Putting Insurance Misconceptions to Rest: How Insurance Will Secure Your Wealth
In the early stages of creating your Canadian asset protection plan, your wealth management team may have suggested getting life insurance. All too often, life insurance is immediately dismissed out of hand. You may feel that the cost of life insurance greatly outweighs its benefits, or you may believe that you already have enough liquid wealth to cover any costs that may arise upon your death.
However, the costs your loved ones will need to pay upon your death go beyond paying for the funeral (although life insurance can help with this too). There are various tax consequences that would be administered upon your passing, along with other fees that can add up quickly. While your estate may be able to cover all these fees, you’ll end up having a lesser fortune to pass on to your heirs.
To avoid these pitfalls, it’s important to understand the common misconceptions you may hold regarding life insurance. This will allow you to make an informed decision when crafting your Canadian asset protection plan.
Misconception 1: “I Thought There Was No Inheritance Tax In Canada?”
Canada does not have a death tax or inheritance tax, but that does not mean that there will not be any tax expenses applied to your estate. Upon your death, the Canada Revenue Agency considers you to have disposed of your assets immediately before death, which can include shares in a corporation, rental properties, or RRSPs. These assets will be designated “sold” at their fair market value, and any capital gains made on that sale will be taxed to the estate of the deceased. This means that a portion of the assets you planned on passing to your heirs goes directly to the Canada Revenue Agency in the form of taxes.
Misconception 2: “I Should Have Enough to Cover These Taxes, so I Don’t Need Life Insurance.”
While you may be learning behind enough wealth to cover these taxes for your heirs, it’s important to remember that the CRA taxes a significant portion of your estate’s assets. Your legal representative will be required to file a final return, which calculates your income from January 1st of the year of death, until the date of death. This income evaluation includes the capital gains from the figurative sale of your estate assets by the CRA. 50% of the capital gains from selling at fair market price will be taxed, leaving your loved ones with half of what you wanted them to have.
Income earned after the date of death will also need to be reported on a T3 Trust Income Tax and Information Return. The T3 will require you to report income earned through any severance pay received because of death, deferred profit-sharing plan payments, and income earned on an RRSP after your death.
While you can certainly have your estate pay these taxes, this strategy greatly reduces what you end up passing on to your heirs. Instead, you can cover these taxes through life insurance proceeds. This means that your beneficiaries do not have to liquidate any assets you pass on to them in order to pay for your post-death taxes. This prevents situations where they need to choose between keeping a sentimental asset, like a family cottage, or selling it off to pay the taxes owed by your estate. In this case, life insurance should be an integral part of your Canadian asset protection plan.
Misconception 3: “The Assets I’m Passing on Aren’t in Canada, so I’m Safe.”
It’s true that Canada doesn’t levy estate taxes, but that may not be true for other jurisdictions. The United States, for example, imposes estate taxes on deceased non-residents if they hold American assets. This can include real estate, personal property, and stocks from corporations that operate under U.S. law. The executor of the estate would be held liable for these estate taxes. With life insurance, these tax burdens are eased.
Misconception 4: “I Have Enough to Cover Probate and Legal Costs.”
Probate costs, or the costs associated with confirming your executor and with validating your will, actually vary between provinces. In Quebec, there are virtually no fees, while Ontario and British Columbia charge some of the highest probate fees in the country. In British Columbia, probate fees are applied if the estate is valued at over $25,000. The fees are even higher if the estate’s value exceeds $50,000. When you consider that many provinces do not enforce limits on these fees, the amount lost to probate fees can get out of control very quickly. Your beneficiaries can use the proceeds from a life insurance payout to cover some of these fees.
Misconception 5: “The Cost of Life Insurance Outweighs the Benefits.”
While you may be skeptical over the upfront costs of life insurance, investing in life insurance will allow you to transfer more wealth to your heirs. Here’s how:
They Are Mainly Tax-Free
The funds or assets that your beneficiaries receive from your life insurance policy are not heavily taxed or may not be taxed at all. Your loved ones will be able to keep nearly every penny from the payout following your passing.
They Play a Role in Estate Equalization
Life insurance can be used to ensure the equal distribution of an estate between multiple beneficiaries. For example, a common major asset of most estates is the family business. Often, the shares of a family business will only be distributed to family members who are actively involved, which leaves little for everyone else. With life insurance, beneficiaries outside of the family business can still get a fair inheritance, despite not being involved in the operations.
Learn More Before Making Your Final Decision
Life insurance often gets left out in a Canadian asset protection plans due to several misconceptions. While Canada does not have an inheritance tax, there are other taxes that must be paid upon your death. The cost of taxes, probate costs, and legal costs can quickly pile up and get out of control. This is especially for wealthy residents in certain provinces. You also need to remember that your foreign assets may be taxed by their country of origin as well. While the upfront costs of life insurance can be expensive, they play a part in protecting your assets, leaving more for your heirs.
Life insurance comes in many different forms, so you’ll need an expert who can find the right life insurance strategy that suits your estate plan. At Global Solutions West, we tailor our solutions to your individual plan, securing your hard-earned assets. Contact us to get started.