New rules beginning January 1, 2017, will impact the taxation of Canadian life insurance policies. If you’re considering changing your existing insurance policies or buying permanent insurance, you may want to review your overall estate planning and insurance needs with your advisor before the new regulations are in place.
How the rules work today
Here’s how the current rules work: when you purchase a permanent life insurance policy, you don’t pay tax on the income earned on the funds within that policy. This sheltering can make the insurance more affordable. Virtually all permanent life policies sold in Canada qualify for this exempt tax status.
Insurance companies monitor the status of the policy and, if the policy would otherwise lose its exempt status, will notify you, or automatically implement a previously selected remedy. For example, the fix could be to increase the death benefit or return some cash value to you.
The current rules to calculate a policy’s tax exempt status have been in place since 1982, so Canada’s Department of Finance is updating them to reflect more recent actuarial (or risk) assumptions and to ensure consistency across all insurance companies and all products. Most policies issued before January 1, 2017 will be grandfathered; however, in certain circumstances, grandfathered status can be lost after 2016.
Impact of updated regulations
The new rules will allow for more sheltering in the first decade of a policy and less over the long term, with the impact felt most by the holders of certain Universal Life insurance policies. The rules will also mean:
- There will no longer be single premium policies
- Surrender charge amounts will no longer provide additional tax exempt room
- If you want to prepay policy premiums, you have to do so over at least 8 years
How you build your policy’s fund value makes a difference to its exempt status. Your advisor can help you determine how to schedule your deposits to ensure you have the right coverage in place, build value for your heirs and maximize the tax effectiveness of your policy.
New actuarial tables
In 2017, the government will adopt the CIA 86-92 actuarial table, and the annuity table will be increased from 1971 to 2000. This will affect companies that sell life insurance and annuities. Products may not become more expensive, but some strategies using permanent life insurance may not be as effective.
For instance, using back-to-back annuities combines an annuity with a permanent life insurance contract. This produces a higher rate of return than what’s available on passive investments like GICs. The new mortality tables will result in a lower return on the annuity, resulting in a lower overall return to the strategy.
John McKay is a Fellow of the Canadian Institute of Actuaries and a member of the PPI Planning Services group of lawyers, accountants and actuaries.