As a continuation of our series on life insurance, this week we explore the concept of life insurance being used for estate planning. In our previous articles, we discussed the different types of life insurance – from Term Insurance to Permanent Insurance – and the different types of permanent insurance, including the pros and cons of each.
What is Estate Planning?
An estate is the net worth of a person at any point in time alive or dead. That is, the sum total of a person’s assets – legal rights, interests and entitlements to property of any kind – less all liabilities at that time. Estate planning therefore is the process of anticipating and arranging for the disposal of an estate during a person’s life. Estate planning thus attempts to address and eliminate uncertainties over the administration of a probate and maximize the value of the estate by reducing taxes and other expenses. However, the ultimate goal of an estate plan is determined by the specific goals of the client and may be as simple or complex as the client’s needs dictate
The Costs of Dying
When a person passes away in Canada, there are certain costs that need to be considered (besides just the funeral expenses), such as probate fees, taxes and, in the case of business owners, succession planning. In regards to taxes, there are multiple taxes that need to considered such taxes on tax deferred investments, taxes on capital gains, as well as taxes on income earned in that tax year (terminal tax). Any assets owned by the deceased are deemed to have been disposed of; that is, it is assumed they were sold right before death. Let’s briefly look at what these costs are.
Probate Fees: Upon passing away an executor needs proof that they are authorized to represent your estate. This process provides the courts all the documents as requested by the government, financial institutions, agencies, etc. This process is known as probate and comes with a cost. This cost can run pretty high. The official fee is a percentage of your estate value and varies by province (1.5 percent in Ontario). This is also known as estate administration tax.
Tax on tax-deferred investments: Investments in registered accounts, such as RRSP’s and RRIFs, will be subject to tax at the highest tax rate, unless you have a spouse, in which case, the proceeds will be passed unto them tax-free, but will be subject to taxes upon withdrawal or death.
Tax on capital gains: You are deemed to have disposed of any capital assets upon death, which are taxable except your principal residence.
Taxes on income: In the year that you pass away, your estate still needs to file a tax return on your income for that year. This is known as the terminal tax return.
Corporate taxes (for business owners): Normally, excess corporate funds stay trapped within the company, attracting high taxation no matter how you manage the funds. Without a proper plan taxes could significantly deplete what is left during succession planning.
Considering all of the above, it can be very expensive to die. The more wealth you accumulate, the more attention needs to be paid to your annual and pending estate tax liabilities. Life Insurance, along with Wills & Trusts and many other strategies is one of such tools used in an estate plan. With life insurance rather than just paying out these taxes from proceeds of an estate, proper tax planning can help ensure the taxes don’t deplete the estate. (This is even more important if a major portion of your estate consists of shares of private companies or real estate, in such cases it may not be possible to satisfy your tax bill on death without selling off the assets.)
Life insurance provides that cash payment for these taxes at a much lower cost than would have been paid. It can be designed that either your company or you own the policy, but both options have different advantages. Furthermore, due to the effectiveness of life insurance as a tax planning tool, the government is constantly looking to close loopholes, so it’s important to periodically review any estate planning measures using life insurance with a tax and insurance planning specialist.
Life Insurance which is often ignored can play a significant role in an overall financial and estate plan. It’s important to sit down with qualified and caring professionals to ensure you, your family and business are prepared. It is also an ongoing process that needs to be constantly reviewed. If you have any questions about this article or creating a well-structured financial and estate plan, feel free to contact our office.