Financial Post / Rechtshaffen: Borrowing against life insurance can be a unique source of cash — if you can do it


A large benefit of life insurance is the ability to use the cash value and even borrow against it

By Ted Rechtshaffen and Asher Tward

There is nothing like finding cash where you don’t expect it and for some Canadians, their life insurance policy may just be that source of cash.

Many Canadians own life insurance, the most common of which is term life insurance. This is insurance you own for certain periods of your life, and then the coverage ends. It is often a 10- or 20-year term policy, indicating the number of years of coverage. Another common example is having term coverage that ends at age 65 or 75.

Unfortunately, there is no way to borrow against term life insurance in Canada, but it is possible using permanent life insurance with cash values, usually whole life and universal life, which is meant to cover some things beyond just risk management.

In short, it’s insurance that is meant to be held until death. It can be helpful for tax, estate planning, and simply as an investment asset class.

A large benefit of life insurance is the ability to use the cash value and even borrow against it. This would be similar in many cases to a line of credit, but rather than using your home as the collateral, you are using the cash surrender value of the life insurance.

This line of credit can be set up, and be used or not used, as needed. The best part is it provides access to capital that is not tied to your home and is otherwise not usable by you. This loan would only be repayable upon death using tax-free proceeds from the life insurance policy.

One area where we often use this type of insurance is in corporate planning. Some Canadians have professional or holding corporations that are helpful for tax purposes, but in most cases, you must pay tax on the assets if you ever want to use them personally (by withdrawing funds as taxable income or dividends).

Permanent life insurance is one of the best ways to get money out of a corporation tax efficiently. The biggest problem is that this is in most cases a generational transfer of funds, rather than assets you can pull out to use during your lifetime.

To overcome this issue, there is a specific way to set up a personal line of credit against the collateral in a corporate-owned life insurance policy. We see this as a unique opportunity: effectively making the living benefit of corporate cash available personally, while still having the tax-effective growth within the policy inside your corporation.

This is not just an opportunity for corporate-owned policies. If you hold a policy personally, and it has cash surrender value, you can also borrow against it.

Typical users of this corporate strategy would be a business owner or highly paid professional with an investment or holding corporation that has a value of at least $1 million and is generally not drawing money out of their corporation (or they are seeing the corporate assets growing faster than any withdrawals).

In these cases, owning life insurance in the corporation can be a great tax and estate strategy on its own, but the collateral line of credit might allow them to buy a cottage or other real estate investments personally, or use funds to help family members. If used to generate income, the interest cost would likely be tax deductible personally.

There are a few important things to remember.

With a collateral loan, you can borrow as much as 95 per cent against the cash surrender value of a whole life or universal life policy (sometimes less for universal life). If you have life insurance, but little or no cash surrender value, then there is nothing to be borrowed against.

The insurance policy must make sense as part of your overall planning. Borrowing against the policy can have real benefits, but the insurance planning comes first.

You will need a bank that has a specialized lending program to set this up.

Banks will re-look at the loan limits over time as your cash values rise. This is very valuable as most whole life plans dramatically grow over time, and this could create ever more funds that can possibly be borrowed.

Just like a line of credit that you might be more accustomed to, there is an interest cost, often in the range of prime plus 0.5 per cent for a collateral loan.

What I have been talking about here is collateral loans. There is a different way to borrow against a life insurance policy, and that is using what is called a policy loan, which is one where an insurance company will let you borrow against the policy itself.

One of the benefits of a policy loan is that you can capitalize the interest, meaning you can let the loan build without paying it down. This is structured so that the loan would be repayable at death, out of the Insurance policy proceeds. It is also an unconditional loan that requires no financial underwriting.

A policy loan may seem fairly similar to a collateral loan, but there can be a big tax difference. It can get a bit technical, but if someone receives a policy loan from the insurance company, and the value of that loan exceeds the adjusted cost basis of their interest in the policy, then the loan will be considered as taxable income.

It is for this reason that we prefer collateral loans since the loan will not be considered taxable because it isn’t borrowed from the policy itself. That said, depending on your situation, there may be other technical considerations that should be reviewed with your accountant before proceeding.

Borrowing against a permanent life insurance policy isn’t an option for many, but for those who can do so, it can free up meaningful cash while you continue to have a tax-efficient and strong estate planning component in place.

Reproduced from Financial Post, March 7, 2023 .

Financial Post / Rechtshaffen: 4 ways the wealthy can make a dent in a large tax bill


These ideas could help the wealthy pay 5 times instead of 7 times what the average person pays on taxes

The top 20 per cent of Canadian income earners pay more than 61 per cent of the income tax, according to a Fraser Institute study from 2022. Today, the marginal tax rate in Ontario for those earning over $235,675 is 53.53 per cent.

Nevertheless, our prime minister said in 2017, “Everyone knows, the middle class pay too much in taxes and the wealthiest don’t pay enough.”

