What are the ins and outs of using a whole life policy to cover tax liability?

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Written by Julie Cousin with Alan Norman

S: I have a whole life insurance policy that I purchased 34 years ago. I paid dividends/cash value, a principal of $100,000 and pay a premium of $1,000 per year. The life insurance amount has increased to $300,000 through dividends paid and there is cash value as well. I am currently in the process of estate planning and wondering if it makes financial sense to add an amount to the principal of this life insurance policy. Is this possible? Or is the better option just to purchase a new life (or other) insurance policy? I am 62 and would like to add to this policy tax coverage upon death, but am wondering what is the best and cheapest way to do this at my age. – Thank you, Julia

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FP Answers: Hello Julia. You will not be able to add additional life insurance to your existing policy. It is possible to reduce a policy’s death benefit, but not increase it.

Your question made me wonder: What is your rationale for wanting to cover taxes upon death? It sounds like something you should do, and life insurance is often offered as a solution to doing so, but do you really need to cover your taxes upon death?

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If your taxes are the result of calculating a Registered Retirement Income Fund (RRIF) or capital gains in an investment portfolio, you can pay taxes from the returns from the investments. Purchasing an insurance policy means getting less money for yourself while you try to create a larger estate for your beneficiaries.

On the other hand, if you have rental properties, a cottage or other assets that you do not want to sell, you will have to cover the tax and an insurance policy may be the best solution. Before turning to insurance, estimate the expected value and taxes associated with your assets upon death. Is there anything in your estate that you do not want liquidated or divided equally among your beneficiaries?

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Will there be enough money to cover the tax when you liquidate everything and convert it to cash so you can keep the assets you don’t want to sell and settle the estate? For example, this is the case if you were to leave the cottage to Mary, for example, and compensate Bill.

If your expected future liquid assets are not enough to cover taxes, you probably won’t want insurance. My colleague Jeff Kite, an insurance professional, might ask, “But do you want to die tidy?”

Relying on selling assets for an expected future value can be messy. You may have some tax-exempt assets (house, tax-exempt savings accounts), taxable assets (RRIF) or assets paid out of the estate with the estate responsible for taxes (RRIF). Asset values ​​may differ from expected and the sale of such assets and settlement of the estate may take longer than expected. There may also be potential conflicts with beneficiaries.

Using insurance adds certainty to estate planning. What options do you have with your current policy? The original death benefit on your policy was $100,000 and has grown to $300,000, and will continue to grow as long as you are alive and paying premiums. Find out how much it has grown by requesting three policy illustrations from your insurance company.

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• Continue to pay insurance premiums;
• Balance the policy on the anniversary date, meaning there is enough money in the policy to pay the premiums on its own, although it is not guaranteed that it will be able to pay for itself forever;
• Offset policy on bicentennial date.

If you continue to pay premiums, what will be the policy’s death benefit upon your expected death, and will this amount cover future expected taxes?

If you redeem the policy and stop paying premiums, it may still grow a little, and you can redirect your existing premiums to a new policy. Having a second offset illustration allows you to gauge the value of another premium payment on the expected death benefit. This will help you decide whether or not you should continue paying your premiums.

A new $300,000 whole life policy has a premium of about $12,000 per year, or if you go for 10 or 20 years, the premium will be about $1,600 per year and $3,000 per year, respectively.

With whole life, you know the money will be available to cover taxes, whereas with a term, once the term is up, it’s done, unless you renew for a new term or convert to a whole life or permanent policy. But these options are only allowed until a certain age, and the term eventually expires.

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Julia, what is your estimated tax issue? Is it as big as you think? Do you have to cover everything? If you must cover all taxes, what are your options? If using insurance, how can you best use your current policy? If you choose a new policy, do you want to commit fully to a whole life policy or alternatively hedge your bets with your existing policy and some term insurance that you can convert if you want?

Alan Norman, MA, CFP, CIM, offers fee-only financial planning services and certified insurance products through Atlantis Financial Inc. It provides investment advisory services through Aligned Capital Partners Inc., which is regulated by Canadian Investment Regulatory Organization. Alan can be reached at alnorman@atlantisfinancial.ca.

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