Reduce taxes; safeguard wealth

The biggest roadblock to wealth accumulation is taxes.


With minimal volatility, a predictable rate of return, tax reduction benefits and estate protection, Canadian business owners are taking advantage of participating life insurance. Why? Changes to Canadian tax laws combined with lower than optimal returns on fixed return asset classes like GIC’s or bonds have savvy investors looking to participating insurance as a way to get their money working for them in more ways than one.

This Q & A provides a detailed look at why  and how permanent whole life insurance optimizes wealth for business owners by getting their money working in many ways. Tax free investment gains can cover tax debt at death, decrease taxes, reducing risk while delivering reliable returns, protect family, provide liquidity, income & growth and maintain control & flexibility of funds for business investment.

Learn more in this Q & A with Ryan Witmeyer (RW) and John Robinson  (JR) of Strategic Succession. Both Ryan and John have deep expertise in business value enhancement and wealth protection strategies.  


Have questions? here are our client’s top 20 Q& A’s.

 
  1. What is participating whole life insurance?

    (RW) Participating or PAR whole life is a type of permanent insurance and is one of the oldest financial vehicles that dates back more than 150 years.

    (JR) Participating whole life is separate asset class unto itself.  It creates the best of both worlds with a tax-sheltered growth of accumulated funds in the policy and a tax-free distribution of funds upon death.  This unique asset has some of the best returns in the risk management arena.  The growth has been stable over many decades with the variability being less than the consumer price index in Canada. Therefore, the returns and equity inside a participating policy are guaranteed and predictable.

    (JR) This preferred asset class offers not only superior cash values but combines the tax sheltered growth and distribution elements.

  2. Why is participating whole life recommended?

    (RW) Properly structured participating whole life insurance is an ideal vehicle for saving. It allows money to complete different functions including coverage for premature death, buying of other assets, reducing tax, increasing cash flow, providing liquidity for an opportunity/emergency, improving protection, recapturing opportunity cost, recovering control, gaining confidence and lowering restrictions.


  3. Are there any other types of permanent life insurance?

(RW) There are generally two types of permanent insurance that create cash value growth which are universal and whole life. Universal life is designed to be more flexible and they have different investment options within the contract. However, these policies shift all the burden and risk of managing the policy from the insurance company to you, the policy owner. Alternatively, whole life has guarantees and cash value accredited to the policy can’t drop in value. For this reason, we recommend properly structured whole life insurance for building the foundation of a wealth plan.

(JR) The two main types of permanent insurance are:
       i. Universal Life, which is good alternative if the client is willing to accept
             investment risk.  They must make decisions from time to time about
             selection of investments that drive the returns inside the policy.  
      ii. Participating whole life, on the other hand, is a more passive asset which
            is proven to have superior returns over a longer period of time because
            of the guaranteed cash values and dividends.  
            In general, business owners and investors take enough risks in other
            places in their life, they should not have to do it in their insurance
            arrangements.

4. What is the difference between participating whole life insurance and term insurance?

(RW) Term insurance provides coverage for loss of life at a specific price for a specified period or term which usually is 10, 20, or 30 years. Costs can be quite low because policies typically are cancelled or terminate before death occurs. For this reason, it’s estimated that 99 percent of all term policies never pay out a claim. Alternatively, participating whole life insurance is designed to be in place until death with a guaranteed fixed premium. Think of whole life as being an ‘owner’ of the insurance whereas term is being a ‘renter’ of the insurance.

(JR) As the name indicates, whole life is designed to last for the entire lifespan of the insured person.  The premiums are generally level and guaranteed.  In most cases they can be paid up in a shorter period of time.

(JR) Term insurance on the other hand as the name implies lasts for a term or period of time.  There is no cash value in a term policy.  It is strictly designed as risk coverage. If premiums were not paid, the policy would lapse due to nonpayment of premiums.  Cost for term insurance always go up as age increases for the insured party.  Term insurance will have a finite end period when the insurance will terminate.

(JR) The analogy is the difference between renting and owning.  In term insurance you simply rent a risk coverage for a period of time, and whole life you will own the policy and the cash values for your entire life.  In doing more sophisticated estate planning, tax restructuring, it is usual that a client will opt for permanent insurance, as the need is also permanent.  This matching of the need and insurance must go hand-in-hand.

