With higher tax rates and lower allowable contribution limits to Tax-Free Savings Accounts, Canadians may be looking for new ways to shelter their money. But if they want to do it through permanent exempt life insurance policies, they better move quickly because of new rules coming into effect January 1, 2017.
“You should be motivating your clients to buy their insurance as soon as possible,” Kevin Wark, a lawyer and president of the Conference for Advanced Life Underwriting (CALU) told the Toronto chapter of Advocis in January.
The last time tax rules on life insurance underwent a major revision was almost 35 years ago, just as universal life insurance was coming to the fore. But Canada’s income tax laws on life insurance policies are changing as of January 1, 2017, and will now include universal life and level the playing field, said Glenn Stephens, a lawyer and vice-president, planning services, with PPI Advisory.
The changes stem from a 2012 decision to change the exempt test of life insurance policies, sharply reducing the maximum cash value accumulations that are allowed to build up tax-free.
In particular, the rules propose to limit how much can be put into a policy over and above the premium needed to pay for the basic death benefit. Currently, if the policy is deemed exempt from tax, anything over the basic amount can grow without tax within government limits. Starting early next year, the tax-free amount will be reduced.
Universal life most affected
Wark said the product most significantly affected by the amount of funds that can be accumulated in a fund is universal life. “Currently the embedded reserve in that policy that is funding the level cost of insurance is not included in determining the accumulated fund of the policy for exempt test purposes. UL cost has actually had an advantage over other types of permanent products. That will be fixed under the new rules.”
Calling the changes “evolutionary as opposed to revolutionary,” Wark said the new rules can also affect current policies with high early surrender charges, taxable disposition of multi-life policies as well as policy loans.
“But the overall story in many scenarios is that you won’t see a significant change in how you market products and illustrate products with the exception of universal life level cost insurance,” he said.
Another change deals with policyholders who use their policies as collateral security for investment loans. Currently, policyholders are able to deduct some of the premium for the policy. However, after this year, the amount of that deduction will be reduced significantly, states a PPI report distributed at the Advocis meeting on the changes to the Income Tax Act.
Capital dividend account credit
Also affected by the new tax changes is the capital dividend account (CDA) credit for life insurance owned by corporations, states the report. Right now, the proceeds paid on death to the corporation can be paid out to shareholders and/or their estates tax free and can reduce or eliminate capital gains on death. But next year, the CDA credit for level cost of insurance (LCOI) policies will be cut considerably from where it is now.
That’s because the calculation that goes into determining the capital dividend amount is changing, said Stephens. “In future years – 2017 and later – non-grandfathered policies, the ACB [adjusted cost base] of those policies will generally be higher and last longer. So the policies under the current rules typically … will disappear much more slowly after 2016. So that means that capital dividend account credits will be smaller in future years.”
Wark said CALU and the Ministry of Finance have spent a lot of time on the grandfathering rules governing the new exempt test legislation. Policies acquired or issued before 2017 will keep their current tax-exempt status – unless two events take place, he said. The first is if the policy is converted into another type of coverage (except if it’s for change in premium or cost of insurance rates). The second is if insurance is added to the policy that is medically underwritten after 2016.
It is still up in the air whether the Ministry of Finance will agree to allow the current tax-exempt rules to apply to a policy purchased in 2016 but not settled until 2017.
“There is no certainty that if someone buys insurance let’s say, in September and is issued January 1, that it will be grandfathered,” said Wark. “Technically, the rule is issue date – that’s how it’s set up on the systems of insurance companies. We are trying to get Finance to agree that if a policy is applied for in good order in 2016 but not issued until later on – even though premiums are paid and it has an effective date of 2016 – that it would be grandfathered. But right now we’re not getting good feedback on that.”
Wark said some advisors may want to talk to current clients who have term insurance about the possibility of taking advantage of the current tax-exempt benefits of a permanent policy before the end of the year. He said there are clients who have purchased term only because they can’t afford permanent insurance, but would be better off with the current tax advantages.
The 2015 budget, brought in by the former Conservative government but not yet passed into law, also introduced some new tax rules that may cause concern and issues, he said. Issues in terms of definitions when talking about proceeds of disposition when there is a share redemption strategy and donations involving private shares or real estate, can have significant planning issues when dealing with high net worth clients, said Wark.
Small business owners
He said planned new rules for business and property owners who want to make donations at death can involve “significant complexity.”
“Assuming this legislation is passed, [it] will revolutionize the planning you do with your small business owners who are looking at philanthropy as part of their estate planning strategy, said Wark.
Other proposed changes in budget 2015 include a long list of anti-avoidance rules and buy-sell arrangements with life insurance.
Courtesy of : FinancialTechTools.ca