An ongoing series of informative entries
An ongoing series of informative entries
When Canadians think of life insurance, they may provide a spectrum of thoughts.
First, an individual may recall how it helped their family when their mother or father passed away. Those in the charitable sector will tell the story of one of their beloved donors designating their charity a beneficiary under a life insurance policy. They were able to thank his family for the much-needed funds to support many of the programs offered in their community. THEN there may be a business owner that holds up his hand in a stopping motion when the word life insurance is even mentioned as an option in their estate plan.
Why does life insurance conjure up such strong emotion? Is life insurance misunderstood? Perhaps? Perhaps, any perception of life insurance stems back to the insurance salesman that went door to door many years ago. Is that what people remember? Have we failed over the multitude of decades to highlight that life insurance is a tax-savings vehicle like many other financial planning tools that we have available in Canada?
In our journey to understand life insurance, I believe we can look to a couple of the most well-known plans that we have in Canada – life insurance’s younger cousins, RRSPs and TFSAs.
RRSP’s history started in 1957, when new legislation permitted individuals to make deposits into personal savings plans, with tax-assistance, for future retirement income. Sounds like a very approachable plan to help Canadians save for something in the future. However, it was a slow start. Canadians did not contribute to the new plan that was available to them initially. Was it not understood? Numbers only started to ramp up during the 1970’s and 1980’s. However, it was not until the 1990’s that we saw the first members of the baby boomer generation effect the RRSP numbers in two ways - highest contributions and highest rates of participation. We saw these Canadians in this group were in their prime working years—a stage in life when earnings were relatively high and assets were being accumulated. We also have to remember that the amendment to the Income Tax Act (the Act) introduced in 1990, included a new ceiling for RRSP contributions, similar to what we see today, and this allowed these Canadians that were experiencing higher income levels a means to maximize the use of tax deferral opportunities under their RRSP.
Saving for retirement occurs through many financial vehicles such as RRSPs, but it may also include Canada Pension Plan (CPP), Registered Pension Plans (RPPs), Individual Pension Plans (IPPs), investment savings, rental properties, the use of home equity, or Tax Free Savings Accounts (TFSAs) to name a few. Since its introduction in 2009, TFSAs have become a popular tax-assisted or tax-sheltering savings vehicle like the RRSP.
TFSAs and RRSPs do hold similar attributes:
• The Act is quite flexible with respect to the types of qualified investments that can be held in a registered TFSA or RRSP.
• Both TFSAs and RRSPs have maximum amounts that can be contributed and set legislative contribution room limits.
• Beneficiaries can be designated to allow funds to be received directly at time of death.
• Investment growth and capital is not taxable within the plan.
Since TFSAs have come available, there has been the “TFSA vs. RRSP” controversy. Which one is better? This should not be the discussion - it truly depends. It depends upon goals, tax brackets, age, income levels, etc. – the list goes on. There is still misunderstanding of both. Individuals are not fully aware of the options, tax considerations and other attributes that are specific to either savings plan. However, more and more understanding of RRSPs and TFSAs has emerged over time.
Understanding how such tax-sheltered savings vehicles work and what they can do in a financial and/or estate plan just takes time; just like saving does.
Canadians save for different reasons. Individuals save for:
• Unforeseen events or unexpected expenses,
• Large purchases (car, house, etc.),
• Education needs,
The same reasons can hold true for business owners. Very similar stories emerge for business owners as they may save for a new piece of equipment or save for their own retirement.
NOW, what are the attributes of life insurance and do they look similar to TFSAs and RRSPs?
1. If I am speaking about TFSAs, RRSPs, or life insurance, they are all contracts. Each have contract numbers. For life insurance, the policy holder owns the contract, much like a TFSA holder owns his/her TFSA contract.
2. Non-residents of Canada can own TFSAs, RRSPs, and life insurance (with differing tax consequences).
3. Individuals can only contribute up to legislative limits, otherwise it may be taxable. For life insurance, this is the “exempt test”.
4. Beneficiary designations are available under all three. And there is the flexibility to change beneficiaries.
5. There is choice. The choice in investments held in a TFSA, RRSP, or life insurance contract depends on risk tolerance, legislative factors, and options provided by the issuer.
6. Withdrawals from a TFSA, RRSP or a permanent life insurance contract can be done during one’s lifetime.
7. Funds are deposited into the contract to obtain a certain future result. These deposits are not considered costs or expenses (including funding a life insurance contract).
8. Tax advantaged accumulation - Investment growth and capital are not taxable (subject to legislative limits).
It appears that RRSPs, TFSAs and life insurance may share quite a few similarities. Most of them are tax related. These tax-savings vehicles also have many differences. The differences between RRSPs, TFSAs and life insurance means they are not perfect substitutes. One is not better than the other. They just have different attributes and may sometimes share the struggle of not being completely understood when it comes to saving. Sometimes that takes time.
The question is if I am looking to take $X and save it to get to $XX what should I be looking for in a tax-savings vehicle? Should questions like these be considered:
1. What are the tax consequences at death? Tax free?
2. What is the tax exposure of the growth inside the plan?
3. Can beneficiary(ies) be designated? Can beneficiaries be individuals, charities, trusts, or corporations?
4. What are the risks associated? Risk of market volatility, etc.?
5. Are there any guarantees inside the contract that are available?
6. What is the time horizon for savings?
7. Can I hold this tax-savings vehicle corporately?
8. Can I transfer the contract to different individuals or corporations?
9. Does it bring liquidity to a beneficiary with an intended result? When it is most important?
Perhaps, when it comes to incorporating a financial, succession, retirement, tax and/or estate plan, we should be prepared to ask some of these questions to help gain an understanding of the tax-sheltering vehicles available.
Perhaps, we should be prepared to determine if the attributes associated with life insurance make it a viable tax-sheltered vehicle for individuals and business owners.
Jos Herman, BComm, CPA, CA, CFP, CLU, TEP
This material is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. All comments related to taxation are general in nature and based on current Canadian tax legislation for Canadian residents, which is subject to change.