Most people think of life insurance as a form of protection, providing financial support to loved ones after death. However, for wise investors, life insurance is used as a living asset that can help grow wealth and preserve capital in a tax-sheltered way, while still providing them with the flexibility to access funds. Used strategically, it is an effective wealth-building tool.
More Than Just a Death Benefit
Life insurance is a contract; you pay premiums, and in return, your beneficiaries receive a tax-free payout when you pass away. However, there are some life insurance products which build cash value over time. Certain permanent life insurance policies effectively act more like a hybrid between a long-term investment account and a safety net. With these, the cash value grows tax-exempt, can be accessed during your lifetime, and offers stability during market downturns.
It is important to note that only some permanent life insurance policies, such as participating whole life and certain well-structured universal life policies, can be used in this way, while other policies cannot.
Why Canada’s Wealthiest Families Use Life Insurance
There are several advantages to using permanent life insurance as an investment vehicle.
Tax-Free Growth
The cash value in a permanent life insurance policy grows without being taxed annually.
Tax-Free Access
One of the biggest strengths of using life insurance as an investment is its liquidity. With cash-value life insurance, investors can borrow against the policy without triggering income tax, providing them with flexibility to take advantage of other opportunities or to meet personal needs.
No Market Exposure
No Contribution Limits
Unlike a TFSA, there’s no $7,000/year limit. You can fund your policy with significantly more, allowing larger capital deployment.
Estate Planning
The death benefit is paid out tax-free, helping to offset estate taxes or leave a legacy
A Strategic Asset for Business Owners
For business owners and incorporated professionals, permanent life insurance can also be part of a capital-efficient investment strategy. By routing funds through a cash-value life insurance policy, business owners can benefit from two productive assets. The original life insurance policy continues to grow, while money can be reinvested in the business.
To use this strategy, buy a suitable permanent, cash-value life insurance policy. It will grow in value over time and provide both a death benefit and a living benefit in the form of accessible cash value. Next, the policy is assigned to a bank as collateral, once it has built sufficient cash value. The bank loan can be structured so that it does not trigger taxable income. In many cases, the interest costs may even be tax-deductible, depending on how the funds are used. Finally, the borrowed funds can be used to support the business or other income-generating asset, giving your capital another layer of productivity.
In this scenario, the life insurance policy continues to accrue value and provides a tax-free estate benefit, while the business or other investment can also grow, thanks to the infusion of capital. Importantly, this tactic allows you to retain control over both, and helps maximize working capital without sacrificing long-term financial security.
The Role of Trusts: Control and Tax Planning
Combining life insurance with a trust structure adds another layer of flexibility and control. A trust can manage and distribute insurance payouts to beneficiaries over time, which is especially important for minors or beneficiaries who may not manage a lump sum well. This also helps avoid complications with future policy ownership or taxable transfers.
Holding life insurance inside a trust can help avoid a major tax issue known as the 21-Year Rule. In Canada, this rule applies to most capital property held in a trust, including stocks, real estate, or private company shares. Every 21 years, these assets are considered sold at fair market value, triggering a deemed disposition and a potential tax bill, even if the assets have not actually been sold.
However, life insurance is not considered capital property, so it is exempt from this rule. This means a life insurance policy held in a trust can remain there indefinitely without triggering tax every 21 years. The death benefit can then pass to beneficiaries tax-free and outside of the estate, helping to reduce probate fees and preserve wealth across generations.
However, trusts must be structured carefully. CRA has expressed concerns about certain trust-owned policies, especially when spousal or alter ego trusts are involved, potentially jeopardizing tax benefits. Specialized advice is essential, particularly in regards to premium payments and beneficiary rights.
Key Considerations
While using life insurance as an investment can be highly beneficial, there are key factors to keep in mind.
First, the structure of the policy is critical. Not all life insurance products offer the same advantages, so it is important to work with an advisor who understands both the insurance options and the wealth-building strategies behind them.
If you plan to borrow against the policy, those loans need to be carefully managed. Although the borrowed funds are tax-free, they do accrue interest and will reduce your death benefit if not repaid.
Finally, if a trust is involved, it must be set up with care. Improper structuring can lead to unexpected tax consequences, so specialized guidance is essential to ensure the trust achieves your intended goals.
Is This Strategy Right for You?
If you’re looking to grow wealth, protect your estate, and maintain control over your capital, life insurance might be an excellent solution for diversifying your portfolio. The right policy structure can open up valuable opportunities.
At SafeBridge, we take a personalized approach to every client’s financial plan, ensuring insurance and tax strategies work together to support long-term goals. Contact us today to schedule a consultation and explore the alternatives best suited to enhancing your overall financial plan.
