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The 2012 Budget proposes an update to the 30-year-old exempt rules for life insurance policies, meaning investing in insurance could become more expensive in a few years.

Read: One in five Canadians unsure if they have enough insurance

Some background:

In the early 1980s, the Department of Finance amended the Income Tax Regulations because the advantages in the accumulation sections of life-insurance policies seemed too generous. The new rules distinguished between investment and protection policies using actuarial assumptions and interest rates.

But over time, increased longevity, product innovations and low interest rates have created problems for both the insurance industry and the CRA. There’s little consistency as to how the exempt test rules are applied across the industry, which means they inadvertently penalize some protection policies, while favouring some investment insurance.

In 1998, the industry asked the Department of Finance to deal with this inconsistency. It only took 14 years for the Federal Budget to propose changes to the exemption test.

They are:

  1. The exemption test will reflect improved mortality rates and prevailing interest rates;
  2. The test will take into account that people are living longer than was predicted in the 1980s; and
  3. Plans should be more consistent with those available in other countries.

What’s that mean for our clients?

First, the changes will standardize mortality and interest rates, resulting in lower accumulation room than what’s currently available. Short-pay policies will likely no longer be exempt.

They’ll also affect the calculation for NCPI (net cost of pure insurance) and the ACB (adjusted cost basis) of a policy. That could mean less insurance funds will be available for loans on a tax-free basis and less credited to the CDA (capital dividend account) of a corporation.

Finally, the level of the IIT (investment income tax) could also increase.

Taken together, these changes will likely increase the price of insurance, limit the exempt accumulation room, and could diminish its appeal as an investment-class alternative.

Fortunately, the Department of Finance will consult with stakeholders on the proposed changes.

But if the current regime is favourable to your clients, don’t wait. Suggest they purchase policies before the beginning of 2014, when Finance has proposed the new rules take effect.

David Wm. Brown, CFP, CLU, Ch.F.C., RHU, TEP, and a member of the MDRT. He is a partner at Al G. Brown and Associates in Toronto.

Originally published in Advisor's Edge

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