The 2016 proposed federal budget and introduction of changes relating to life policies issued January 1, 2017 and beyond are the focus of many articles, most of them hard to understand due to the technical jargon needed to explain these changes. The result has been a preponderance of rumors. What is all the noise about and what changes should you care about?
The proposed 2016 federal budget contains 3 provisions that affect the taxation of death benefits of existing and new life policies that are corporately owned, whether the corporation is an investment, professional or active business. They are complicated, but in reality, affect very few of these policies. The changes represent a desire by the federal government to clean up sections of the Income Tax Act (ITA) that resulted in preferred taxation i.e. they closed some loopholes. Unless your corporation owns a life policy that was previously transferred into the corporation at its fair market value (FMV) or the beneficiary of the policy is a different corporation, there is likely no change that you need to be concerned about, or better still, try to understand. If any of the two scenarios apply to you, call your insurance advisor to discuss.
The changes to life insurance policies issued January 1, 2017 and beyond, whether personally or corporately owned, affects us all both positively and negatively. These changes include but are not limited to, the reduction of tax free contribution room available within a policy, how much death benefit can pass tax free through a corporation, how much cash value can be withdrawn tax free, and the cost of level insurance premiums. These changes are meant to reflect our longer life expectancy and equalize the variables used by insurance companies in their product creation. Existing life policies, in effect before January 1, 2017, are considered grandfathered, although there are some events that may result in the loss of grandfathering.
Overall, it is better to take out life insurance in 2016 rather than 2017 if it is going to be:
- Corporately owned, as more, if not all, of the death proceeds can be paid tax free out of the corporation.
- Overfunded, as the room to add extra premium to increase the death and cash values on a tax deferred or tax-free basis is higher.
- Used as collateral for a loan in which a portion of the premium is being deducted, as the amount that can be deducted is higher.
- A permanent policy such as a T100 or Level Cost of Insurance Universal Life policy, as the cost of insurance is lower.
- A prescribed annuity, as more of the payment is considered a tax-free return of capital and subject to less tax.
Overall, it is better to take out life insurance in 2017 if it is going to be:
- A rated policy and used as collateral for a loan.
- A personally owned policy in which the objective is to use policy loans to withdraw cash at some future date.
There are a number of changes in regards to the taxation of life insurance. The rules are complicated and there is a lot of misinformation. Talking to your insurance advisor about how the new tax rules affect your financial situation is recommended as there are actions that are better taken in 2016, before the changes apply in 2017.