Chapter 4: Risk Management and Insurance Flashcards
1
Q
When purchasing insurance on the lives of children or grandchildren, why would insurers ask if the policy owner owns insurance on their own life first?
A
It can be an indication of whether the purchaser views insurance as a risk management tool or simply as a means of enriching themselves in case of a claim.
2
Q
What are 3 groups that can offer critical illness insurance?
A
- Employers
- Creditors
- Associations
3
Q
How are premiums for CII as part of group benefits banded?
A
Normally based on a 5-year banded rate, meaning a plan member will have the same premium for a given 5-year age band. (Example: 33 year old will have the same premium as a 34 year old, then the 35 year old would have a higher premium)
4
Q
What is the typical guideline used for determining how much CII is appropriate?
A
1-2 years of household income
5
Q
Which type of households tend to incur higher costs in the event of a critical illness?
A
Households with just one income earner, as the income earner ends up taking on caregiving responsibilities that cause the loss of that income source
6
Q
What is anti selection?
A
Anti selection is a term often used in conjunction with adverse selection. It is defined as an increase in the chance for a person to take out an insurance contract because they think their health risk is higher than what the insurance company has allowed for in the premium amount.
7
Q
Why does cancer coverage in CII typically have a 90-day period where claims are not possible?
A
Due to anti-selection risks (people who may have a strong reason to suspect they will have a claim in the near future)
8
Q
When is the premium for a LTC policy purchased as part of a CII rider determined?
A
Likely not until the conversion privilege has been exercised.
9
Q
Which rider(s) allow for a CII claim if the individual experiences a disability that renders them unable to work in any capacity, without meeting any other definition?
A
Total disability or loss of independent existence.
10
Q
Which definition of disability is used for the waiver of premium rider on a CII policy?
A
Usually “any occupation” definition of disability.
11
Q
How does inflation protection on a CII policy work?
A
Some insurers allow a rider that sees the amount of coverage increase periodically, such as a 5% increase in the face amount every 5 years.
12
Q
What are the 3 basic types of LTC policies?
A
- Reimbursement
- Indemnity
- Income
13
Q
How does a reimbursement LTC policy work?
A
Under a reimbursement plan, the person insured must submit receipts and can receive up to the monthly maximum in reimbursement.
14
Q
How does an indemnity LTC policy work?
A
An indemnity policy will pay up to its face amount as an income benefit once the insurer knows the the insured is incurring that much of an expense. If there is a surplus in the difference between the cost of the expense (facility cost) and the face amount, that will usually extend the benefit period.
15
Q
How does an income LTC policy work?
A
Like a traditional disability policy. Once a claim has been submitted, the benefit will be paid until the end of the policy’s benefit period.
16
Q
When do LTCI policies provide benefits?
A
When the insured can no longer perform 2 activities of daily living or demonstrates a cognitive impairment.
17
Q
What are the different types of home care that could qualify to be reimbursed under a LTCI policy?
A
- Professional care (such as an RN)
- Skilled care (such as a home care attendant, PSW)
- Non-skilled care (family member or friend) - while this works with an income type of policy, it may or may not work for a reimbursement or indemnity style.
18
Q
What is respite care?
A
Care facilities not being used on a permanent basis, such as dropping off a parent on your way to work and picking them up on your way home. Or to provide care during a shorter period of time, such as a vacation.
19
Q
For which type of care home might a LTCI policy have a shortened elimination period?
A
Palliative care/hospice care
20
Q
What are Instrumental Activities of Daily Living?
A
IADLs are used in the underwriting process as they are considered early warning signs for a possible concern around ADLs. These include using the phone, managing finances, driving or taking the bus, shopping, doing laundry, housework, managing medications, preparing meals.
21
Q
Are ratings on LTCI policies common?
A
No, although a rating could be applied for height/weight.
22
Q
What does it mean if a LTCI policy is issued on a modified basis?
A
A policy could be issued with a shorter benefit period in a smaller face amount than applied for. This is a risk management tool for the insurer.
23
Q
Do insurers typically add exclusions to LTCI policies?
A
Due to comorbidity concerns (risk that one condition makes another worse), insurers will typically use a decline rather than an exclusion to manage risk. Exclusions may be used for lifestyle risks though, such as a travel exclusion for someone who regularly travels to dangerous places.
