Big Changes Coming to Life Insurance

April 12, 2016

Changes are coming to the rules governing life insurance policies in Canada—and they may affect you.

The federal government has passed legislation that will alter how life insurance is taxed for policies issued after January 1, 2017. This has potential tax implications for policyholders.

If you have an existing life insurance policy, it will be grandfathered and nothing will change. But your policy may lose its grandfathered status if you make certain modifications to it after January 1, 2017.

We recommend that you contact your MD Advisor or MD Insurance Consultant to find out whether the new rules might affect your existing insurance or your plans to buy insurance in the future.

The essentials remain the same

Despite the potential tax implications of the new rules, life insurance remains a powerful financial planning tool.

For incorporated physicians, it will still be a tax-efficient way to pass down money from a corporation to surviving shareholders and/or beneficiaries on the death of the insured person.

Still, in some situations you may be wise to lock your policy in under the old rules. Let’s take a look at three scenarios in which a physician may want to review his or her insurance situation before the new legislation comes into effect.

Scenario 1: Physician has an existing term policy

Dr. Anjali Modi, 36, is a family physician with two young children. At this stage in her career, she’s finding it tricky to balance her financial priorities. Between paying down her medical school debt, buying a house and paying for child care, there isn’t a lot of breathing room. Yet a few years ago, she knew she needed life insurance too.

While she recognized the value that permanent insurance could bring to her financial plan, the most affordable solution—term insurance—is what Dr. Modi bought. Term insurance provides pure insurance coverage for a specific period of time. It will give her beneficiaries a tax-free death benefit if she passes away during that period. If she dies after that, no death benefits would be paid out. Term policies also have no accumulating cash value, while permanent life insurance policies do.

Dr. Modi felt a $1 million policy was adequate to cover her family’s financial needs if she were to die unexpectedly. Her term policy gives her the option of converting to a permanent policy, with its additional tax-advantaged benefits, without any requirement for proof of good health.

Recommendation: Dr. Modi should consider converting to a permanent life insurance policy before January 1, 2017. Converting now would ensure she can benefit from the tax deferral and tax-advantaged features of a permanent policy under the current rules. After January 1, 2017, the advantages of converting to a permanent life policy could be significantly lower as a result of the new rules.

Dr. Modi should contact her MD Advisor or MD Insurance Consultant to review her long-term planning.

Scenario 2: Physician plans to grow assets in a permanent life insurance policy

Dr. James Theriault, 50, incorporated his medical practice more than 10 years ago. As part of his long-term financial strategy, he plans to start transferring excess corporate assets—money that he doesn’t need access to—into a permanent life insurance policy.

There are tax advantages to moving money into an insurance policy owned by the corporation. By making extra premium deposits in his policy (in excess of the cost of the insurance), Dr. Theriault will create additional cash value. This will accumulate on a tax-advantaged basis, thus increasing the death benefit.

When Dr. Theriault dies, the death benefit is paid to his corporation (the named beneficiary) tax-free. The corporation receives the proceeds of the death benefit as a credit to its capital dividend account (CDA). Proceeds are then paid out to the corporation’s shareholders as tax-free dividends, net of the policy’s remaining adjusted cost basis (ACB), if any. If there is an ACB amount, it can be paid to shareholders as a taxable dividend.

Recommendation: With the help of his MD Advisor or MD Insurance Consultant, Dr. Theriault should consider applying for a permanent life insurance policy and implementing this strategy before January 1, 2017. That’s because if he waits until the new rules are in effect, the extra premiums he can pay into a policy (over and above the cost of the insurance) may be less than under the current rules.

Also, the new rules are expected to increase the level of the ACB compared with the current rules. The combined effect may be that the CDA credit paid to surviving shareholders will be lower, with a larger percentage of it taxable compared with the same strategy implemented under the current rules.

Scenario 3: Physician wants to transfer wealth to grandkids

Dr. Douglas Parker, 65, is recently retired. During his career, he managed to save and invest enough wealth to enjoy a comfortable lifestyle. He’s happy with his financial plan, but is looking to transfer about $500,000 to his three grandchildren in a tax-efficient way.

The grandchildren are currently 16, 13 and 8 years old. Dr. Parker wants to maintain control and oversight of the money until the grandchildren are mature enough to assume responsibility.

One solution Dr. Parker is considering is buying permanent life insurance policies on the lives of his grandchildren. He would be the owner of the policies and make premium deposits. At any time after the grandchildren are 18, and when he feels they can prudently manage the policies, Dr. Parker can transfer policy ownership to them. This type of policy ownership transfer qualifies as a tax-free rollover under the Income Tax Act (Canada).

Each grandchild will then become the owner of his or her own life insurance policy and have all the rights associated with that ownership. They can choose to withdraw the funds from the policy’s cash value and pay any taxes owing on it at their then assumed tax rate; or they can let it continue to grow as part of their own financial plan.

Recommendation: Dr. Parker should consider implementing this wealth transfer strategy before January 1, 2017. Permanent life insurance policies issued after January 1, 2017 may not be able to accumulate as much cash value as policies issued before that date. This could lessen the long-term benefits for his grandchildren.

Your MD Advisor or MD Insurance Consultant can answer any questions about how the new rules might affect you and your family. They can help make sure you have the right insurance coverage in place as part of your overall financial plan.

For more information about financial planning, contact an MD Advisor. MD offers objective advice at every stage of your career—from medical school through retirement. Find an MD Advisor near you.

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