08 Dec LOOMING LIFE INSURANCE CHANGES: Changes Hit in 2017
The 2014 Federal Budget introduced major life insurance taxation changes that received Royal Assent (Bill C-43) on December 16, 2014. These changes take effect in 2017 however, there is still time to take advantage of the old rules if action is taken quickly.
The Exempt Test
Some insurance policies may offer the ability to generate investment earnings exempt from accrual taxation. This is particularly beneficial for policies owned by corporations, as investments outside the policy would be subject to non-active business tax rates (generally above 50%). There are, however, “exempt test” rules to ensure that this favourable tax treatment is not available to policies that are mainly investment vehicles with only an ancillary insurance element. This test will be modernized to reflect more recent mortality experiences, to provide standardization across insurance companies and products, and to take into account the new products that have emerged in the marketplace over the last 30 years, such as universal life.
Changes to the “exempt test” will reduce many of the tax advantages available. Policies issued prior to 2017 will be grandfathered, and retain a larger window for cash accumulation and tax sheltering than will be available on policies issued after 2016.
Changes to the Adjusted Cost Basis (ACB)
A second major factor for policies issued post-2016 will be the impact on the capital dividend account (CDA) of corporately owned policies. The investment fund portion of a life insurance policy forms part of the death benefit payout, which may become an addition to the CDA. Dividends paid out of CDA to the shareholders are tax-free.
It is often assumed that the addition to the CDA will equal the full balance received on the death of the insured shareholder. However, the addition to the CDA is actually the death benefit (proceeds), less the ACB of the policy. The ACB is generally the total premiums paid less the net cost of pure insurance (NCPI).
The NCPI is a complex calculation; one that must usually be done by the insurance provider.
The change is related to the way that the NCPI is calculated. Effectively, it will take significantly longer for the ACB to decline to zero. This change will result in a much lower CDA addition for many years after issuance of the policy. As such, a smaller portion of the death benefit will be added to the CDA for tax-free payout to the shareholder.
As indicated above, policies in place before January 1, 2017 will generally be grandfathered. However, alterations to such policies may result in loss of grandfathering. For example, increases in the amount of insurance where medical evidence is required or Term insurance conversions after 2016 may not qualify as pre-2017 grandfathered policies.
Action Item: Consider reviewing your existing coverage soon – don’t wait to the end of 2016 as considerable time may be required to implement a new policy.
This publication is produced by Andrews & Co. as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors.