Permanent life insurance can provide you, your family and your professional corporation with a wide range of benefits. One of these benefits is the cash value that can accumulate over time without being taxed. Having this cash value may be just as important to you during your lifetime as it will be to your estate.
Offering you peace of mind
Many permanent life insurance policies allow the investments held in the policy to grow without being subject to annual tax payments on gains on those investments. Although there are some limitations, this feature allows you to potentially shelter a substantial amount of cash value from accrual taxes within the policy.
You might access the cash value of your life insurance policy for any number of reasons, including: taking advantage of personal or practice opportunities, helping to fund your children’s education, boosting cash flow in retirement or dealing with unforeseen financial emergencies.
While you may not intend to use the accumulated cash value of your permanent life insurance policy, you gain security and peace of mind knowing that the funds are available if you need them.
Benefits at a glance
- Convenience—A permanent life insurance policy can be a source of cash when you need it.
- Flexibility—There are several ways of accessing your cash value, some of which don’t involve applying for a loan.
- Growth—A permanent life insurance policy allows you to accumulate cash value on a tax-advantaged basis.
Accessing the accumulated cash value
There are several ways to access the cash value in your permanent life insurance policy–each with its own advantages and disadvantages.
- Policy withdrawal
In certain types of policies, you can take a policy withdrawal from the accumulated cash value in your policy. Since this method reduces the total cash value, it also affects future growth and reduces the death benefit. If any amount of your withdrawal exceeds the pro-rated policy adjusted cost basis (ACB), that amount is considered a taxable disposition, creating taxable income. - Policy loan
A provision in your life insurance policy guarantees you access to the accumulated cash value of the policy, by way of a policy loan. A policy loan is issued by the insurer and the insurer will often charge you interest on the loan, but your policy will continue to grow uninterrupted. Upon death, any outstanding loan balance (including any accumulated interest) is deducted from the death benefit, with the remainder paid tax free to your beneficiary or beneficiaries. - Surrender whole or part of the policy
You can also surrender the whole or part of a permanent life insurance policy at any time for its cash surrender value. A partial surrender will typically reduce the value of the policy. - Collateral loan or line of credit
Your cash value can be used as collateral to secure a line of credit from a third-party lending institution. The main advantage of this strategy is that, under current tax rules, no personal or corporate tax is payable on loan advances. However, this strategy involves greater risk and more administration than a policy loan or policy withdrawal. You’ll also need to apply for the loan and disclose your financial situation to the lender. While you remain the policy owner, the insurance policy is pledged to the lender as collateral for the line of credit. Under this type of loan arrangement, the interest on the loan is either capitalized or paid annually. At death, the loan balance (including any capitalized interest) is repaid to the financial institution from the insurance proceeds, with the remaining proceeds paid tax free to the policy beneficiary(ies).As mentioned, there are risks involved with this kind of collateral loan, so it’s not prudent to purchase a permanent life insurance policy solely for this purpose. Risks include fluctuations in the growth of your accumulated cash value, changes in the interest rate on your loan, changes to tax rules and changes in your own financial situation or objectives.
Understanding the Adjusted Cost Basis (ACB)
Accessing the cash value of a permanent life insurance policy through a policy withdrawal, policy loan or a partial or full surrender of the policy also raises tax issues that need to be carefully considered. These forms of accessing the cash value of a permanent life insurance policy are considered as taxable dispositions under the Income Tax Act (Canada). The taxes may be payable to the extent the cash value that is withdrawn exceeds the pro-rated ACB. The pro-rated ACB will generally be the same proportion of each policy’s total ACB that the withdrawal amount represents of the total cash surrender value of that policy. The ACB is calculated this way:
| Total premiums paid to date (excluding those for additional benefits) | |
|---|---|
| Less | The cumulative “net cost of pure insurance” |
| Less | Policy dividends (if applicable) that weren’t used to purchase additional life insurance or pay premiums for the policy |
| Less | Any policy loans taken in the past |
An insurance professional can explain this further. He or she can also help you obtain the ACB calculations and the accumulated cash value of your policy from the insurance carrier.
Find out what’s best for your liquidity needs
Talk to an insurance professional about the best way to access the cash value of your permanent life insurance policy when you need it. Permanent life insurance can also serve as a vital component of other financial strategies, such as reducing taxes on registered retirement plans or your professional corporation.
Learn more about insurance for physicians or contact your MD Advisor*.
* MD Advisor refers to an MD Management Limited Financial Consultant or Investment Advisor (in Quebec), or an MD Private Investment Counsel Portfolio Manager.
