Insurance opportunities for the HNW client

Let’s face it, life insurance does not have the “sex appeal” of other types of financial products available to high-net-worth (HNW) individuals. But most wealthy individuals and business owners have purchased life insurance for the significant benefits these products provide to their overall financial and estate position. Here are three scenarios that show how insurance can meet the goals and objectives of HNW individuals.

Case #1: The concerned professional

Amy is a successful surgeon earning well over $400,000 per year. She is married and has three children under the age of 10. Her husband Kim eventually decided he would like to stay home and be the principal caregiver for the children.

Amy has been concerned for some time about the financial risks to her family if she were to become disabled or die prematurely. She also recently learned that one of her friends, another surgeon, was being sued for negligence as a result of the death of a patient. The amount of the claim far exceeds his liability insurance and, if successful, could bankrupt him.

Amy’s advisor explained the benefits of using insurance as a means of creating tax-free capital to replace income in the event of her death. For example, a $3 million insurance death benefit invested at 5% would create income of $150,000 per year, while still preserving the capital. The advisor noted that the insurance death benefit could be paid into an “insurance trust” for the benefit of Kim and the children, and in doing so, reduce the overall tax burden on the income.

If Amy designated her husband and/or children as beneficiaries under the policy, the death benefit would be protected from her creditors and would also not be subject to probate fees and other estate expenses. It was also possible for Amy to make additional deposits into a permanent insurance policy, which would accumulate on a tax-deferred basis and would also benefit from creditor protection. The accumulated values in the policy could be used to fund future premium payments, supplement income in the event of a disability, fund retirement benefits or eventually be paid out as a tax-free benefit under the policy.

Amy was happy to learn that one product could create a source of tax-free capital in the event of her premature death, provide creditor protection, avoid probate fees in her estate, and create a flexible tax-deferred savings vehicle that could be used for a variety of purposes in the future.

Case #2: The philanthropist

Robert is in his late 40s and has built a successful business, now worth approximately $20 million. He was recently asked to join the board of a local charitable foundation and would like to demonstrate his leadership and support by making a large gift. Unfortunately, most of his wealth is tied up in the value of his shares and he does not want to significantly reduce his current cash flow, which is being used to support his high standard of living.

Robert’s insurance advisor suggested he explore converting some of his company’s common shares (say $750,000) on a tax-deferred basis into redeemable preference shares with a fixed dividend rate. As part of this transaction, Robert would use the capital gains exemption to increase the cost base of those shares to equal their fair market value of $750,000. Robert’s company would then acquire a $750,000 insurance policy on Robert’s life, which would be used to redeem the preference shares on Robert’s death.

As a next step, Robert would donate the preference shares to the charitable foundation and receive a charitable donation receipt for $750,000. This donation receipt can be used to offset taxes in the current year and/or be carried forward for up to five years to offset his taxable income. This gift would generate a tax saving in the range of $337,500 assuming a top marginal tax rate of 45%.

While Robert is alive, the charitable foundation will receive dividends on the preference shares, which can be used to fund its charitable activities. On Robert’s death, the shares will be redeemed with the life insurance proceeds, so the foundation will have $750,000 in cash for charitable endeavours.

There is another benefit to this strategy. The insurance proceeds received by Robert’s corporation on his death will create a credit to its “capital dividend account.” Tax-free dividends can be paid from the capital dividend account to the surviving shareholders in the company. This will generate an additional tax savings to Robert’s beneficiaries in the range of $150,000 to $225,000, depending on the dividend tax credit available on the dividend.

Case #3: The conservative retiree

Grace is 74 and has been widowed for a number of years. She received a significant inheritance on the death of her husband, which she initially invested in a balanced equity and bond portfolio. Recently she has become more fearful of the markets and has reduced her equity exposure, putting approximately $1 million into GICs. The GICs are earning on average a 4% return, and after taking into account taxes at her 40% marginal rate, Grace is netting approximately $24,000 per year. She is interested in ways to increase the after-tax return on these funds, while preserving the capital for the benefit of her children and grandchildren.

Her advisor outlined a strategy that would involve Grace putting the $1 million currently in GICs into an annuity that provides her with an income of $98,500 a year for as long as she is alive. A significant portion of this payment will be considered to be a tax-free return of income, so the tax payable on the annuity income would only be $7,400 per year.

This cash flow would cease upon her death, depleting her estate of the $1 million in capital. To replace this capital on Grace’s death, she would also be underwritten for $1 million in permanent life insurance. The cost of this insurance would be approximately $44,000 per year.

Deducting the insurance premium and taxes from the annuity payments would still leave Grace with net annual cash of over $47,000, almost two times more than the after-tax cash flow generated by the GICs. As well, Grace can name a specific beneficiary or beneficiaries for the $1 million insurance death benefit, removing it from her estate and avoiding probate fees or estate administration expenses.

By implementing this strategy, Grace can enhance her cash flow while she is alive, replace the capital with life insurance on her death and ensure it is paid directly to her specified beneficiaries outside of the estate.

“As you can see, a number of insurance planning strategies can be put in place, depending on the client’s objectives and situation. So while insurance may never become the hottest topic on the cocktail circuit, it is clearly worth the conversation.”

Kevin Wark, LLB, CLU, TEP, is senior vice-president, business development, at PPI Financial Group.

(09/15/09)

Kevin Wark

Insurance

Kevin Wark , LLB, CLU, TEP, is managing partner, Integrated Estate Solutions, and tax consultant, Conference for Advanced Life Underwriting. He’s also the author of The Essential Canadian Guide to Income Splitting.