24
Q
What are common LTCI benefit periods?
A
100 weeks, 150 weeks, 250 weeks, or lifetime benefits.
25
What are common LTCI elimination periods?
Although policies in the past had elimination periods as long as 1 year, elimination periods are now 90 days or 180 days.
26
Why are LTCI premiums subject to change and by how much?
It's a relatively new type of insurance, so insurers do not yet have a lot of claims experience. They reserve the right to adjust premiums based on submitted claims, but normally guarantee premiums for 5-year periods. They may also includ a limit to how much the premiums can increase from one 5-year period to the next.
27
What is a first payment bonus for LTCI?
Some insurers provide an additional benefit once the first claim is accepted to make up for any costs the person incurred during the elimination period or for renovations/assistive decides.
This may be automatically included in the base premium or may be an additional rider.
28
What are the two non-forfeiture provisions that are available on some LTCI policies?
1. Extended term insurance - policy may simply stay in force for a period of time if a policyowner stops paying premiums.
2. Reduced paid-up insurance - depending on how long premiums have been paid, the insurer could keep the policy in force at a reduced face amount.
29
What do many LTCI insurers do to reduce the chance of an LTCI policy lapsing?
Many insurers will notify a third party, such as a policyowner's child, if that policy owner misses a premium (requiring consent at time of application or later).
30
Do LTCI policies typically offer return of premium?
Normally only at death.
31
What are the two types of inflation protection riders that can be added to a LTCI policy and which is more expensive?
Automatic inflation protection each year or indexing only once a claim has started. The latter is less expensive.
32
How does the LTCI future purchase option work?
Some insurers offer the insured the ability (through a rider) to elect to have their coverage amounts increased in certain increments (such as $100 per week) at certain intervals (such as every 3 years) with no medical underwriting required (although financial underwriting may be required).
33
What are the 3 different types of "go" years in retirement?
Go-go years
Slow-go years
No-go years
34
What are the 2 important historical dates when determining the taxation of life insurance policies?
December 1, 1982
January 1, 2017
35
For policies issued between December 1, 1982 and December 31, 2016, how is the ACB calculated?
ACB = premiums paid (excluding ratings, riders + benefits, but including term riders) - dividends received - net cost of pure insurance (cost of a term policy less any policy fees)
36
How did the rules change with regards to the ACB of life insurance on January 1, 2017?
As of 2017, a rating or smoking status will increase the "net cost of pure insurance" NCPI. This means that policies issued to riskier insureds as of January 1, 2017 will have lower ACBs.
37
What is the ACB for life insurance policies issued prior to December 2, 1982?
Premiums paid - dividends received
(Net Cost of Pure Insurance) NCPI has no impact on the ACB.
38
Which events create a taxable disposition of a life insurance policy?
- Policy loan
- Complete surrender
- Partial surrender
- Absolute assignment
- Annuitization
- Lapse
39
What are the tax consequences of a lapsed life insurance policy?
Although this is considered a disposition, there are typically no tax consequences as the cash values would have been reduced to zero by APL provisions before the policy would have lapsed.
40
How are policy loans taxed?
The amount borrowed is taxable as income. If repaid, there will be a tax deduction for any previously taxed amounts. Loans made for business or investment use would mean that the interest is not tax deductible.
41
How is the ACB of a life insurance policy impacted by interest payments made for a policy loan?
If the loan is for personal use, interest payments made will increase the ACB (but will not reduce the loan). If made for business/investment purposes, interest payments will not increase the ACB.
42
How is a partial surrender of a life insurance policy taxed?
Taxed as income on the proportion of the cash value withdrawn. For example, if a policy owner wanted to withdraw $20K cash value from a total of $40K, they are withdrawing 50%. If the ACB was $10K, then the taxable income would be... $40K - $10K = $30K x 50% = $15K taxable income.
43
How are absolute assignments of life insurance policies taxed?
It is a taxable event, taxed like a complete surrender. However, a spouse can elect to receive the policy at the original owner's ACB. A parent absolutely assigning a policy to a child (or grandchild) where the life insured is the child, can also do so without tax consequences.
44
What are the tax consequences for a person who chooses to annuitize a life insurance policy?
This is normally taxed as a complete surrender as the individual is essentially surrendering the policy in exchange for a cash flow.
