Permanent insurance in estate planning

The problem estate planning is solving

Canada does not levy an estate tax or an inheritance tax. What it does instead has a similar effect in the cases that matter.

When someone dies, they are generally treated as having disposed of their capital property at fair market value immediately before death. Any accrued gain is realized in the final tax return, and the estate pays tax on it. Nothing was actually sold, so no money came in, but the tax is owed.

For most estates this is manageable. A principal residence is generally exempt, registered plans left to a spouse roll over, and there is nothing much to pay.

It becomes a real problem in a few specific situations.

Where the bill shows up

A second property. A cottage bought decades ago for a modest sum and now worth a great deal carries a large accrued gain. The principal residence exemption normally covers only one property. The tax comes due, and the asset producing it cannot be turned into cash without selling the very thing the family wanted to keep.

A non-registered portfolio with large gains. Same mechanism, though usually easier because the assets can be sold.

Shares in a private company. Often the largest number of all, and the least liquid. A business worth several million on paper generates a substantial bill and no cash.

Registered plans not going to a spouse. An RRSP or RRIF left to adult children is generally brought into income in the year of death, and the resulting tax can be very large.

The spousal rollover, and why it only delays things

Capital property left to a spouse or common-law partner generally transfers at cost rather than at market value, so no gain is realized. The tax is deferred, not cancelled.

The consequence is that the bill lands on the second death, and by then it is bigger because the asset has appreciated for longer. Planning that stops at the first death has usually just moved the problem.

For couples, this is why joint last-to-die insurance is common in estate work. It pays on the second death, which is exactly when the liability arrives, and it costs less than insuring either life alone because the insurer is covering the later of two deaths.

Why insurance rather than saving

Three reasons, in order of importance.

Timing. The tax is due with the final return. Money set aside for the purpose might be enough by then, or the death might come first. A policy pays the full amount whenever it happens, including the year after it is issued.

Liquidity. A death benefit paid to a named beneficiary goes directly to that person, normally free of income tax, without waiting for probate. That speed matters when there is a deadline and an executor with no cash.

Cost. For someone in reasonable health, the total premiums paid over a lifetime are usually well below the eventual benefit. It is an efficient way of guaranteeing that a specific sum exists at an unknown date.

Which product

This is one of the clearest cases for permanent coverage, because the liability does not expire. Term coverage ending at 70 does not help an estate settled at 89.

Within permanent, the choice depends on whether you want anything beyond the death benefit.

If the goal is purely to have the cash available, Term to 100 provides it at the lowest permanent cost. If you also want guaranteed cash value and a benefit that grows, participating whole life does that at a higher premium.

Both work. Paying for a savings feature you have no plans to use is money that could have bought more coverage instead.

Who receives it

A death benefit paid to a named person bypasses the estate. It arrives directly, is not part of probate, and in most provinces is beyond the reach of estate creditors.

A death benefit paid to the estate goes into the pot and follows the will. That can be the right structure when the purpose is specifically to give the executor cash to settle a tax bill, since the executor controls estate money and does not control a personal beneficiary’s money. It also exposes the proceeds to probate fees and to estate creditors.

Which structure fits depends on what you are trying to achieve and on your province. The trade-offs are set out in naming your estate versus a person, and this is a decision to make with an estate lawyer rather than from a general page.

Corporate ownership

Where the asset is a private company, the policy is often owned by the corporation rather than personally. On death, much of the proceeds can typically be credited to the capital dividend account and paid out to shareholders as a tax-free capital dividend.

This is genuine and widely used, and it is also technical enough that it needs an accountant and often a tax lawyer. The ownership structure, the beneficiary designation and the shareholders’ agreement all have to line up, and getting one of them wrong can undo the benefit.

Review it

The size of the eventual bill moves with the value of the assets. A policy sized against a cottage valued fifteen years ago may now cover a fraction of the liability.

Tax rules change too. Anyone using insurance for estate purposes should revisit the arithmetic every few years with their accountant, and treat this page as orientation rather than as advice on their own situation.