Each year as RRSP season draws to a close and tax season begins to ramp up, we get a lot of questions from high-income earners and business owners, including successful Mortgage Agents and Brokers.
They are frustrated after being limited to their RRSP contribution room, or after having just written what felt to be a much larger check to the CRA then they expected.
The reality however is that there are options. One of which is understanding the tax-free power that a properly structured life insurance policy provides. And not just for loved ones or the next generation, but for you. Our discussion inevitably turns to helping our client truly understand how to turn a tax-exempt, cash-value life insurance into one of the safest and most powerful assets in their portfolio.
Life insurance is by far the most misunderstood asset class in Canada. Most people only see it as a benefit to their dependents or their already successful family members. But that forces the question. Why do almost all the wealthiest families in every industrialized nation in the world see this instrument as an asset to use for themselves, not just the next generation?
If you’re a high-income earning professional or business owner, you can use life insurance to create tax-free growth, tax-free income and a liquid, accessible tax-free account during your lifetime. Sound familiar? All three of these benefits are what make a traditional TFSA so powerful, only this asset does not come with a $6,000 annual deposit limit, or need to be held in your personal name alone.
Whether you are incorporated or not, using life insurance as an asset gives you three critical advantages:
- Tax-Free Growth: Whether you own your policy, a Holdco owns it, or even a family trust owns it, there’s steady, predictable growth of your tax-free cash value.
In fact, these policies have been paying a profit every year since 1848 in Canada, without ever missing a single year.
- Tax-Free Access: How many financial products in Canada offer you both tax-free growth and tax-free access? Only three. Your TFSA and principal residence and of course, your personally or corporately funded life insurance policy.
Tax-free, predictable retirement income is an absolute priority for all Canadians during retirement.
- Capital Preservation: Market volatility has hit every Canadian at least once in their life. Especially in the past year.
One of the unique features of cash-value life insurance is that your dividend cash value vests each year. This means that you never have to worry about a market crash or even subtle decrease, because your cash is safe and contractually guaranteed.
The biggest reason why wealthy families own life insurance is not because they need life insurance. It is because they understand the inherent value it provides as a tax planning tool and specifically, a tax-free living asset as they continue to build their family’s generational wealth.
If you’re like many of the families and professionals we work, you are more focused on wealth creation then you are wealth preservation. That makes access to your capital essential which is especially true if you invest in private mortgages and real estate.
One powerful strategy that many of our clients use as they continue to accumulate their own family wealth is to use their policy as an asset that can be leveraged to build additional assets.
If you own a business, invest in real estate, or fund private mortgages, this is a unique strategy for you.
Why not consider flowing those same taxable dollars through a tax-free life insurance policy first, then right back out to the original investment or asset you were going to take advantage of in the first place?
You have effectively used one source of capital to build two separate assets simultaneously. All the while ensuring that your family keeps as much of the wealth you have built over your lifetime, without having to fire sale half of it to pay your terminal tax bill with the CRA.
Sound familiar? The exact same concept and tax rules apply to borrowing from your real estate to invest in your business or other qualifying assets.
Using this strategy ticks a lot of boxes for high income earning professionals and business owners:
- You own a permanent life insurance for life and are only responsible for the interest on your loan
- You have created a tax-free benefit to your estate or business that will cover your terminal tax liability
- You have repurposed funds you were already investing to create two assets and an estate benefit
- If corporately owned, you can use corporate tax dollars to fund this policy as opposed to personal tax rates of 50% or higher in some provinces
If you’re looking for new ways to build wealth as tax efficiently as possible, this is an asset class worth understanding.
1. You purchase a cash value life insurance policy
2. You assign this policy to any major Canadian bank
3. This bank then lends you back 100% of your annual deposit, or 100% of your total cash value
4. You reinvest these proceeds into your business, real estate portfolio or investment of your choosing