For those, who may not agree with him, let’s look at four ways wealthier Canadians might save on taxes so that they might only be paying something like five times instead of seven times what the average person pays.

Flow-through shares

For more than 50 years, the Canadian government has had a program to help support the mining industry by encouraging investment in exploration and development projects. This program allows Canadians to invest in shares that qualify for flow-through credits.

It benefits investors in two major ways. The first is that money invested in flow-through shares is deducted from your taxable income, just like registered retirement savings plan (RRSP) contributions. The second is that there are additional tax credits provided by the federal and provincial governments. The tax benefits are significant, especially for those who are paying marginal tax rates at the top bracket — usually more than 50 per cent.

One drawback with flow-through shares is that the shares you buy are considered to have a zero-cost base, so it creates capital gains. Even with this drawback, the tax on capital gains pales in comparison to the tax savings above. Having said that, if you have meaningful capital losses to carry forward, this makes flow-through shares an even better investment.

The other drawbacks are that you have to invest in shares of companies you might not otherwise want to invest in, and sometimes flow-through shares are purchased at a premium over the true market price of a stock.

This risk can be eliminated in some cases with specialized flow-through share programs that lock in the price of the stock. The net result is that there is certainty about the tax benefit to you overall, without the potential future gain or loss on the stock.

Life insurance purchased by your corporation

This is ideal for someone who has a holding company or professional corporation with a value of $1 million or more, especially if they are unlikely to spend these funds in their lifetime.

Like an RRSP or registered retirement income fund (RRIF), money in a corporation is taxed when withdrawn. Unlike the RRSP or RRIF, the income earned in the corporation is taxed fairly highly if it is considered passive (generally considered to be income earned through minimum labour).

Some wealthier Canadians have managed to build up funds in their corporations, but are able to access money more tax efficiently from other places. The challenge is that the income on those funds is taxed highly in the corporation and, ultimately, the funds will be taxed upon the death of the corporation’s owner.

Life insurance on the corporation’s owner (this can sometimes be expanded to others) can be purchased by the corporation. One benefit is that the funds shifted to the life insurance policy are no longer subject to tax. But the biggest benefit is that a sizable percentage, if not all of the ultimate insurance payout, will be able to come out of the corporation tax free.

In many cases, the after-tax benefit of this strategy will be of significant financial benefit whether the insured lives one, 10 or 30 more years. In the right situation, it simply becomes wise estate planning, because most of the time, returns in excess of 10 per cent per year are possible if it is set up properly.

Using taxable investment income more effectively

This often applies to anyone with meaningful assets invested in taxable accounts, either personal non-registered accounts or corporate accounts.

As most of us know, in general, a dollar of income earned in a tax-sheltered account such as an RRSP, RRIF or tax-free savings account (TFSA) will not result in any tax owing, while that dollar of income in a taxable account is taxable. Of course, whether the dollar of income is interest income, Canadian dividends, capital gains or a return of capital determines how it is taxed.

The tax opportunity here is that some people hold tax-inefficient investments in taxable accounts and hold some tax-efficient investments in accounts that are tax sheltered.

For example, if you hold a bond paying six per cent in a taxable account, while at the same time you hold Alphabet Inc. shares (that don’t pay a dividend) in your RRIF account, you could lower your tax bill while not changing your investment holdings. You would simply sell both investments, then buy the Alphabet shares in your taxable account and buy the bond in your RRIF.

This will lower your taxable income because the interest income is now tax sheltered. The Google shares might create tax if you sell them for a capital gain, but it will be taxed at half the amount. If you end up selling the Alphabet shares at a loss, you can use the capital loss against other capital gains.

From a tax-efficiency standpoint, stocks that don’t pay income, stocks that pay Canadian dividends (U.S. dividends are treated the same as interest income) and real estate investment trusts (REITs) that pay much of their distribution as a return of capital are examples of ways to relook at your taxable investments (including inside corporations) to find ways to lower taxes.

Giving to charity more tax efficiently

This primarily applies to those who may give $10,000 or more to a charity, but, at its base level, giving a dollar to charity can generally provide a tax credit of between 40 and 50 cents depending on the province. This is a very good option and is appropriate for most smaller gifts.

Some people will use flow-through shares (as mentioned above) to improve the efficiency of charitable giving. The reason is that on top of the other flow-through benefits, a gift to charity will eliminate the capital gains tax on the shares, because donated shares don’t require you to pay this tax.

Other ways to gift more efficiently are to donate stock that has the highest percentage capital gain in your taxable portfolio, and to make gifts through a life-insurance policy, making the charity the owner while your annual insurance premiums are considered a charitable gift. This can be a powerful option.

The key is that if you are considering a larger charitable gift, either now or in your will, there are likely more tax-efficient ways to do this than simply through cash.

There are always aggressive tax strategies out there that may not end up being in your interest, but the ideas above can be powerful, yet straightforward ways for you to make some dent in your large tax bill.

Reproduced from Financial Post, January 18, 2023 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
(416) 733-3292 x 221