Exception: if the person has suffered a permanent and severe disability, the annuity stream would be taxed as a series of partial surrenders.
45
What are the tax consequences of a life insurance policy lapsing?
Although this would technically be considered a disposition, the cash values would have been reduced to zero by automatic premium loan provisions before the policy would be allowed to lapse. As a result, there should be no real tax consequences.
46
What are the tax consequences of a collateral assignment of a life insurance policy?
This is not a tax-triggering event.
47
When can a policyowner deduct some or all premiums in the case of a collateral assignment?
If the loan is made for business or investment purposes, the loan is from a recognized institution of lending, and the lender has set a condition that there must be life insurance in place.
48
In the case of a collateral assignment of life insurance, how much of the policy premiums can be deducted by the policy owner (assuming all conditions are met)?
The limit to what can be deducted is the lesser of the net cost of pure insurance (NCPI) or the actual premium paid. The amount must also be proportional to the amount of the loan.
49
Why is it important for a borrower to remove a collateral assignment from their life insurance policy even if the related loan has been paid off?
The collateral assignment is made to the institution, not to the loan. If the collateral assignment remains and the policyowner dies with other outstanding debt with the institution, the lender can use its collateral position to collect from the insurer.
50
How is a collateral assignment removed from an insurance policy?
The lender sends a letter to the insurer explicitly stating that the collateral assignment is to be removed.
51
Why would someone use cash value of a life insurance policy as a collateral for a loan?
It does not result in a disposition, unlike a traditional policy loan.
52
What is impaired term life insurance?
A situation where term insurance is used as collateral where the life insured is terminally ill.
53
What would likely be required by a lender using impaired term life insurance as collateral?
Will likely want an independent actuary and underwriter to provide an opinion based on medical reports, as this type of collateral is intended to be used if the life insured is terminally ill.
54
What name is the lender given if they are offering a loan using cash values of an insurance policy as collateral?
The lender is a "collateral assignee".
55
If a loan exceeds the CSV in a situation where cash value of a policy is used as collateral, what happens?
The lender may call the loan. At which point, the borrower could use other resources to pay off the loan or find some other source of collateral. If the borrower cannot resolve the situation, the lender would have the right to remove the CSV directly from the policy.
56
What happens at death if a charity has been named the beneficiary of a life insurance policy?
The death benefit would flow directly to the charity, resulting in a charitable donation tax credit for the estate of the deceased. This tax credit can be used to reduce income to zero for that year, and can also reduce the previous year's income to zero if needed.
57
Why is naming a charity as a beneficiary not an effective way to reduce taxes at death?
If an individual is projected to pass away with a $100,000 tax liability (as an example), they would need to purchase a life insurance policy with a $100K death benefit to pay their tax bill at death. To use a charitable donation credit to reduce the same tax bill to $0 at death, a significantly larger death benefit would be required (depending on province, could be $200K+).
However, if someone wants to donate to charity and reduce their taxes at the same time, this is a great option to "kill 2 birds with 1 stone"
58
How does it work if an individual absolutely assigns a life insurance policy to a charity during their lifetime?
It would be a taxable disposition and would be taxed in the hands of the donor. At the same time, the donor would receive a charitable donation tax credit equal to the value of the policy. If the donor continues to pay premiums, those premium dollars will also qualify for a charitable donation tax credit. There is NO tax advantage to the donor or the donor's estate on death.
59
How is the value of a life insurance policy calculated if it assigned to a charity?
An actuarial valuation is required to determine the value if the policy was acquired more than 3 years ago and/or not purchased with the intent of donating to charity. If acquired within 3 years and the intent was to donate the policy, the value is determined based on the least of the CSV or ACB.
60
For which policies are the investment component of a life insurance policy ALWAYS considered "exempt" (not subject to taxation)?
Policies that fit into pre- Dec 2, 1982 tax rules are always exempt. Otherwise, the policy must be tested.
61
What is the exemption test for life insurance policies with an investment component and when is it completed?
Exemption test occurs at every policy anniversary and at issuance. The test essentially measures whether the amount of money going into the policy is appropriate given the death benefit of the policy. The CRA completes this test.
62
What happens if an exemption test is completed on a life insurance policy and the CRA deems that the policy is no longer exempt?
