Corporate life insurance

Deadline looms for corporate-owned life insurance

July 8, 2016

Legislation passed in December 2014 is going to significantly affect the taxation of life insurance policies issued after December 31, 2016.

This means that policies must be approved and in place by that date to take advantage of the older, more lenient tax rules.

The biggest negative effect is on corporate owned life insurance policies. However, all universal life level cost of insurance (LCOI) policies will also see a big change in the amount of cash value that can be accumulated long term, without tax.

Action needed:

If you are contemplating putting in place a permanent insurance policy - especially one that might be corporately owned - complete your application by the end of summer, to make sure that the policy can be approved and in force by year end.

Background:

Since 1982, life policies have been allowed to accumulate a certain amount of cash value without annual taxation, as long as the policy continued to pass the “exempt test”. This test was designed to set a limit on how much tax-sheltering could be achieved and how quickly a policy could be paid-up through over funding.

Longer life expectancies and a desire for better standardization are the primary motivations behind the changes. Since universal life LCOI policies were developed mostly after 1982, they are seeing the largest impact.

Changes pending:

1. Corporately-owned insurance

The death benefit of a personally-owned life insurance policy continues to be tax free. However, changes to actuarial assumptions mean that the tax-free portion of the death benefit of corporately-owned (CO) life policies is negatively affected, hence the urgency to get these in place.

A CO policy pays its death benefit (DB) to the corporation that owns it. Part of this payment adds to the company’s Capital Dividend Account (CDA), which is an amount that can be paid out to the shareholders as a tax free capital dividend.

The CDA inclusion is calculated as the DB minus the Adjusted Cost Base (ACB) of the policy. ACB = total premiums paid, minus the Net Cost of Pure Insurance (NCPI). Since the NCPI is going down due to the longer life expectancy assumptions, the ACB goes up, and amount included in the tax free CDA goes down.

(Better news is that a higher ACB will generally mean less tax to pay when a policy is surrendered for cash.)

2. Quick pay policies

Paying more than the required payments has enabled people to pay up a policy in a short time. After a few years, the cash value earns enough tax-sheltered investment income to pay the premiums.

There was a time when this could be done in three years, and more recently five years, while still keeping the policy exempt. The new rules will likely stretch this out to more like eight years.

Note also that a term life policy which is converted to permanent status after the end of this year will come under the new rules, as will any permanent policy already in place, if additional insurance is added to it.

3. Prescribed Annuities

Life annuities purchased with non-registered money provide a guaranteed income for life, and only part of that income is taxable. A portion of the payment is considered to be your own capital being returned to you, and this part is tax free.

The longer life expectancy assumptions mean that the taxable portion of a prescribed annuity will be higher for annuities put in place after December 31, 2016.

These and other smaller changes to the taxation of insurance policies mean that now is a very good time to meet with your insurance professional, review your current plans and submit any applications for new insurance that may be desirable.

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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.Please consult legal, tax, insurance and investment experts for advice on your unique situation.

David Christianson, BA, CFP, R.F.P., TEP, CIM is a Certified Financial Planner and senior advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.