"Giving" Advice | March 2015

Upcoming Legislative Tax Changes that will Impact Future Life Insurance Policies
IMPORTANT TO GRANDFATHER IN EXISTING RULES TO MAXIMIZE VALUES
Written by: Eric Benchetrit, Director, Professional Development, Independent Financial Concepts Group Ltd.

The exempt test rules for life insurance policies are being modernized to reflect more recent actuarial pricing tables, 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. The changes to these rules were passed into law in December 2014. The rules will apply to life insurance policies issued on or after January 1, 2017.

Grandfathering
Generally, policies issued before January 1, 2017 will be grandfathered; however, in certain circumstances, grandfathered status can be lost after 2016. As a result, any conversions from term to permanent insurance should be completed before January 1, 2017. There are significant benefits to retaining grandfathered status.

Impact on Exempt Test Maximum Tax Shelter Room
If a life insurance policy is exempt, then there is no tax on the accrued investment income attributed to the policy, essentially allowing for the policy cash value to grow and accumulate tax free.

There are several changes to the calculations used to determine the amount that can be invested in a policy and still retain its tax free status. These revised rules have significantly decreased the accumulation room for policies, in particular, Universal Life policies with a level cost of insurance structure.

Maximum Fund Value Per $1,000 of Insurance - Today vs Revised

Maximum Tax Exempt Room Under Today's Rules

Corporately owned policies have had many advantages over the years, including the benefit of having insurance proceeds paid through the capital dividend account of the corporation on a tax free basis. In the earlier years of the policy there is an adjustment to the amount that is payable tax free – it is reduced by the portion that is considered the adjusted cost basis (ACB) of the policy. This ACB portion paid out as part of the insurance proceeds would be subject to tax as a dividend. The longer the policy is in force, the lower the ACB portion becomes, resulting in a zero ACB by life expectancy. This ultimately enables the entire amount of the life insurance proceeds to be paid out tax free through the capital dividend account.

Under the new rules, which require the use of more current actuarial pricing tables, the calculation of the adjusted cost basis (ACB) of a policy, will result in higher ACBs for insurance policies in the earlier years. The new calculation lengthens the time period before the ACB of the policy is reduced to zero. Consequently, for many products, the point in which zero ACB is reached will be 7-17 years later than in the past. In the earlier years, particularly, this change will result in a reduced amount that is paid out tax free through the capital dividend account under the new rules.

CDA Benefits Under Today's Rules

Call to action: Those in the market for permanent life insurance should be educated on the changes to the decreased accumulation room for policies and the change in the calculation of the ACB. If they need corporate–owned life policies, they should buy them now.

The new rules won’t be the end of these strategies, but they won’t be as attractive as they are now. It is important to note that the new rules do not impact on life insurance related philanthropy. They still retain the most attractive advantage of using life insurance, which is to allow one to make a much larger gift to a charity as part of an overall estate and tax planning strategy.

Eric Benchetrit can be reached at, ericb@ifcg.com

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