Wealthy Canadians with a net worth over $1 million can use life insurance not only for income replacement but also as a tax and estate planning tool. 

Life insurance can do more than insure your life. Many policies combine a death benefit with cash value, offering certain tax advantages and allowing you to maximize wealth.

Learn all about high-net-worth life insurance and how you can use it to protect and enhance financial capital.

What is life insurance?

Life insurance is a legally-binding contract in which the insurer agrees to pay a tax-free lump sum to a beneficiary upon the insured’s death. In exchange, you pay monthly premiums.

In addition to paying a death benefit, many life insurance policies also accumulate cash value. These plans can be a good option for high-net-worth individuals who have maxed out traditional investment accounts, like an RRSP.

Apart from the insurance companies, three parties are involved in a life insurance contract: 

• The policy owner: Also referred to as the life insurance policyholders, this is the person who buys life insurance and pays the premiums. The policy owner owns the rights to designate beneficiaries, update beneficiary designations, and cancel the policy. 
• The insured: This is the person for whom the policy is purchased. The policyholder and the insured are usually the same individual.
• The beneficiary: The policy beneficiary is the one who receives the death benefit when the insured passes. You can name anyone as a beneficiary for your policy, even a pet. 

Life insurance is available in two flavors: Term life insurance and Permanent Life Insurance.

Term Life Insurance

Term life insurance lasts for a set period, hence the word “term” is in its name. The policy term can be as short as one year or as long as 30 or 35 years. It pays a death benefit if the insured passes while the policy is active.

Once the policy term ends, the policy owner has three options: 

1. Let the policy expire
2. Renew coverage for another term
3. Convert the plan to a permanent life policy

You can renew a term life plan without submitting proof of good health. However, every time you renew coverage, your premium will increase due to age. Converting a term life plan to permanent coverage also does not require any medical underwriting. 

Unlike permanent policies, term life plans do not accumulate wealth. This means you cannot take out a loan against your policy or get a payment when you cancel it. The upside, however, is that term life plans are many times cheaper than permanent policies, on average.

Permanent Life Insurance

Permanent life insurance lasts as long as you do and combines the death benefit with a savings component. These policies build cash value, which you can access at any time and for any purpose while you are still alive. If you terminate the policy prematurely, you will receive a cash sum, referred to as the cash surrender value. 

As long as you pay premiums, a permanent policy guarantees a payout to your beneficiaries, making it a useful tax or estate planning tool. The beneficiary could use the insurance proceeds to pay for your funeral expenses, debts, tax liabilities, probate fees, and legal fees. This, in turn, helps keep the value of your estate intact for your heirs.   

Permanent life insurance policies are of two types: whole life and universal life.

Whole Life Insurance

Whole life insurance offers lifelong coverage and accumulates cash value at a fixed rate set by the life insurance company. Its death benefit and insurance premium remains the same throughout. Whole life plans can be either participating or non-participating. 

• Participating whole life: Apart from paying the death benefit and building wealth, participating whole life plans pay dividends. Policy dividends are generally paid annually, but you may not receive them every year. Depending on the insurer, you can use this extra sum in different ways, including buying paid-up additional insurance or reducing your premium payments. ‍
• Non-participating whole life: These policies provide a combination of lifelong protection and an opportunity for tax-deferred cash value growth, but they do not issue dividends.

Universal Life Insurance

Universal life insurance offers flexibility in lieu of guarantees. You can increase or decrease your monthly premiums, within limits. If you do so, the death benefit will be adjusted accordingly. Universal life do not provide guaranteed cash value growth; instead, the rate of growth varies according to market rates.

Who needs life insurance?

Some high net worth  individuals may be attracted to life insurance as an investment tool. Apart from paying a death benefit to the beneficiary, cash value life insurance can help with tax or estate planning. However, life insurance is not only for high-net-worth individuals. Rather, it is something that practically everyone can benefit from. Purchasing life insurance, regardless of your net worth, may make sense if:

• You have dependents
• You are the primary income earner for your family 
• You have a debt that is co-signed by someone
• You do not want to burden your family with your funeral and other final expenses 
• You want to donate money to charity after death

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How to use life insurance to grow and protect wealth?

You can use life insurance to grow and protect financial capital in many ways, including the following: ‍

1. Asset protection 

Generally, life insurance payouts are protected from creditor claims. In other words, your creditors cannot take the coverage intended for your beneficiaries. Not only is the death benefit immune from creditor claims, but so is the cash value. A creditor cannot force you to cancel the policy for its cash surrender value to repay the debt.

