxable benefit to shareholder • Avoid by naming corporation as the beneficiary

19. # 5 Principal Residence Exemption

20. Insurance planning errors # 5 • You can always claim the principal residence exemption on your cottage! • Taxpayers can only designate one property as their principal residence for a particular tax year • For taxation years after 1981, only one property per family unit can be designated as a principal residence • If husband and wife own a house and a cottage, one of the properties may have a taxable capital gain on disposition

21. # 6 Beneficiary Designations

22. Insurance planning errors # 6 • You should always name a beneficiary on your RRSP to avoid probate fees! • Usually true, but consider this example: • Taxpayer is widowed and has the following assets: • RRIF: $300,000 • GICs: $300,000 • Taxpayer designates Son as beneficiary of the RRIF and leaves the GIC to Daughter through the Will • The result: Son gets the $300,000 from RRIF, Daughter gets $300,000 from GIC LESS tax on the RRIF • Oops!

23. # 7 Tax-Free Rollovers

24. Insurance planning errors # 7 • You can transfer this policy to your son tax-free! • Tax-free rollover is available for transfers between spouses and between a policyowner and a child of the policyowner, but only if a child of the policyowner or the transferee is the life insured • Otherwise, the transfer is treated as a disposition to a non-arm’s length party (not a tax-free rollover!)

25. # 8 Taxation of Policy Gains

26. Insurance planning errors # 8 • A capital gain is only 50% taxable, and a policy gain on a disposition of your life insurance policy is treated the same way! • A policy gain is reported on a T5 and is fully included in income in the year it is reported • A policy gain may occur in the event of: • Policy loan (loan exceeds policy ACB) • Partial or full surrenders (if accrued policy gain) • Transfers of ownership (other than tax-free rollovers)

27. # 9 Capital Dividend Account

28. Insurance planning errors # 9 • Proceeds from a corporate-owned life insurance policy pass through the corporation to your heirs tax-free! • Insurance proceeds received by a private corporation on the death of the life insured are credited to the capital dividend account (CDA) only to the extent the proceeds exceed the policy ACB immediately before death • The corporation can distribute tax-free capital dividends to its shareholders to the extent of the balance in the CDA

29. # 10 Projections

30. Insurance planning errors # 10 • Your capital gains tax liability will grow at 10% per year to be at least $12,000,000 at life expectancy!

31. Tips and Traps Top 10 Opportunities Using Exempt Insurance

32. # 10 Risk Management

33. WEALTH PROTECTION Insurance planning opportunity # 10 • Financial planning • Planning Pyramid • Investment management • Education • Retirement • Estate • Risk management • Contingency fund • Insurance (life, health, DI, CI, home, auto) • Wills, POAs

34. Insurance planning opportunity # 10 • Financial planning • Insurance to fund basic estate liquidity needs • For example … • Final expenses • Estate administration • Debt repayment • Professional fees • Income continuation • Matrimonial obligations • Charitable bequests • Education trusts

35. Insurance planning opportunity # 10 • Financial planning • Insurance to fund basic estate liquidity needs • What to look for … • Married couple or single parent with dependent children • Have not yet achieved financial independence

36. # 9 Funding Business Needs

37. Insurance planning opportunity # 9 • Business planning • Business owners often have a significant amount of their net worth tied up in their business • The death of a business owner or key executive can impair the value of the business and create financial hardship for the deceased’s family and the surviving shareholders

38. Insurance planning opportunity # 9 • Business planning • Protect the business against the loss of an owner or key executive with insurance • For example … • Funding shareholder agreements • Keyperson insurance protection • Collateral insurance

39. Insurance planning opportunity # 9 • Business planning • Protect the business against the loss of an owner or key executive with insurance • What to look for … • Businesses with more than one shareholder • Businesses with loans • Owners or other key executives whose death would have a significant financial impact on the business • Needs may differ at different stages in business life cycle

40. # 8 Funding Family Business Succession

41. Insurance planning opportunity # 8 • Business planning • Over 75% of current family businesses will have to deal with a change in leadership over next 15 years • Only one-third of family businesses survive the transition to the 2nd generation primarily because of a lack of planning, no qualified successors, and a lack of liquidity

42. Insurance planning opportunity # 8 • Business planning • Facilitate family business succession plans with insurance • For example … • Fund capital gains taxes on the parent’s shares • Fund a redemption of the parent’s shares • Equalize the estate amongst the heirs

43. Insurance planning opportunity # 8 • Business planning • Facilitate family business succession plans with insurance • What to look for … • Successful family-owned businesses • Business owner within 1 - 5 years of planned retirement • Business owner has a desire for an orderly transition

44. # 7 Creating Tax Advantages

45. Insurance planning opportunity # 7 • Tax planning • Life insurance is a unique financial instrument • It is possible to split the ownership of a universal life policy into the pure death benefit and the fund account • The growth in fund account values is tax-advantaged Owner A Account Value Owner B Death Benefit

46. Insurance planning opportunity # 7 • Tax planning • Create a tax-advantaged investment account for business owners and executives by using a split-ownership arrangement • For example … • Opco owns death benefit (buy-sell, keyperson protection) and business owner (or executive) owns fund account • Opco owns death benefit and Holdco owns fund account • Opco owns death benefit and RCA trust owns fund account • Parent owns fund account and adult child owns death benefit

47. Insurance planning opportunity # 7 • Tax planning • Create a tax-advantaged fund account for business owners and executives by using a split-ownership arrangement • What to look for … • Need for insurance by one party and excess cash/capital for investment by another party

48. # 6 Funding Retirement

49. Insurance planning opportunity # 6 • Retirement planning • The demographics in Canada indicate that boomers will be retiring from active employment in ever increasing numbers over the next two decades • Retirement planning and retirement income are becoming an increasing priority in the minds of your clients

50. Insurance planning opportunity # 6 • Retirement planning • Provide supplemental retirement income to a business owner or executive • For example … • Leveraged life insurance • Insured retirement compensation arrangement (RCA)