Offset Taxes At Death With Permanent Insurance

On the first death of a married/common-law couple, there is a spousal rollover to defer the majority of taxes. But what about on the 2nd death? Read our success story below, where we put a plan in place for our clients that allows them to offset their future tax bill.

Client Names (altered for anonymity): Jack & Diane

Client Information: Both are age 60, good health, no tobacco usage in the past year

Problem: Concerned about the sizeable tax bill on the 2nd death of the two

Background

Jack & Diane are nearing retirement and are in a solid position with significant pensions and savings, so income throughout their retirement years is not of concern. What is of concern to them is the major the tax liabilities resulting from the 2nd death of the two of them. Here is a snapshot of their joint assets:

If they were both to pass away tomorrow (Diane one minute after Jack), the taxes owing on Diane’s terminal return plus the taxes her estate owe would be $400,000, in addition to over $40,000 in probate fees.

While their adult children are financially secure, Jack & Diane want to pass on as much of their estate as they can, which ultimately means paying the least amount of taxes. One crucial component of their legacy wishes is the family cabin, purchased in 2012 as a vacation property. Based on current values and taxation rates, the tax owing would be upwards of $125,000, and the tax liability will presumably continue to rise over time.

Solution

Jack & Diane are approved for a Joint-Last-To-Die, permanent life insurance policy (Term to 100) for $500,000. With this type of policy, there is one death benefit, one premium payment, with both Jack & Diane the policy owners and the insured. As the name applies, there is a death benefit paid out on the last of the two deaths.

As a part of their overall estate plan, Jack & Diane’s two adult children (who are also co-executors) will be named 50/50 beneficiaries of the insurance policy and will receive the $500,000 death benefit tax-free. The purpose of the insurance is to provide liquidity to cover the taxes owing in the estate in a timely manner and will maximize the legacy passed on to their children, notably keeping the cabin in the family for future generations.

They will re-allocate roughly $600 per month (or $6,700 if paid annually) from their non-registered portfolio to fund the $500,000 life insurance policy.

Comparison

Instead of allocating a small portion of their investments into a permanent life insurance policy, an alternative option for Jack & Diane was to keep the $600 per month in the non-registered portfolio. To match the life insurance option outlined above, here is the equivalent rate of return that the investment would need to earn based on the year the 2nd spouse passes away (conservative 30% tax rate estimated):

Naturally, the longer Jack & Diane live, the smaller the rate of return will be on the Term-100 solution we have implemented. However, that is a scenario they are more than comfortable with.

Outcome

Two desirable outcomes have been accomplished:

1. The adult children will receive a tax-free cash infusion of $500,000 to eliminate the tax bill as a result of Jack & Diane’s passing.
2. By re-allocating assets from their non-registered portfolio into a future tax-free life insurance asset, they gain the ability to shelter a portion of their assets from the costly, invasive, slow probate process.

Note: some clients prefer the life insurance beneficiary to be their estate. Although this negates the bypassing of probate advantage, it still will be received tax-free by the estate. In the case of Jack & Diane, naming their children as beneficiaries aligned with their holistic estate plan and the advice of their lawyer.

For more information or to review your options, contact Jeff Graham at (604) 363-7549 / jeff@firstoakfinancial.ca, or schedule a complimentary consultation using the link below: