How To Access The Cash In Your Life Insurance Policy

Participating whole life insurance has two distinct differences from term insurance: 1) it never expires; and 2) the policy has an accessible component called the cash value

Cash value can be viewed as the investment portion of a life insurance policy (for a comprehensive breakdown on this, read our article HERE).

Cash value can be accessed three ways:

1. Policy Loan (sometimes taxable)
2. Policy Withdrawal or Surrender (sometimes taxable)
3. Using the policy as collateral to secure a 3^rd party loan / line of credit (never taxable)

Options #1 and 2 are straightforward in nature: the policy owner approaches the insurance company to request either a policy loan or to request a policy withdrawal. In the early years of the policy, these transactions will likely be tax-free. However, as the cash value grows and grows, policy loans and withdrawals may become taxable as income to the policy owner. Important to note: this is not taxed as a capital gain, this is taxed as a policy gain, which is treated as regular income.

Option #3, using the policy as collateral to secure a 3rd party loan, is the method used to implement the Insured Retirement Plan as well as other tax-effective planning solutions. For larger cash needs, this tends to be the recommended strategy. Here is how it works:

1. Working with one of the Canadian lenders who specialize in cash value lending (eg – Manulife Bank), a tax-free line of credit is secured by collateralizing the policy’s cash value. Lenders typically will loan up to 90% (sometimes as high as 100%) of the cash value for participating whole life policies. Depending on individual circumstances, additional collateral might be required and interest may be capitalized.
2. If it is a corporate owned insurance policy, the loan can either be taken out corporately or personally. If a corporate insurance policy is leveraged for a personal loan, a guarantee fee should be paid to the corporation to avoid it being deemed a shareholder benefit.
3. If the purpose of the loan is to earn business or investment income, the interest might be deductible.
4. If assigning the policy is required to secure the loan, a portion of the insurance premium might be deductible.
5. On death, the insurance proceeds are used to pay off the outstanding loan to the 3rd party lender. The remainder of the death benefit is received tax-free. Note: if a corporate-owned policy was leveraged to secure a personal loan, there are some additional steps to the payout of the death benefit and repayment of the loan to ensure the corporation’s capital dividend account gets handled properly.

Advantages to using Option #3:

1. The cash value, in essence, is being accessed on a tax-free basis, to be used however the policy owner chooses.
2. By leveraging the cash value instead of withdrawing it, the policy owner maintains the entirety of the cash value, which means full exposure to dividends and tax-sheltered growth that continues to compound.
3. Further tax planning opportunities may be available in the form of deducting the premiums and the interest on the loan.
4. Assuming the loan remains outstanding on death, a corporation has the ability to receive a Capital Dividend Account (CDA) balance on the entirety of the death benefit, regardless of how much the outstanding loan is. This potentially leaves the corporation with a leftover CDA balance from the life insurance proceeds to distribute tax-free dividends to surviving shareholders.

For more information or to get started with this concept, contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.

DISCLAIMER: this commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice. The numbers projected can fluctuate based on a wide variety of factors and approval for an insurance policy is not guaranteed. Always seek advice from your tax and/or legal advisors prior to implementing these strategies.