The CRA would deem the policy a tax avoidance policy. It would be considered a disposition for tax purposes and taxed as a complete surrender. Any future growth would be taxed as regular income.
The ITA allows the insurer to move the funds out within 60 days of failing the test or to increase the DB by up to 8% per year to allow the policy to remain exempt.
63
The policy exemption test is completed by the CRA, how does the test work?
The line against which policies are tested is based on a 3.5% growth rate in the policy up to age 90 and is known as the Maximum Tax Actuarial Reserve (MTAR).
Policies placed prior to 2017 with no changes made that require underwriting continue to use the older exemption test.
64
How can an individual use life insurance for an immediate tax benefit (prior to death)?
If an individual has permanent insurance and no longer needs the coverage, they can donate the policy to a charity on an inter vivos basis. This would provide a charitable tax credit. If the policy was simply cashed in, the disposition would create a taxable gain for the individual.
65
What are the benefits of naming a charity as a direct beneficiary vs naming the charity in the will (and vice versa)? What are some of the disadvantages?
If a direct beneficiary designation is made, there is no probate and it is kept confidential. If the charity no longer exists, other charities have to apply to receive the death benefit (which is complicated). The charitable donation tax credit must be used against the terminal tax return or the prior year's return.
If a beneficiary designation is made in the will, the death benefit will be probatable (unless language in the will makes this an explicit beneficiary designation, should consult a lawyer). There is a loss of confidentiality. If the charity no longer exists at death, the executor likely can name a substitute charity. The charitable donation tax credit can be used against the terminal tax return, the prior year's return, or the estate's tax returns.
66
When would it be beneficial to set up life insurance as a form of estate equalization?
Useful tool for somebody who may die leaving substantial illiquid assets, such as a farm, family business, or vacation property to one or more heirs, and may have no liquid assets for other heirs.
67
What are the primary concerns for an individual passing away with a significant amount of illiquid assets (which can be mitigated through life insurance)?
1. Estate equalization (ensuring all heirs receive assets fairly)
2. Paying for taxes owing at death
68
What is the benefit of having a small life insurance policy, even if it is not needed for any purpose?
It provides some immediate liquidity to an executor, which can give them funds to pay professional fees, court filing fees, and other expenses. Bank accounts and many investment accounts will typically be frozen until administrative requirements have been met.
69
What is a life insurance opportunity for members of a DB pension?
The DB pension plan member may recognize that their pension provides a higher monthly income benefit if their spouse waives their survivor’s benefit. Having a permanent insurance policy in place when making the pension decision gives more flexibility. The spouse may be willing to waive their rights knowing that if the pension plan member dies prematurely a death benefit will be available to offset the loss of pension benefits.
70
Which type of insurance policy can be used as an investment for the purpose of diversification?
Whole Life. While UL contains an investment component, it's not accurate to consider the assets themselves diversified as the policy owner has access to the same types of investments outside of a UL policy.
71
What are the policy reserves of a WL policy typically invested in?
Policy reserves are typically invested on a much longer time horizon than a retail investor is subject to. They also tend to include more infrastructure-type investments, as they can afford to sacrifice liquidity for returns and stability. Because of the long-term and non-retail nature of WL participating policy reserves, investments tend to benefit from low volatility. Returns are typically less than equity returns, but with less volatility.
72
When is a WL policy most illiquid?
Typically in the first 8-10 years after the policy has been issued, when surrender charges severely limit access to the CSV. May be less if the policy has a heavy investment focus.
73
What are the components of an insurance policy premium?
- Cost of insurance
- Provincial taxes (2% ON)
- MER for managing investments
- Investment component
74
When would it likely make sense for an individual to invest using permanent life insurance?
For somebody who has used all available investing opportunities and is seeking to maximize the value of their estate.
75
Why does it often make sense for a corporation to hold an insurance policy vs an individual from a tax perspective?
Insurance premiums are paid with after-tax dollars. The business' tax rate will often be considerably lower than the individual's tax rate.
76
Why might it not make sense for a business to hold life insurance on behalf of an individual even if it makes sense financially? How can this be mitigated?
If insurance is held in a corporation, then it is potentially available to help settle a claim. If owned personally, then a lawsuit or other claim against the corporation would not impact the insurance coverage.
