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Are you looking for a way to transfer your wealth to your children in the most efficient way possible?
Did you know you can do this with the wealth transfer strategy using life insurance?
With this strategy, you:
- Reduce the tax you have to pay
- Avoid costly probate and other estate fees
- Can build up significant cash value inside the policy tax-sheltered
And much more.
So if you’re want to know more about how this strategy can help protect your wealth, this post is for you.
Let’s get started.
Family Wealth Transfer
In Canada, $1 trillion of wealth will transfer from baby boomers to their children from 2016 to 2026. This is the largest intergenerational wealth transfer in history.
Of that $1 trillion, how much of it will go to CRA? You guessed it: a lot.
By using life insurance for wealth transfer, you get a tax-effective way to transfer your money to your children and grandchildren. Not only that, but you save a ton on probate and estate fees as well.
Before we look at how the wealth transfer strategy with life insurance works, let’s see if you’re a good candidate for it.
Who is it for?
If the following goals are a priority in your life, then you can consider the wealth transfer strategy:
- You are retired and have more wealth than you’ll need in your lifetime
- You want to leave a larger legacy for your children or grandchildren than using other traditional investments
- You want a tax-efficient way of transferring your wealth to the next generation
- You want to maximize the assets that bypass your estate to avoid probate and executor fees
- You want to maintain control of the assets until you’re ready to pass them on
- You want to provide a gift for both your children and grandchildren while you’re living and after you die
- The child or grandchild you want to insure is healthy
Using Life Insurance For Wealth Transfer
Here is a step-by-step process of how to execute the wealth transfer strategy using life insurance:
1. You buy a permanent life insurance policy on the life of your child or grandchild. As the owner, you pay premiums in excess of the cost of insurance, building tax-sheltered cash value.
2. While you can use this cash value, the goal is to put it in the hands of your child or grandchild. To do this, you transfer ownership of the policy to them. You’ll want to do this when you’re ready to relinquish control and they are ready to accept the gift. The transfer qualifies for a tax-free rollover so you don’t have to pay tax even if there’s cash value inside the policy.
3. As the new owner, your child/grandchild continues the premium payments. They can use the cash value for their own needs, like paying for a wedding, as a down payment for a home, for tuition, or for retirement. If the withdrawal is taxable, it’s taxed in their hands, not yours.
4. The policy is now an important part of their financial plan. They can maintain the policy for income and debt protection and name a beneficiary important to them.
What are the benefits?
- The policy builds up a tax-sheltered cash value that either you or your child/grandchild can use during your lifetimes
- You provide lifetime insurance protection for your child/grandchild
- You have complete control over the policy before the transfer
- Your gift bypasses your estate, avoiding probate and other estate fees
- After the transfer, your child/grandchild owns the policy and can access the cash value within it for important life events like paying for education, a wedding, or a down payment for a home
- They pay the tax on any withdrawals after the transfer
- The transfer of ownership occurs on a tax-free rollover basis
- The beneficiary gets a tax-free death benefit
- You lock in the insurability of your child or grandchild while they are young and healthy
What types of insurance can you use?
Any type of permanent insurance works but the most common ones are whole life and universal life. Both let you build up cash value tax-sheltered and defers tax until withdrawal. While you can choose the deposit amount and investments for a universal life policy, whole life is more rigid with its premium and investment.
How much money can you put inside the policy?
The amount of money you can deposit into the policy is directly correlated to the death benefit. The larger the death benefit, the more you can invest tax-sheltered inside the policy.
However, that doesn’t mean you can just buy millions of dollars of death benefit. Financial underwriting plays a role in determining how much you can buy. The underwriter will look at any existing insurance, income, net worth, and other important financial information when considering whether the death benefit is appropriate.
Can you buy this for your child or grandchild?
Yes. The wealth transfer strategy works great for both your child and grandchild. Because you might be limited on the amount of insurance you can buy on a young grandchild, you might be better off buying it on the life of your adult child instead. By doing so, you can buy a policy with a larger death benefit and accumulate a larger cash value.
Here are a few typical arrangements:
- You are the owner and your adult child is the life insured and transferee
- You are the owner, your adult child is the life insured, and your grandchild is the transferee
- You are the owner, your grandchild is the life insured, and your adult child is the transferee. Eventually, your child will gift the policy to your grandchild as a second transfer.
Besides your child and grandchild, you can also buy this for your son-in-law, daughter-in-law, great-grandchild, and step-child. In fact, you can buy this for anyone under age 19 who is dependent on you.
Some grandparents even have one policy for each of their grandchild. That’s one way to show that you’re not playing favourites.
What if you don't want your child to have to pay the premiums after you die?
You have a couple of options. First, you can buy a policy with a shorter payment period. Common pay periods are 10 and 20 years. While the premiums are higher for these paid-up policies, you benefit from not needing to pay them for life.
Your second option is to buy a joint last-to-die policy on your and your child/grandchild’s lives. The death benefit is paid upon the second death. If you choose the option of paying premiums until the first death, then the policy is paid-up after you die.
