Many clients are asking us about the merits of life insurance as an investment. The following discussion presented by Garth Howes discusses the taxation of life insurance policies and how the policies are structured for tax purposes.
Premiums paid are not tax deductible and death benefits received are not taxable.
Each premium paid is used as follows:
- a portion purchases the insurance (how much depends on health; this may affect who the insured parties are),
- a portion pays for the sales commission and administrative costs charged by the insurance company to issue and maintain the policy,
- the remainder, which often is most of the premium, is invested (the type of investment depends on the type of policy, (i) Participating Life policies are mostly fixed income where the investment decisions are made by the insurance company for a pool of policies; you have no say in how they invest but you benefit from their low cost structure and (ii) Universal Life policies are like mutual funds; you pick the allocation between a large variety but you also pay higher fees).
Guaranteed and fixed income investments are considered to be very secure given the reserves the insurance company is required to maintain.
Income earned on the investment portion is not taxable; this is the main attraction of these policies and normally allows them to out perform non-registered investments on a long term basis (particularly for fixed income investments).
The death benefit paid depends on the type of policy; Participating Life policies pay the base amount plus additions resulting from the income whereas Universal Life policies pay the base amount of insurance acquired plus the cash value of the investments.
Policies can be owned corporately which allows for the premiums to be paid from pre-personal tax funds; at the same time, often the entire death benefit received by the company can be paid tax-free to the shareholders.
Rules are changing for policies acquired after 2016; the two most important aspects of these changes are (i) the long term accumulation of these policies is being reduced and (ii) the amount that can be paid tax-free to shareholders may be reduced.
If the policy is terminated “early” (typically prior to 7 – 10 years), there is often a significant administrative charge by the insurance company.
You can withdraw the investments from the policy; a portion of what is withdrawn would be a return of your original contributions and a portion would be from the income earned and this must be included in income. As an alternative to making withdrawals from the policy, it is possible to borrow from a financial institution using the policy as security; under this scenario, the loan would eventually be repaid from the death benefit and the income earned in the policy would never be taxed; tax deductibility of the interest expense on the loan can be an issue.
The cash value is an asset on the corporation’s balance sheet.
Upon the death of a shareholder, when valuing the shares of a corporation for tax purposes only the cash surrender value of a life insurance policy is taken into account (not the death benefit payable on that life insurance).
Garth Howes is a Tax Partner at Graham Scott Enns LLP with many year of experience advising clients owning life insurance products on tax issues. Please note that we are not life insurance advisors and advice from a professional insurance advisor should be obtained in regard to any life insurance product.