Table of Contents
- What is life insurance?
- The Role of Life Insurance in Estate Planning
- Provides Liquidity
- Compensates Loss in Income
- A Wealth Transfer Plan Suiting One’s Family Needs
- Bypass Taxes: A Combination of Life Insurance and Leveraged Credit Shelter Trust
- Bypass Taxes: A Combination of Life Insurance and Spousal Lifetime Access Trust (SLAT)
- Compensating Those Less Involved in the Business
- Giving to a Greater Cause
- Bottomline
The information presented herein is for educational purposes only. Laws keep changing. Before taking any legal steps, consult our professionals.
Life insurance can be an excellent tool for relief in times of need. A person doing estate planning asks himself: How much taxes will my loved ones have to pay on my death? Where will they get the money to pay these taxes? Will they sell some of my assets?
In the context of Canadian estate planning, life insurance stands out as a unique and invaluable asset. While almost every other asset a person leaves behind is subject to taxes by the Canadian Revenue Agency, life insurance is exempt. This fact makes life insurance a must-have tool for any estate planner, offering a strategic advantage in minimizing tax liabilities.
What is life insurance?
Life insurance is a program that an individual enrolls in. Upon their passing, the insurance company is responsible for paying a specified amount to the chosen beneficiaries.
The amount of money depends on how much premium the deceased used to pay.
The Role of Life Insurance in Estate Planning
- Provides Liquidity
Life insurance plays a crucial role in estate planning by providing essential cash to beneficiaries upon the policyholder’s death. The heirs can use insurance to settle taxes, debts, and other expenses. While beneficiaries can seek tax deferral, it’s only sometimes guaranteed. In many cases, they may need to sell off some assets to cover the taxes, potentially at a lower value than their worth.
Life insurance covers these expenses and provides an adequate financial cushion to the heirs.
- Compensates Loss in Income
If a person dies, his family may experience an interruption in income. Life insurance can go a long way in ensuring the availability of support in times of crisis. Following are some of the ways it can work:
- The family can use it to pay off a mortgage or debt.
- A replacement for lost services.
- Facilitate long-term financial goals for family members.
- It can help settle the deceased's final medical bills.
- A Wealth Transfer Plan Suiting One's Family Needs
Some families have complex formations. For instance, a blended family is one in which two adults have a child or children and one or more children they have with previous partners. Life insurance provides more clarity in such an air of complexity.
Suppose a blended family has some children under ten and some above 25. To avoid making his finances intertwined, he creates two sets of funds: one set aside for the young ones’ education and care, etc., and another group of adults with entitlement to insurance money.
In this way, life insurance can have an equalizing effect and bring more certainty and equity in the distribution of assets.
- Bypass Taxes: A Combination of Life Insurance and Leveraged Credit Shelter Trust
A Leveraged Credit Shelter Trust allows the tax-free passing down of assets to the next generation after both partners pass away. However, it does not work without life insurance.
To explain, a spouse can transfer some assets to such a trust, and the trust then uses those assets to buy life insurance.
On the death of the surviving spouse, the trust, the owner and beneficiary of the insurance policy, receives the life insurance death benefit, which is tax-free.
In this way, the spouses leave a more considerable legacy to the heirs by moving some assets outside the taxable Estate.
- Bypass Taxes: A Combination of Life Insurance and Spousal Lifetime Access Trust (SLAT)
A SLAT is a trust that a couple can use to maintain their current lifestyle and leave a final legacy.
Like LCST, a life insurance policy is mandatory to fully utilize this trust. Following are the steps that a couple takes to maximize the benefits:
- The couple creates a SLAT trust.
- Money transfer to the trust takes place via gift.
- Negligible tax liability arises due to tax credits on gifts.
- The couple keeps the per-year gift transaction below the $10000 cap.
- The trust subscribes to life insurance using the amount received.
- A spouse can make cash withdrawals from the policy to sustain a lifestyle.
- The proceeds roll over to the designated beneficiaries outside the taxable Estate upon the spouse's death.
- The proceeds can help purchase assets from the Estate or lend money to it. They will also provide tax relief to the Estate.
- Compensating Those Less Involved in the Business
To distribute assets fairly, you might want to compensate those not involved in the business but cannot give them a share from inheritance.
To prevent selling some assets from the Estate, you can purchase life insurance and compensate the less interested family members via proceeds from the insurance plan.
- Giving to a Greater Cause
Life insurance can help you leave a more sublime impact by ensuring your legacy supports others when you are gone.
You can purchase life insurance and make your favourite charity organization a beneficiary.
Upon your death, the designated charity will receive a certain amount, which will also bring tax benefits to your heirs.
Bottomline
Life insurance is a reliable tool with multiple benefits for estate planning. It can produce its maximum effect when incorporated diligently and with expert advice.