Permanent life insurance is an established estate planning tool. And with continuing low interest rates and market volatility, it’s emerged as a valuable asset class.
Insurance as an alternative asset class
A client’s specific situation will determine which type of insurance policy is right for them. But when compared to fixed-income investments, life insurance provides an appealing solution for high net worth clients, particularly those who have a need to diversify their portfolio and maintain liquidity during their lifetime.
Why consider permanent life insurance
Permanent life insurance can be an ideal solution for clients who want to:
- maximize the value of their estate,
- minimize the tax burden associated with non-registered investments,
- maintain liquidity within their investment portfolio, and
- improve their portfolio risk/return profile.
Open doors with corporate clients
Clients who own a Canadian controlled private corporation with assets in a holding company may face some challenges:
- Investment growth on these assets is taxed each year.
- Any dividend distribution is taxable.
- Upon death of the owner, the shares in the holding company will be deemed to have been disposed of for fair market value. Half of the gains in the value of those shares will be treated as income on the owner’s final tax return.
The owner of the corporation can help to address these challenges using a corporate-owned life insurance policy funded by the assets within the corporation.
Many factors determine if corporate ownership is an appropriate option. An important consideration is choosing an ownership option that properly reflects the insurance need, and avoids the need for any future transfer of ownership of the policy. When properly structured, corporate-owned life insurance can offer several benefits, including:
- tax-preferred growth through the cash value of the life insurance policy, and
- a tax-efficient method of moving money out of the corporation to the estate or the new shareholders.
These benefits often allow strategies using corporate-owned life insurance to outperform alternative taxable investments, in particular when the policy is held until the death of the person insured.
Understanding life insurance as an asset class can help you create more opportunities with high net worth clients.
- Use the whitepaper to introduce the conversation with clients.
- For more information about how to use this strategy with high net worth clients, contact your Sun Life sales director.
A high net worth case study
Dr. Wise is a 50-year-old oncologist with an annual income of $450,000. His non-registered investment portfolio has a current value of $1 million: 60% equities and 40% real estate. The lack of diversity is riskier than he’s comfortable with – he’s heading toward retirement and wants stable returns. But he’s also interested in keeping his money accessible in case he needs it for extra retirement income or unexpected events.
Dr. Wise is committed to adding $50,000 a year to his non-registered portfolio until at least age 65. Based on his goals and certain assumptions, consider:
- the after-tax rate of return,
- benefits to his estate, and
- the level of risk.
Which asset class best meets his investment goals: universal or participating life insurance, or a fixed-income portfolio?
In Dr. Wise’s case, participating life insurance (par) comes out on top. The participating account’s smooth and stable returns satisfy his goal to reduce his risk and diversify his assets leading up to retirement.
At each time horizon, par outperforms taxable investments to maximize the estate for his beneficiaries.
The par policy also offers the liquidity he wants. Dr. Wise has a few options:
- He could cancel the policy and collect the cash surrender value. But this option is seldom used; any policy gains are fully taxed as income.
- He could take out a policy loan, but there may be tax consequences.
- Or, he could use the policy as collateral for a third-party loan. The cash values in the insurance policy may offer higher collateral values than the traditional investment portfolio. Banks may be willing to lend up to 90% of the policy’s cash value.
Meanwhile, a loan against the traditional investment portfolio is susceptible to changing interest rates. If the value of the portfolio sinks below the loan amount, the lender may require Dr. Wise to repay part of the loan or additional collateral. He may be able to get a loan of up to 90%, but in this case, capping the amount at 75% of the cash value would be prudent.
For Dr. Wise, permanent life insurance, specifically participating whole life insurance, would help him achieve his goals and is an attractive alternative asset class when compared against his taxable investments.
For a detailed look at this analysis – including assumptions about Dr. Wise’s situation – read the Life insurance as an asset class whitepaper.
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- How to diversify corporate assets and enhance the value of a legacy
- How to be the leader of an advisory team for your client
- Probate fee minimization: Important facts, tips and traps – part 1
This information is being presented with the understanding that it is intended for information purposes only. Sun Life Assurance Company of Canada does not provide legal, accounting, taxation, or other professional advice. Before you act on any of this information on behalf of client, always have the client seek advice from a qualified professional including a thorough examination of the client’s specific legal/tax situation, and a detailed analysis of the relevant section of the Income Tax Act (Canada) and related regulations.