For investors with substantial diversified assets and a portion of their portfolio invested in bonds, redirecting the bond allocation to a life insurance policy can return better guarantees and possibly returns that are double or more what a long term bond would be expected to produce.
Life Insurance for Intergenerational Wealth Transfer
A properly structured life insurance policy can allow you to transfer part of your estate to your children or grandchildren in a very tax efficient method. It allows you to generate tax sheltered growth during your lifetime, then transfer that growth to your children or grandchildren without triggering taxes. After the transfer, your children or grandchildren can access those funds which will trigger taxes – but at their tax rate rather than yours. And until they access the funds, they will continue to grow on a tax-sheltered basis. If desired, the strategy can also be structured to provide a fully paid up life insurance policy to them as well.
The strategy takes advantage of two attributes of life insurance policies. First, growth inside policies is tax-sheltered. Secondly, in specific situations, the CRA allows transfer of assets inside a policy to a child or grandchild without triggering taxation.
Basically, during your lifetime you fund a life insurance policy and take advantage of the tax sheltered investment growth. Upon your death, control of the policy (including the tax sheltered investments) is passed to your child or grandchild. They can now use the investments for education, weddings, or housing purchases, with any withdrawals being taxed in their hands instead of yours.
Wealth accumulation stage
Parent or Grandparent purchase a joint last to die policy (pays at second death, not the first) in conjunction with their child or grandchild. The policy is relatively inexpensive as the mortality will be primarily on the younger person.
The policy is then maximum funded, placing funds into the policy to grow on a tax-sheltered basis.
Wealth transfer stage
Upon the passing of the parent/grandparent, the policy comes under control of the child/grandchild. At this point, they have access to the funds inside the policy that have been growing in a tax sheltered environment.
Variations and Considerations
Policies can be structured so that the policy is fully paid up upon the parent/grandparents death (if they want to provide a fully paid up policy to their progeny).
There are also various configurations surrounding whether this is a parent-child relationship, or grandparent-grandchild relationship. And if it’s a grandparent-grandchild relationship, whether control passes to the parent instead of the child upon passing of the grandparent.
These variations mean it’s difficult to provide a generic example. However since the intention here is intergenerational wealth transfer the one attribute inherent in most policies would be to minimize the insurance component and mazimize the investment component (ensuring that we are maximizing wealth transfer at minimal cost).
We’ve illustrated three strategies that can be used as tools in estate and tax planning; Insured Retirement Plan, Life Insurance As An Asset Class, and Intergenerational Wealth Transfer. All three work due to the tax sheltereing of investments inside policies, and because death benefits (which include the investment component) are paid tax.
A final reminder again that these strategies are excellent ways for those with tax and estate planning considerations to use, shelter, and transfer more of their investments and that similiarly, they are not the best solution for those that do not have tax and estate planning considerations.