Holding the insurance in a holding company rather than the operating company can somewhat reduce the risk.
77
What is the role of an Advanced Case Specialist?
Often a former accountant or tax lawyer who is a CLU, available to be consulted on specialized insurance cases.
78
What is the rough FMV of a life insurance policy?
Roughly equal to the PV of the death benefit at the most likely age for mortality, minus the PV of any premiums yet to be paid.
79
What are factors that a consulting actuary (or independent actuary) would use to determine the FMV of a life insurance policy?
- CSV of the policy
- Loan value of the policy
- Face value
- Health/life expectancy of insured
- Conversion privileges
- Riders + other benefits
- What it would cost to buy the same insurance today
80
What is an insurance share or transfer share?
Special class of preferred shares that gives its shareholder access to a limited set of rights. Normally have to be issued/acquired before any insurance policy is purchased by a business. Insurance share would likely have no voting rights, only equity rights are those directly associated with insurance policy in question.
81
Which (3) characteristics of a life insurance policy can an insurance share have its value based on? (Any combination)
1. Death benefit - insurance shareholder would have predetermined rights to access some or all death benefit after it's paid to corp.
2. CSV - CSV is owned by corp, but equity associated with the share would be specifically based on the CSV of the policy. This limits the corp from using the CSV as collateral without consent of shareholder.
3.CDA credit - insurance shareholder would have rights to some or all of the CDA credit associated with the insurance death benefit.
82
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is the corporation?
Premiums not normally deductible, benefit not normally taxable.
83
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is a shareholder?
This would create a taxable shareholder benefit. The corp would not be able to deduct premiums and the shareholder would be assessed a taxable benefit based on the premiums paid. Death benefit is tax-free.
84
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is the spouse of a shareholder?
This is treated the same way as if the shareholder was named a beneficiary. This would create a taxable shareholder benefit. The corp would not be able to deduct premiums and the shareholder would be assessed a taxable benefit based on the premiums paid. Death benefit is tax-free.
85
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is an employee? What if it's the spouse of an employee?
This creates an employee benefit. The corp would be able to deduct premiums and the employee would be assessed a taxable benefit. The DB would be paid tax-free. If the individual is a shareholder and employee, they will be treated as an employee if they can show that other employees in the same position are receiving the same benefit. It is the same if it's the spouse of an employee.
86
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is a parent corporation?
A taxable benefit is created the same as naming a shareholder as beneficiary. When the death benefit is paid, it is tax-free to the corporation. The CDA credit is based on the amount of death benefit less the corporation that owned the policy's ACB for the policy.
87
What are the tax implications of a corporately-owned life insurance policy where the beneficiary is a subsidiary corporation?
No taxable benefit is created when a subsidiary corp is named as beneficiary. This is essentially the same as the corp naming itself as beneficiary. The CDA credit is based on the amount of death benefit less the corp that owned the policy's ACB for the policy.
88
What are the tax implications of a corporation transferring ownership of a life ins policy on the life of a shareholder to the shareholder? When would this likely occur?
Can happen if the shareholder is selling the business or winding up the corp but still needs insurance.
Taxed based on FMV of the policy. Shareholder must pay tax as if they had received a dividend based on this valuation. The dividend amount would be reduced by any consideration the shareholder pays for the policy.
89
Why is there a higher tax cost for a shareholder to have an insurance policy owned by a corp transferred to them if they are in poor health?
If an insured person is in poor health, the FMV of the policy is higher as health/life expectancy is one of the factors used for actuarial calculations.
90
How did the rules change for transfers of life insurance policies from a shareholder to a corporation?
Before 2017, a shareholder could transfer a policy to the corp, paying tax on a disposition using CSV - ACB to determine the taxable policy gain, while the corp would pay the shareholder the FMV of the policy (and FMV could be quite high).
As of 2017, the shareholder has to pay tax on any amount they receive from the corp in excess of their proceeds of disposition. This means that that any value in excess of the CSV is taxable.
91
How does it work when a corporation transfers a life insurance policy to a parent corporation?
The ITA is not clear, but it seems that the corp can transfer a policy tax-free as an intercorporate dividend to the parent corp. This depends on whether the corp has "safe income", which the accountant will determine.
This is a taxable disposition based on CSV - ACB.
92
How does it work when a corporation transfers a life insurance policy to an employee?
