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Advisor SunLife

Insurance tax rule changes: How will they impact clients?

Life insurance is an important part of retirement planning. Here's an overview of key changes to life insurance tax rules, taking effect as of 2017

By: Marjo Johne

Date: January 3, 2017

Building wealth to support clients’ life goals is a key mandate for most advisors. But that’s just one part of a solid retirement plan – protecting this hard-earned wealth should also be a priority for advisors and their clients.

This is where insurance comes in.

“Insurance provides a way to protect individuals and families financially in the event of a death,” says Noel D’Souza, a Toronto-based fee-for-service certified financial planner with Money Coaches Canada. “In some cases, it might also be useful for tax planning, where insurance is used to reduce or pay for a potential tax liability.”

Given the critical role of life insurance in financial and retirement planning, it’s important for advisors to ensure they have a solid understanding of the various types of insurance available to their clients, says Dean Chambers, vice-president, individual insurance at Sun Life Financial.

“Life insurance plays an important role in a client’s overall financial plan,” he says. “Advisors who ensure clients have the protection they need help establish the foundation that will enable their clients to achieve lifetime financial security.”

There are many ways to use life insurance to protect wealth. A basic strategy, for instance, might take advantage of the tax-free death benefit from life insurance to pass on wealth to the next generation. For the more complex needs of high-net-worth (HNW) clients, advisors could complement traditional savings vehicles by combining the protection offered by life insurance with the ability to achieve tax-preferred cash value growth within the policy.

“That cash value can be accessed later in a number of ways,” explains Mr. Chambers. “For the more complex situations, there may be opportunities to leverage the policy to create a potentially tax-free stream of income while also providing tax deductions.” Life insurance can also be used to preserve the value of a business for shareholders, he adds.

The start of the new year brings a number of changes to the tax rules on life insurance. Here is an overview of these key changes, which take effect on January 1, 2017:

Tax exempt status

• At each policy anniversary, every life insurance policy is compared to a hypothetical benchmark policy called the exempt test policy or ETP. As long as the savings component of the actual policy stays within the savings element of the ETP, the policy will remain exempt. The savings component of both the ETP and the actual policy is measured by the accumulating fund in each policy.

• For universal life policies, the accumulating fund of the actual policy was typically the cash value of the policy, including a reduction for surrender charges. With the new rules, surrender charges will no longer be taken into account when comparing against the accumulating fund.

• The changes to the accumulating fund of the actual policy, when compared to the ETP, affect the pattern of the funding room, with the potential for a reduction over the lifetime of the policy.

• This situation is particularly significant with level cost of insurance universal life policies, because of the change in the calculations for the net premium reserve. This significantly affects the fund accumulation available with universal life policies, particularly for policies with level cost of insurance and a face plus fund death benefit.

• The impact to traditional types of insurance, such as participating insurance, will be much less severe.

• The new 8 per cent rule creates a new ETP when death benefit coverage increases by more than 8 per cent annually. This change could result in less funding room for some product types.

Calculation of net cost of pure insurance (NCPI)

• Changes could result in a lower NCPI, and potentially lower tax deductions for clients using a leveraging strategy.

Adjusted cost basis (ACB) calculations updated

• Substandard premiums will now be included in the ACB calculations of a life insurance policy. In most cases, the lower NCPI will also affect the ACB, resulting in a higher ACB for most product types, and an extended period before the ACB reaches zero.

• Term policies will be affected the least; universal life policies will see the most change to exempt room, NCPI, and ACB.

Mr. Chambers notes that generally, existing policies will be grandfathered under the current rules. He also notes the tax rule changes to take effect as of January 2017 are relevant to both individual and corporate policyholders, although the changes to the calculations of NCPI and ACB may have more of an impact on corporate insurance.

“Regardless of the tax rule changes, Canadians want life insurance and need the basic benefits that it provides,” he adds.

“It’s important to complete a thorough review of clients’ needs and ensure life insurance is in place to protect what matters most to them.”

Advisor SunLife


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