The only time creditors may pursue your life insurance policy is when it becomes part of your estate. This could happen in three scenarios: 

• You have named your estate as the beneficiary of your policy
• You have not named a beneficiary
• All of your beneficiaries pass away before you do (and you don't update your policy)

2. Estate preservation

Life insurance can help preserve the value of your estate, ensuring that most of what you own (if not everything) is passed down to your family. Here are some ways in which life insurance can help with estate planning: 

• Your beneficiaries can use the payout to pay off your debts, thereby avoiding the need to sell a part of your estate to raise cash.
• Life insurance profits may be used to pay probate expenses, which are calculated depending on the worth of the deceased's estate. The death benefit can also be used to pay for executor’s fees, and other legal expenses associated with estate distribution and filing your final tax return. If you do not have life insurance, these expenses might deplete your inheritance, leaving your family with far less than you expected.
• The life insurance payout could help cover the cost of your funeral and other end-of-life expenses. Otherwise, your beneficiaries or estate would have to shoulder the financial burden if you didn’t prepay for final arrangements.

3. Estate Equalization

Estate equalization means balancing your estate among your heirs so that each of them receives an equitable share. However, dividing the estate equitably among your beneficiaries can be a challenge. For example, say one asset accounts for the majority of your estate (e.g. your home) and if you want to bequeath that asset to a specific person. In this situation, life insurance can provide you with the necessary liquidity to ensure all your heirs are treated fairly. 

Here’s an example: Madeline owns a house that is valued at $4 million, while the total value of her estate is $8 million. She has three children — Robert, Miles, and Susan — and wants to pass the house to Susan, as her other two children are living abroad. But if she goes ahead with her wishes, the other two will receive a smaller share (Susan gets 50% while Miles and Robert each receive 25%). To balance the inheritance, Madeline takes out a $4 million life insurance policy and names Robert and Miles as her beneficiaries. This way each of her children will receive an equal inheritance after she passes.

4. Tax-free death benefit

Life insurance payouts are not subject to tax, meaning your beneficiaries will receive the exact amount you wanted to leave them. ‍

5. Diversifying portfolio

Whole life insurance can be a valuable addition to your investment portfolio. Unlike other asset classes, such as stocks, whole life guarantees a fixed interest rate. As a result, your cash worth is protected from market changes.

6. Funding a buy-sell agreement

A buy-sell agreement, usually funded by life insurance, helps protect your business, family, and business partners. When a co-owner passes, the insurance proceeds are used for buying the deceased’s shares from his or her family. This ensures the surviving owners gain full control of the business.

What are the tax laws with life insurance?

Tax laws favour life insurance.

1. The death benefit payout is not taxable income for your beneficiary, with the exception of when the profits go to your estate. Keep in mind while the death benefit is not subject to tax, any interest earned on it is. 
2. The cash value of a permanent policy grows tax-deferred, meaning you pay tax only when you access it. So as your cash value grows, the CRA will not take a cut. This arrangement allows you to accumulate more cash value since it is not being reduced by taxes each year. It could also reduce your tax liability if you defer accessing the cash value until you are in a lower tax bracket. 
3. If you take a loan against your policy, you will not have to taxes on the borrowed amount as long as your policy is active. 
4. If you withdraw the cash value, partially or fully, only that amount that is above the policy’s adjusted cost basis (ABC) is taxable. For example, if you withdraw $30,000 from the cash value and your policy’s ABC is $22,000, you would pay taxes only on $8,000 (not the entire amount).

Conclusion

Apart from ensuring your beneficiaries receive a payout upon your death, high-net-worth life insurance can help you grow, manage, and protect wealth.

Both whole and universal life policies offer lifelong coverage and build cash value. These policies can benefit someone who has maxed out other traditional investment vehicles and wants to use life insurance as an investment or a tax-saving tool. However, those who want insurance protection without any cash value should consider term life insurance instead. 

Still not sure which type of life insurance product is right for you? Let Dundas Life team of licensed insurance advisors help you. Contact us by phone or email and we'll walk you through your options to help you pick the best policy for your unique needs. 

Frequently Asked Questions

Should high net worth individuals choose whole or term life insurance?

When deciding between whole or term life insurance, here's a few things to keep in mind.

Do you want life insurance protection for a specific period, such as until your children become financially independent? If so, term life insurance may be a good option since it is much more affordable than whole life.

If you want to use life insurance as an investment tool or need coverage for your entire life, you may want to choose whole life. These policies do not come with an end date, meaning your beneficiaries will eventually receive the insurance payout. They also promise tax-deferred cash value growth. You can access the policy’s cash value for any purpose, such as to pay a large expense or supplement your retirement income.

What are the main differences between whole and universal life insurance?

While both whole life and universal life combine the death benefit with a savings component, there are key differences between them. 

Whole life has fixed premiums, a fixed death benefit, and offers a guaranteed cash value growth rate. Universal life policies, in contrast, have flexible premiums (within limits) and a flexible death benefit (within limits). Also, they do not offer guaranteed cash value growth; the rate at which the cash value grows depends on the performance of the investment accounts picked by you.

Compared to whole life, universal life plans can be up to 50% cheaper.