TAX TALK THE ADVISOR’S GUIDE TO LIFE INSURANCE …

TAX TALK

THE ADVISOR'S GUIDE TO LIFE INSURANCE TAXATION 2023? 2024

Life insurance helps Canadians manage risk, provides security for their families and businesses, and is an important component of estate planning. While the rules related to the taxation of life insurance have changed over the years, its special tax attributes remain. This guide will assist you in answering the on-the-spot questions clients may have when it comes to insurance taxation.

Information in this guide was last updated July 2023. To the best of our knowledge, the information in this guide is accurate and up-to-date. It is highly recommended that clients seek independent accounting, legal and taxation advice with regard to the use of life insurance in their business and estate planning.

TABLE OF CONTENTS

THE BASICS OF LIFE INSURANCE TAXATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Personally-owned Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 Corporate-owned Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

TERMS AND CALCULATIONS YOU SHOULD KNOW . . . . . . . . . . . . . . . . . . . . . . . . . 3 Adjusted Cost Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Cash Surrender Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Death Benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 Net Cost of Pure Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Capital Dividend Account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Refundable Dividend Tax On Hand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2017 Tax Reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Exempt Test . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 250% Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Fair Market Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 Proceeds of Disposition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Policy Gain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Investment Income Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

THE QUESTIONS WE HEAR MOST OFTEN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Are life insurance premiums deductible? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 When is there a disposition of a life insurance policy? . . . . . . . . . . . . . . . . . . . . . . . 9 Can the Canada Revenue Agency seize life insurance proceeds to pay a deceased's tax liability? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 What are the rollover rules for life insurance? . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 What happens on the death of the owner of a life insurance policy where the owner is not the life insured? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Can a life interest trust own life insurance? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Do I need to have a successor or joint owner on a joint-last-to-die policy? . . . . . . . . . . 12 What is a policy loan? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 What are policy dividends and how are they taxed? . . . . . . . . . . . . . . . . . . . . . . . . 12 What are life insurance shares? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 What are the tax consequences of transferring a corporate-owned policy to a shareholder or employee? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Is the growth in an exempt life insurance policy subject to the passive investment income rules? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Is life insurance planning affected by the Tax on Split Income rules? . . . . . . . . . . . . . 14 How are segregated funds taxed and what are the differences between a mutual fund and a segregated fund? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Is life insurance subject to U.S. Estate Tax? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

What is a Graduated Rate Estate and why is it important? . . . . . . . . . . . . . . . . . . . . 18 How does corporate-owned life insurance affect share valuation? . . . . . . . . . . . . . . 18 How are disability and critical illness insurance taxed? . . . . . . . . . . . . . . . . . . . . . . 19 What are the ways to donate life insurance to a charity? . . . . . . . . . . . . . . . . . . . . 20 How can life insurance be used to enhance donations? . . . . . . . . . . . . . . . . . . . . . 21 What is an Insurance Trust? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22 Why separate ownership of life insurance from the beneficiary? . . . . . . . . . . . . . . . .23 What are probate fees and are life insurance proceeds included? . . . . . . . . . . . . . . . . 24 Can family members of a shareholder or the shareholder's estate be the beneficiary of a corporate owned life insurance policy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Does divorce revoke a life insurance designation or a will? . . . . . . . . . . . . . . . . . . . . 27 What are the key aspects of beneficiary designations? . . . . . . . . . . . . . . . . . . . . . .28 How do the proposed changes to the intergenerational transfer rules affect life insurance planning? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

ACCESSING CASH VALUE FOR INVESTMENTS OR OTHER PURPOSES . . . . . . . . . . . . . 30 Interest Deductibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 Guarantee Fee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

POST MORTEM PLANNING ? A QUICK REFRESHER . . . . . . . . . . . . . . . . . . . . . . . . .33 Capital Dividend Stop Loss Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34 Alternatives when grandfathering is not available . . . . . . . . . . . . . . . . . . . . . . . . .34

CAPITAL DIVIDEND ACCOUNT ? TAX CONSIDERATIONS . . . . . . . . . . . . . . . . . . . . .36

CONSEQUENCES OF TRANSFERRING LIFE INSURANCE . . . . . . . . . . . . . . . . . . . . . .39

SHAREHOLDERS' AGREEMENTS ? DON'T MISS THE INSURANCE PROVISIONS . . . . . . . 43

DISABILITY BUY-SELL PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

QUICK REFERENCE FOR TYPES OF LIFE INSURANCE PRODUCTS . . . . . . . . . . . . . . . . 46

POLICY GROWTH TABLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Increases and access to Cash Values . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 Increases and payout of Death Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

ACRONYMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49

ONLINE RESOURCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

PPI RESOURCES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

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