5. What is the main benefit of whole life insurance?

(RW) Properly structured whole life insurance designed for maximum cash value growth allows for the powerful use of the ‘living benefits’ of the contract including safety, guarantees, flexibility, liquidity, control, and tax advantages.

(JR) The main benefit is that premiums can be paid up in a limited period of time.  The growth inside these policies is tax-sheltered and does not attract income tax.  In addition, a death benefit will be paid out on a tax-free basis.  The rate of return has been very stable over decades and decades of time analysis.  It is one of the least volatile asset classes today. The cash values can enhance the balance sheet of a corporation or the net worth of an individual.  If structured properly, these plans can be paid up in a limited period of time and be sheltered completely from income tax.

6. Why haven’t I heard about the tax benefits of whole life insurance before?

(RW) The growth in permanent life insurance contracts is exempt from annual taxation. Furthermore, death benefits are received tax free. Taxation is the biggest challenge to wealth accumulation and permanent life insurance helps to overcome this challenge.

(JR) Pre-1975 whole life was in-vogue and offered by most companies and advisors.  In an interest rate environment, where interest rates could be generated in the 10-20% range, it fell out of favour.  There was then the movement of buy term and invest the difference.  The problem being that most people never invested the difference and were left with nothing.  Whole life coverage is a more sophisticated product, especially when used to back loans and is not clearly understood by most insurance advisors and/or investors.

7. Why are the gains inside whole life tax exempt?

(RW) According to the Income Tax Act, growth in permanent life insurance is exempt from annual taxation.

(JR) Gains inside a whole life plan are tax exempt under the Canadian Tax Act Section 148.  Any gains or growth are sheltered from tax until such time as they are either surrendered or cashed out.  Note: individuals may take out up to approximately the amount they have paid without generating a tax bill.  If in fact they withdraw more than they have put in in general, this could create a tax liability by way of interest profit.  Therefore, the sheltering aspect refers to the internal cash value.

(JR) The tax exempt status of a permanent policy refers to the death benefit of such a policy when paid out to the beneficiaries.  
(JR)  Clarification between the word tax-exempt and tax sheltered: The gains inside a permanent insurance policy would be tax sheltered; whereby the death benefits of a permanent insurance policy are tax-exempt when paid out.  

8. Can any insurance company or advisor provide participating whole life insurance?

(RW) Only a handful of insurance companies offer participating whole life insurance in Canada. Although most advisors have access to these products, it’s very important to work with someone that understands opportunity costs, portfolio asset allocation and setting-up a policy for maximum cash value growth. Although life insurance is being used for the death benefit, the power of the financial vehicle is the living benefits obtained through liquidity.

(JR) In general any insurance company that has permanent insurance, i.e. universal or whole life, can be set up this way; however, in our decades of experience, a company or life insured is generally better to stick with one of the mainline big 5 carriers in the marketplace that have large portfolios of tax-exempt life insurance.

9. What kind of returns can I expect?

(RW) Participating whole life insurance is a safe predictable savings vehicle with lower long-term volatility then 5-year term deposits or GICs. With the current dividend scales you can expect a 4% – 5% internal rate of return (IRR) over a lifetime. Depending on your tax bracket and the nature of the tax-exempt structure, these rates may be comparable to other fixed income investments that return 6% – 10% before tax.

(JR) In general, the internal rate of return on an insurance policy including dividends with most of the large carriers today is in excess of 6% per year which again is tax sheltered. Therefore, an individual would have to generate a substantially higher rate of return pre-income tax to net this amount of return for themselves.

(JR) The returns can be amplified in a cash-value policy by using the insurance policy as security for a loan which would thereby be used for a secure investment.

(JR) Because the rates of return have been so predictable and stable over so many decades, this type of an asset class can be used to replace GICs and term deposits in one’s portfolio.

10. How much of investment is required to get started?

(RW) This depends and is different for every situation. Permanent insurance requires consistent premium deposits for a period of ten years or more. The use of whole life as part of an overall wealth plan is best suited for someone that has consistent cash flow or investable assets that can be transferred overtime.

