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Life Insurance as a Tax Minimization and Wealth Building Strategy

November 25, 2020 | Paul Chapman

As part of this series, I try to shed light on some of the often complex financial planning solutions to make it as simple and consumable as possible. Financial planning, wealth management, life insurance, and investments can be very complex in their applications, but are always simple in terms of the human needs which they address. And it is always the simplicity of the need, rather than the complexities of the applications, to which I vow to communicate with you.

There is one financial planning tool that faces a significant knowledge gap that is costing many adults a lot of money – but I get it. Becoming fluent in estate planning and tax minimization strategies is a full time job, and best left to a professional. But the professional you work with should be able to simplify these strategies for you. Most of us need to recognize that we don’t know what we don’t know, and to take some time with a good advisor to be aware of the basics, because it’s a short time very well spent, believe me. Many wealthy individuals believe they know best when it comes to household finances, so they need to take a step back and ensure they are actually armed with all the information – this won’t be the case if they’re not working with an advisor, or firm, who is versed in advanced wealth planning strategies.

This is especially true when it comes to life insurance strategies. To many, life insurance is seen as a cost and not as an investment – and, in many cases, this is simply the wrong way to look at it. There’s a plethora of strategies that can be employed to minimize taxes and add significant value to your estate than traditional fixed income strategies, with significantly lower risk (and we’re talking hundreds of thousands or millions of dollars of additional value in many cases…).

To illustrate this point, the Life Insurance Marketing and Research Association highlights that one-third of wealthy Canadians don’t own any personal life insurance. Among this group, over half say they have enough money to cover their family’s financial needs without the benefit of life insurance in the event of their death. As well, many of these folks don’t consider it a ‘good investment’, while some simply ‘don’t believe in life insurance’, and mistrust the life insurance industry. I suspect these people either don’t work with an advisor at all, or have an advisor that is perhaps not up to the task of understanding and explaining these vehicles… because these people are simply mistaken.

Life insurance should be an integral part of most financial plans. Apart from the income-protection benefits of regular term insurance, I would argue that life insurance is often an important and integral alternative asset class. Unlike term insurance, permanent life insurance policies (that is, whole life and universal life policies that are in effect for your lifetime) have the potential to deliver better returns relative to traditional lower-risk vehicles like GICs and government bonds, especially in today’s interest rate environment – TAX FREE. Traditional investments are taxed annually on earned interest, dividends and realized capital gains. Not only do permanent life insurance policies grow tax-free, they also provide the basic death benefit tax-free. These policies also have an investment income component in the form of a ‘cash accumulation fund’ that is also tax sheltered in both its growth and final payout. Half of wealthy Canadians don’t even realize that a permanent life policy includes an investment component. Unbeknownst to many, the policies also offer access to much of the investment/premium as you can easily borrow against the policy’s collateral for a loan. Finally, these policies also avoid estate settlement costs like probate (which is typically about 1.5% of your entire estate, not an insignificant charge if you have some assets and dough).

Life insurance is just one example of an asset that is misunderstood by so many – it has significant potential and demonstrable benefits for your estate and net worth, and is even more powerful if you own a business and/or corporation. Clients and their accountants often choose to ‘self-insure’, or face a common misconception to take the seemingly ‘cheapest’ term life insurance plan if they assess insurance at all, so you need to ensure you’re integrating the right investment advisor into the process. This is where I and my team can help. If done right, then ultimately this all means that you’ll create significantly more value and wealth for yourself and your family, leaving them a lot more down the road.

Only about 60% of those who own life insurance purchased it through their own advisor. That means that the necessary conversations aren’t being had, likely because of false assumptions and a general misunderstanding around the products. You’re not alone here – there are a lot of moving parts around insurance, but the general benefits can be simplified and are certainly worth assessing since the right structure and solutions can be very beneficial and powerful.

I have found financial literacy and education a personal passion point, and will do everything I can to simplify and spark curiosity around the subject to educate so that as many can benefit as possible. In the current environment, multi-dimensional wealth management solutions are paramount. If I can help at all on this front to spark a conversation and curiosity, I’m here to help – just reach out.