Business and family relationships change over time. When that happens, people may need to move a life insurance policy from one person or entity to another. This requires careful review to ensure client objectives remain achievable.
Typically, when ownership of a life insurance policy changes, the original owner reports a fully taxable policy gain equal to the excess of the proceeds of disposition over the owner’s adjusted cost basis (ACB) in the policy. Losses cannot be recognized. The original owner also files an absolute assignment form with the life insurance carrier to register the change in title. The form identifies the new owner, the relationship between the old and new owner and the value of the transaction.
There are four exceptions to this general rule. In these cases, there can be a rollover of the policy, with no immediate tax consequences.
1. Transfer to a spouse or common-law partner.
The transferring spouse is deemed to receive proceeds of disposition equal to the policy’s ACB while the receiving spouse is deemed to pay an amount equal to the transferring spouse’s ACB.
Tax-deferred transfers between spouses/common-law partners may occur while both people are alive, or between a deceased’s estate and the surviving spouse/common-law partner. When the transfer is between spouses/common-law partners, there’s an automatic rollover, unless they elect to opt out.
2. Transfer of policy on the life of a child.
This can be a valuable opportunity for parents when they purchase a policy on their young child and later transfer ownership to the child as an adult.
Parents can also transfer a policy on the life of one child to another. For example, a grandparent could purchase a policy on the life of a grandchild and later transfer title to the grandparent’s child (the life-insured’s parent). This can help ensure control of the policy remains with the grandparent or parent until the grandchild is mature enough to assume ownership of the policy.
This works while the parent/grandparent is alive and can sign the appropriate forms to register the change of ownership with the life insurance carrier. There can’t be a rollover from the parent/grandparent’s estate to the child. Naming the child as the contingent owner of the policy will allow him or her to receive it on the death of the parent/grandparent.
3. Transfer from trust to capital beneficiary.
In this case, the trust owns the policy and rolls it over to the beneficiary, who assumes the trust’s ACB in the policy.
4. Corporately owned policies
Transfers are rolled over when a policy’s owned by a corporation that’s amalgamated or wound up. In an amalgamation, the new company is considered to be a continuation of the previous companies and the policy moves at ACB. In a windup, the parent company takes over the subsidiary’s assets and assumes the policy at the subsidiary’s ACB.
There’s also an exception for non-arm’s length transfers of a life insurance policy, but with a special deeming rule.
When a policy’s transferred between non-arm’s length parties, the proceeds are deemed to be the cash surrender value (CSV), regardless of the amount the parties agreed to.
The deeming rule applies to the following transfers:
- a. person donates policy to a charity;
- b. shareholder transfers policy to his corporation;
- c. corporation transfers policy to its shareholder; and
- d. brother or sister transfers a policy to sibling.
An example will help illustrate how the deeming rule applies in these scenarios. Assume the following for Policy XYZ:
Cash surrender value
Adjusted cost basis
Fair market value
Scenario A: Tomasz donates Policy XYZ to his favorite charity. He receives a receipt for $500,000 (the policy’s fair market value) and a policy gain of $50,000 (cash surrender value in excess of ACB).
Scenario B: Mohammed transfers Policy XYZ to his private corporation for a cash payment equal to fair market value. He gets $500,000 and reports a policy gain of $50,000 as a taxable event. While this may seem an odd result, CRA has confirmed it in a technical interpretation. The company’s starting ACB will be the deemed proceeds of $200,000, the CSV (not the actual proceeds of $500,000).
Scenario C: A private corporation transfers Policy XYZ to its shareholder, Ellen, for no consideration. The corporation reports a policy gain of $50,000 and Ellen is deemed to have received a taxable benefit equal to $200,000. However, the Income Tax Act contains a shareholder benefit provision that taxes the shareholder based on the fair market value of a transaction. This means Ellen reports another taxable benefit equal to the excess of the policy’s fair market value over the amount already reported as a taxable benefit. That means Ellen’s starting ACB is the deemed proceeds ($200,000) plus any additional amount charged as a taxable benefit ($300,000), for a total of $500,000.
Scenario D: Peter transfers Policy XYZ to his sister, Paula, for $400,000. The transfer is deemed to occur at CSV. Peter reports a policy gain of $50,000, while Paula’s starting ACB is $200,000. Transfers between siblings are deemed to occur at CSV, irrespective of fair market value.
CRA’s position on fair market value
CRA has explained its position on how fair market value of a life insurance policy is determined in an information circular.
Factors CRA would typically consider in an assessment include the policy’s cash surrender value, loan value, face value, health of the insured, life expectancy, conversion privileges, term riders, double indemnity provisions and replacement value.
Understand the pension income tax credit
The pension income amount allows a taxpayer to claim a federal non-refundable tax credit on up to $2,000 of eligible pension income. The federal tax credit rate is 15%, so the maximum federal tax savings available is $300 ($2,000 x 15%). There are also provincial pension income amounts. By claiming them, clients receive the first $2,000 of pension income on a tax-free basis, but only if they’re in the lowest tax bracket. If they’re in a higher bracket they’ll pay tax on the pension income, but at a reduced rate. Income-splitting rules allow taxpayers to split up to 50% of eligible pension income with a spouse or common-law partner.