Taxed the same way as a transfer to a shareholder - taxed based on the FMV of the policy.
93
What are (6) needs that a business might have for insurance?
1. Funding a buy-sell agreement.
2. Liability protection.
3. Key person insurance.
4. Investment.
5. Employee benefits.
6. Business overhead expense insurance.
7. Collateral.
94
How do businesses use insurance for liability protection? How is this type of insurance taxed?
Purchase commercial general liability (CGL) policies. These cover a range of risks depending on the nature of the business. Premiums are generally tax deductible and benefits are tax-free. However, business interruption insurance has tax-deductible premiums and taxable benefits.
95
What can key persons be insured for?
Death, disability, critical illness.
96
While not common today, how did some businesses combine a key person insurance policy with a retirement benefit in the past?
The business would purchase a key person policy, but use permanent insurance (rather than term). The business would pay for the Cost of Insurance (COI) and expenses for the policy, while the employee would pay for any investment component and then own the investment. The death benefit would be assigned on a joint basis, with the business as beneficiary for any non-investment portion and the key person as the beneficiary for the investment portion.
This is a split dollar arrangement.
97
Why should a FP who encounters or considers recommending a split dollar arrangement consult with a tax planner or an advanced insurance case specialist?
Split dollar arrangements have a substantial amount of complexity and tax risk to them.
98
If a business sets up a permanent life insurance policy as a form of a split dollar arrangement, what happens on the employee's departure? What are the tax consequences?
The full policy would normally be transferred to the employee, who then has a permanent policy to help build estate value, or against which they could borrow to fund retirement expenses.
The transfer would be considered a taxable employee benefit based on the FMV of the new death benefit the employee becomes entitled to less any amount the employee is deemed to have paid for the policy.
99
What is a common strategy for using CI insurance as key person insurance? What are the tax consequences?
Have the corp take on a CII policy on the life of a key employee/shareholder. Have the shareholder pay personally for the costs of an ROP rider. If there is a claim, the corp will receive the benefit. If there is never a claim, the key person will get the ROP benefit.
There is no firm treatment of this in the ITA. This could be taxed as a shareholder benefit.
100
How can a Private Health Services Plan be used with a key person CII policy?
If a claim is made, have the CII benefit paid into a Private Health Services Plan. The PHSP could then be used to refund the key person for eligible health expenses incurred as a tax-free benefit. This is a complex strategy that requires consultation with a tax professional and employment lawyer/HR consultancy.
101
Why are some benefits for a business to use permanent insurance for investment purposes?
Tax-exempt insurance policies do not create any additional taxable income for the business and do not contribute tot he AAII test (which reduces the Small Business Deduction).
102
Which business would likely benefit from setting up a permanent insurance policy for investment purposes? What is one big downside for owners of a CCPC?
A business with excess cash that is worried about reducing their small business deduction, and also has an insurance need. This business should not need the invested dollars until the insured person dies.
A downside is that it would be unwise to accumulate value in a life insurance policy or any other sort of passive asset if the business owner plans to use the LCGE one day.
103
How are shareholder benefits taxed compared to employee benefits?
While both are taxable to the employee/shareholder, employee benefits are deductible for the business while shareholder benefits are not.
104
Can a Business Overhead Expense (BOE) plan be used to cover wages?
Can be used to cover staff wages, but not owners' wages.
105
How are non-forfeiture provisions of life insurance policies impacted when a policy is collateralized?
There is less cash value available to support a non-forfeiture provision.
106
What are the 3 main risks faced by someone who employs a leveraged life insurance strategy?
1. Cash flow risk - inability to service the debt
2. Investment risk - disappointing returns could lead to significant net losses over time
3. Interest rate risk - interest rate increases would cause additional drains on cash flow and require a higher return to break even
107
How are life insurance policy loans taxed?
Taxed as ordinary income if the amount borrowed exceeds the ACB of the policy.
108
What can be done to reduce cash flow risk when using a leveraged life insurance investment strategy?
Rather than collateralizing a life insurance policy, take out a policy loan. Insurers will not allow a policy loan that is projected to exceed the CSV of the policy, so it is a debt that does not need to be serviced.
109
What is an Immediate Financing Arrangement?
