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Is Your Insurance Planning Affected By The Recent Budget?



On March 21st, Finance Minister Jim Flaherty tabled his 2013 Federal Budget.  Some of the provisions of that document has or will have an impact on some life insurance products and/or strategies.  However, let’s start on a positive note.

The Lifetime Capital Gains Exemption has been increased from $750,000 to $800,000 starting in 2014.  For the years after 2014, the LCGE will be indexed to inflation.  The Lifetime Capital Gains Exemption applies to capital gains realized by individual taxpayers on disposition of certain qualified property – shares in a Qualifying Small Business Corporation or eligible farm and fishing property.   For those individuals who have already claimed the old limit of $750,000 they will be entitled to the difference from the increased amount.

Two sophisticated life insurance strategies were dealt a fatal blow by the March Budget.  The first of these were the structures referred to as the 10-8 programs.  This was a leveraging strategy which involved a life insurance product that provided a guaranteed 8 % rate of return on the cash value in the policy if the cash value was borrowed back at a 10% fixed loan rate.  If the transaction was structured properly the interest on the loan was tax deductible and the cash value growth was tax deferred potentially resulting in positive cash flow.  The CRA had expressed concern about these programs and started to put them under review in 2008.  Their primary concern was the linkage of the loan to the policy and the ability to manipulate both the interest expense deduction as well as the tax deferred growth in the life insurance policy.

Also shut down was another leverage linked strategy known as a Leveraged Insured Annuity. Here an individual or company would liquidate investments to purchase a life annuity with no guarantee in the event of death creating maximum monthly income.  A life insurance policy providing for the return of capital (amount of annuity purchase) at death was put in place combined with a bank loan which was used to replace the investments liquidated to purchase the annuity.  Both the life insurance policy and the annuity were assigned as collateral for the loan.  With the interest on the loan and a portion of the life insurance premium being tax deductible and the annuity income being taxed on a preferential basis (for individual purchasers), the end result, like the 10-8 programs, was positive cash flow.

The March Budget introduced measures that kill the positive cash flow aspect of these arrangements. These include the non-deductibility of loan interest and the collateral term insurance and, for corporate arrangements the denial of both the Capital Dividend Account credit for the life insurance proceeds as well as the reduction in share value created by the purchase of the zero-guarantee annuity.

Often budget changes that will have a detrimental effect on strategies that have been in placed are grandfathered for the new provisions.  This is will be the case for Leveraged Insured Annuities, however, the 10-8 programs did not receive grandfathering and the new rules will apply to existing plans.  The budget provides a time frame for these programs to be wound up without further undue tax consequences.

The Budget also made a slight upward adjustment to the tax that will be paid on the receipt of non-eligible dividends by a shareholder.  Non-eligible dividends are those that are paid by a corporation out of corporate income that is taxed at the small business tax rate.

Of additional concern is a mention of the intent to review the graduated tax treatment of certain trusts, including testamentary trusts.  Testamentary Trusts have long been a staple of estate planning.  A Testamentary Trust is created by an individual’s will and is funded when death occurs.  The Testamentary Trust enjoys a graduated income tax treatment much like an individual tax payer, whereas, other trusts, such as inter vivos trusts are taxed at the top marginal rate of tax.  The Department of Finance has indicated it will consult on measures to eliminate benefits arising from the use of graduate rates of tax for trusts.  That review is expected to take up to three months, so stay tuned for developments.

Originally announced in the 2012 Budget, this year’s Budget re-confirmed the government’s intention to adjust the exempt test for permanent life insurance.  When implemented this will have the effect of reducing the amount of tax-deferred investment growth currently available in a life insurance policy. It has been suggested that there will be draft legislation in the second quarter of this year, with an effective date sometime in 2015. We expect that there will be grandfathering of existing life plans for the application of the new exempt test provisions, so if you are contemplating the purchase of such plans, now would be a good time.

These certainly are not the only provisions of this year’s Budget but only those that affect life insurance products.  If you feel that you are affected by them and wish to discuss, or if you wish to review your current insurance planning in light of these remarks, please call me.

©iStockphoto.com/ Alex Slobodkin