(JR) The amount of investment is determined by the face amount of the coverage and the age of the life insured. In general, to have a meaningful program one would want to start with at least $25K per year of investment.

11. What can I use whole life insurance for?

(RW) The ‘living benefits’ of whole life can be used for anything. We recommend that individuals use these contracts to enhance their wealth by using conservative leverage and buying income producing investments overtime or investing back into businesses.

(JR) Obviously the death benefit can be used tax-free by the beneficiaries for anything that is required: the tax liability to pay off debts, to satisfy contractual arrangements under a shareholders’ agreement and to take care of a family and so on.

(JR) However, there are many other uses for whole life insurance to secure loans for other investment purposes, possibly to reinvest back in the company that has made the premiums in the first place, additionally to support one’s senior years in retirement if funding is necessary. In fact, the number of uses is limitless.

(JR) The accounting community is now coming to the understanding that permanent insurance is also an excellent way to bolster the balance sheet as the cash values are shown as a current asset (life insurance cash value).

12. Term insurance is less expensive, why not buy term and invest the difference?

(RW) Some issues with typical comparisons of whole life versus ‘buy term and invest the difference’ include: Ignores the ‘option value’ of maintaining coverage – whole life provides the option to keep coverage in place until death while term insurance will eventually expire. A whole life policy’s cash value is guaranteed to grow while a side fund for ‘investing the difference’ can fall. The ‘rate of return’ comparison can be very misleading when factoring in risk. Depending on the setup of the side fund, its market value may be inaccessible for decades.

(JR) This school of thought was prevalent in the mid-70’s - 2000’s. History has shown that the for clients who have a short or temporary need for coverage certainly term insurance may be better. However, ones that have a longer term or permanent need for risk management or liability protection should use whole life or universal life coverage.

(JR) The old saw buy term and invest the difference simply has not proven to be workable as all the people who did buy the term did not invest the difference, and as a consequence have unfortunately been left with a very expensive insurance policy in their later years and no capital pool to support that. It sounds good in theory but not in practice.

13. Who can benefit most from an investment strategy that includes whole life insurance?

(RW) The use of whole life as part of an overall wealth plan is best suited for someone that has consistent cash flow or investable assets that can be transferred overtime.

(JR) Unfortunately the passive income streams held inside a holding company will be taxed at the top marginal rates. These includes bonds, certificates of deposit, savings accounts, rent, etc. Depending upon the province these investments may be taxed at rates of approximately 50% or more (for example, Alberta is 48%, BC 49.8%, Manitoba 50.4% , Ontario 53.53%, Nova Scotia 54%).

(JR) Any individuals are able to benefit from this strategy but most particularly corporations that hold investments. Many people choose to have a holding company hold their investments. Unfortunately, passive income inside a corporation is taxed at the absolute highest possible rate in every province in Canada. The growth in whole life insurance, as mentioned already, is non-taxable. From an investment perspective, the uses of cash-value life insurance are virtually limitless. Suffice to say, that many business owners choose to leverage their insurance to provide additional capital through credit facilities to buy other and ongoing investments. This plan tends to generate enhanced returns for the overall portfolio strategy on top of the resisting returns inside the insurance policy.

14. Is my money tied up in the plan or accessible for growing my business?

(RW) No, your money is not tied up. An important consideration is that most of the cash value of a properly structured participating whole life contract is always accessible. Alternatively, premium financing is an option to free up more money quicker in qualified situations.

(JR) Funds are available inside an insurance policy for many different ways. The life insurance company would obviously give you a loan on the cash value within a policy on their books. Additionally, a partial or full surrender could be taken on the policy at any time. The cash value inside an insurance contract is shown on the balance sheet as current assets “life insurance cash value”. We most frequently see an insurance policy assigned to an outside financial institution as collateral for a loan, the funds to be used to reinvest back in the business or could be used to obtain alternate outside investments.

15. I already have term insurance; why do I need whole life?

(RW) You don’t. However, where are you currently saving your money? Properly structured participating whole life insurance is an ideal vehicle for saving. It allows money to complete different functions including coverage for premature death, buying of other assets, reducing tax, increasing cash flow, providing liquidity for an opportunity/emergency, improving protection, recapturing opportunity cost, recovering control, gaining confidence and lowering restrictions.