This strategy works for high net worth individuals or corporations. Either the insurer or a 3rd party lender will lend an insurance policy owner up to 100% of the accumulating fund value in a life insurance policy with no regard for surrender charges. This allows for borrowing in excess of the CSV (unlike most insurance leverage, which only allows up to the CSV to be borrowed).
110
Why would a shareholder choose to do an Immediate Financing Arrangement with a corporately owned insurance policy personally rather than corporately? Why might this strategy not work?
The shareholder is likely taxed at a higher rate than the corp, so this puts interest deductibility in the more valuable taxpayer's hands.
The problem with this strategy is that if the shareholder simply uses the cash value as collateral, then a taxable shareholder benefit would arise, likely on every premium the corp ever paid to own the policy. There are strategies to get around this, but there is substantial tax and compliance risk with them.
111
What are 2 strategies that, if employed correctly, would allow a shareholder to use an Immediate Financing Arrangement personally on a corporately-owned insurance policy without triggering a taxable shareholder benefit?
1. The shareholder would pay the corp for the right to use the accumulating fund as collateral, thereby creating a commercial arrangement between themselves and the corp. This essentially turns it into an arm's length relationship. The fee paid is generally referred to as a "guarantor's fee".
2. The shareholder could own an insurance share (or transfer share), then use that insurance share as collateral for the loan. As the shareholder acquired the share for FMV, it's theirs to collateralize as they see fit.
**Both of these strategies involve significant tax risk**
112
Why are lenders often more hesitant to take UL as collateral, or do so at a lower lending limit?
Most UL investments involve market exposure and the investment can fall in value (unlike WL where the accumulating fund value cannot decrease).
113
Which types of UL policies are generally used for collateral?
Normally UL policies with a Yearly Renewable Term structure (premiums are low in early years and increase as life insured gets older). As the cost of insurance is low in early years, more dollars are invested, which would lead to more growth in the accumulating fund to eventually pay the YRT premiums.
114
What are some other advisors that a FP using insurance leveraging strategies will likely need to work on cases with?
Insurance underwriters, actuaries, commercial lending specialists, insurance agents, tax accountants, tax laywers.
115
Which 3 retirement income strategies use cash value life insurance?
1. Insured retirement plan
2. Corporate insured retirement plan
3. Retirement compensation arrangement (RCA)
116
What is an insured retirement plan?
Retirement income strategy involving a personally owned insurance policy. During the policy owner's working years, they invest in the policy, growing cash value on a tax-exempt basis. If the life insured lives to retirement, they will start to borrow using the accumulating fund as collateral to provide retirement income each year. At death, the insurance would pay off the outstanding loan and the remainder would be distributed to the heirs.
117
What is a corporate insured retirement plan?
Similar to the insured retirement plan in that a life insurance policy is set up with the intention of borrowing against it for income in retirement. The difference is that the insurance is held in the corporation, so a decision needs to be made as to whether to borrow against the policy personally or corporately. There are tax risks with borrowing personally. Borrowing corporately means the corp will have to pay taxable dividends or salary to the retired shareholder for retirement income.
118
Why does a YRT cost (yearly renewable term) have to be determined for Whole Life policies in a RCA?
The ITA treats insurance as if it's all YRT in almost all cases, so even if the premiums don't reflect a YRT cost, one will have to be determined.
119
What is the benefit of using life insurance for investing within a Retirement Compensation Arrangement?
The CRA withholds a 50% withholding tax on contributions to an RCA and any taxable returns. As life insurance offers tax-exempt returns, it's possible to avoid the 50% withholding tax on returns within the insurance policy.
120
How can a split-dollar arrangement be used with an RCA?
The RCA holds the investment portion of an insurance policy while the risk (death benefit) portion is owned directly by the corp. The investment portion grows tax-exempt within the insurance policy in the RCA, while the death benefit will be paid outside of the RCA and distributed to beneficiaries tax-free as a result.
121
What is a Supplemental Executive (or employee) Retirement Plan (SERP)?
Broad name applied to pension arrangements that work when the RRSP, DC or DB pensions won't be effective (often due to high income). A funded SERP means there is money in place from which the plan member will withdraw funds in retirement. An unfunded SERP means there is a promise to pay, but no funding. With no funding, the plan creates no immediate tax concerns for the plan participant, but will create tax in retirement.