The downside to this option is that you also have to qualify medically for the insurance. This could be a problem if your health is poor.
What if you want to transfer the policy to someone else?
Whenever you transfer a life insurance policy with cash value, you may have to pay tax. If the cash value is greater than the adjusted cost base (ACB), you have to add the difference to your income.
However, if you transfer the policy to your spouse or child, you’re allowed to do it on a tax-free basis. That’s one of the major benefits of the wealth transfer strategy using life insurance.
CRA doesn’t specify that it has to be the same child that’s insured under this policy. You can transfer it to another child and still benefit from the tax-free rollover if you want.
What can you do as the owner of the policy?
As the owner, you have full control of the policy. You can withdraw the cash value, use it as collateral for a loan, change the beneficiary, and more.
If you want, you can name your spouse as joint owner of the policy. As joint owners, both of you have to sign off on any changes you want to make to the policy. Make sure you have a power of attorney so that you can still make changes if one of you becomes incapacitated. The power of attorney should specifically address the attorney’s ability to deal with the policy.
Will you have full control of the policy?
Whoever is the owner of the policy has full control. That will be you until you decide to transfer ownership of the policy. You can even wait until after your death to relinquish control.
Why do you need to name a contingent owner?
If you name your child/grandchild as the contingent owner, the policy will not go into your estate when you die. Instead, it will go directly to your child/grandchild and you can avoid paying probate fees on the cash value of the policy.
The other benefit of naming the contingent owner is tax-related. Without a contingent owner, the policy goes into your estate when you die and the tax-free rollover will not apply.
Will any withdrawals be taxed in your hands after the transfer?
If your child or grandchild is at least 18 when making the withdrawal, the attribution rules do not apply. This shouldn’t be a problem since you’re not going to transfer the policy to them before the age of 18 anyways.
What if your grandchild is a minor?
If you name your grandchild as the contingent owner and you die while they are still a minor, the tax-free rollover still applies. However, as minors don’t have the capacity to make an enforceable contract until age 16, their court-appointed guardian of property will hold the policy.
To plan around this, you can name your spouse as joint owner. You can also name your child (the grandchild’s parent) as contingent owner and change this after your grandchild reaches the age of majority.
Case Study
Let’s take a look at the wealth transfer strategy in action with a case study. In this example, a retired grandparent wants to use this strategy on his 5-year-old grandson.
We can compare using life insurance to an alternative investment to see the benefits of the strategy. To make the comparison fair, both the insurance and the alternative investment earn 6%.
For the life insurance, the grandparent will use a level cost of insurance universal life policy. Any cash value is added to the death benefit and paid tax-free to the beneficiary.
For the alternative investment, we have to take into account probate and executor fees since it passes through the grandparent’s estate.
Here are the details of the situation:
The setup
- The grandparent is in the 53.5% marginal tax rate
- The initial death benefit of the universal life insurance is $500,000
- Although the cost of insurance is only $130.5/month, he will deposit $250/month into the policy with the excess going into a balanced fund that the insurance company offers
- With the alternative investment, he deposits $250/month for an apples to apples comparison
- Executor fees of 5% of the value of the alternative investment
- Probate fees of 1.4% of the value of the alternative investment
The transfer
- The grandparent will transfer the policy to the grandson when he reaches age 18
- The grandson will continue depositing $250/month into the policy until age 65
- First, he will withdraw $10,000 for 4 years from age 19-22 for education funding
- He will then withdraw $20,000 at age 35 to pay for his wedding
- Next, he will withdraw $30,000 at age 40 for a down payment for a home
- Then, he will withdraw $10,000 at age 50 and 55 for vacations
- Finally, he will withdraw $5,000 for 18 years from age 65-82 (his life expectancy) for retirement funding
Let’s take a look at the difference between the two scenarios.
In the graph above, the dips in the cash value and death benefit are due to the cash withdrawals for the grandson’s lifestyle.
As you can see, even after all the withdrawals, there’s still enough cash value in the policy (green line) to keep it in force until the grandson’s life expectancy at age 82. At that point, his beneficiary will still receive over $500,000 (red line) when he dies.
On the other hand, while the alternative investment provides a higher cash value (yellow line), it doesn’t have any death benefit. His beneficiary will only get $181,000 at age 82.
Final Thoughts
The wealth transfer strategy is an affordable and tax-efficient way to provide an inheritance for your children and grandchildren.
If you’ve been thinking about wealth transfer, now might be a good time to consider the strategy while your children and grandchildren are young and healthy.
While we make every effort to keep our site updated, please be aware that timely information on this page, such as quote estimates, or pertinent details about companies, may only be accurate as of its last edit day. Brian So Insurance and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser. This post is a brief summary for indicative purposes only. It does not include all terms, conditions, limitations, exclusions, and other provisions of the policies described, some of which may be material to the policy selection. Please refer to the actual policy documents for complete details which can be provided upon request. In case of any discrepancy, the language in the actual policy documents will prevail. A.M. Best financial strength ratings displayed are not a warranty of a company’s financial strength and ability to meet its obligations to policyholders.