(JR) The concept of risk matching is important. Some risks like family protection, mortgage or debt protection are temporary needs and could be covered off quite easily with term insurance.

(JR) However, other types of needs may lend well to having permanent insurance, such as deemed disposition or tax on one’s estate. In general, this number never gets smaller and always gets smaller as the individuals or investments age. A number of buy-sell arrangements lend themselves well to using permanent insurance because it also has a cash value that can be used as a sinking fund for the eventual share buyout.

16. How come my advisors have never told me about this?

(RW) Most advisors don’t know. Traditional financial education doesn’t focus on understanding money, banking and opportunity costs. Typical advice is often given in ‘silo’ fashion without understanding how all parts of a wealth plan work together. There is simplicity when using properly structured whole life insurance since your money is completing many different tasks within the powerful financial vehicle.

(JR) I guess the old saw “advice is only as good as the person you asked”.

17. How does an insurance product become an income generator?

(RW) Your wealth is always in motion and you can profit from that movement by investing into income generating opportunities. Properly structured participating whole life provides a solid foundation for savings that can then be used for income investing purposes. Proper education and understanding allows for the recapture of lost opportunity costs which ultimately expands wealth.

(JR) The flexibility of participating whole life is virtually unlimited. There have been many incidences where individuals have used the cash value to enhance their existing retirement income. It can be used as a sinking fund to facilitate share purchase arrangements in the future. As previously mentioned, most clients end up securitizing these cash values for a series of ongoing loans to participate in other investments that produce income or to simply spend the money. Lastly, most of the bigger insurance companies, have provisions that if the person is terminally ill, they will pay out a portion of the death benefit well in advance of the actual event.

18. Who is best suited to take advantage of an investment strategy that includes whole life?

(RW) Permanent insurance requires consistent premium deposits for a period of ten years or more. The use of whole life as part of an overall wealth plan is best suited for someone that has consistent cash flow or investable assets that can be transferred overtime.

(JR) In general, the higher the net worth of the client, the more aligned they would be probably be with the use of permanent whole life. It also lends well to being used as an investment inside a holding company that has passive assets because it eliminates the tax on investment revenue. Once clients are properly educated about the flexibility and uses, they can then take and leverage the cash value on other investments through the use of loans.

19. I already have an advisory team, how does this strategy work with what I’m already doing?

(RW) A properly structured participating whole life contract is designed to complement and enhance what you are already doing. Using this vehicle is not an ‘either or’ but rather an ‘and’ strategy where your money can do more.

(JR) Most of our case work is done in conjunction of multi-disciplinary consulting with other professionals, CPA, LOB, and other financial advisors. Our specialty at the Trusted Advisor Network is ensuring that this type of planning dovetails with anything and all other facets of the client’s existing structure.

20. How can I find out if this is right for me?

(RW & JR) Give us a call or send us an email. We’d be happy to have a meeting in person or on the phone, whichever works for you.

Meet Ryan Witmeyer

As a wealth strategist, Ryan specializes in de-risking companies and creating low-risk tax-sheltered capital pools to enhance business value and increase flexibility for business owners. He is a numbers and strategy guy at heart, calling on his experience as a Certified Financial Planner (CFP), a Chartered Investment Manager (CIM), Chartered Life Underwriter (CLU) and traditional BComm education in Entrepreneurial Management (Royal Roads University).

Connect with Ryan Witmeyer at (604) 910-8187, on LinkedIn or by email: ryan@strategicsuccession.com

Meet John Robinson:

John has been helping business owners for 35 years increase their company’s value to optimize their sale and/or succession outcomes. Maximizing enterprise value and transforming business performance from average to excellent is his specialty. John is a Certified Financial Planner (CFP), Elder Planning Counsellor (EPC) and Certified Exit Planning Advisor (CEPA) from the Chicago-based Exit Planning Institute.

Connect with John Robinson at (604) 874-4429 x 101, on LinkedIn or by email: john@strategicsuccession.com