Too often, we view estate planning as a visit to the lawyer's office to sign a new will once every 15 years or so. It is important to keep in mind that, not only are there other documents which are crucial to a comprehensive estate plan, but also that a wide variety of other products and assets should be reviewed as part of any updated estate strategy.
Life insurance is one of those additional components to many estate plans that can be beneficial or necessary in a wide range of family and financial circumstances. The most common use for life insurance is for risk management purposes used as income replacement in event of an untimely death of a family member. Parents of young children need to ensure that funds will be available for the remaining family members should a sad and unexpected event occur.
There are many other creative ways to use life insurance as a positive force in your estate plan. Since life insurance is paid to beneficiaries on a tax free basis, it presents an excellent opportunity to create an asset which will not be diminished by tax obligations upon your death. In fact, life insurance can often be used to fund the tax liability owing as a result of the other assets owned by the deceased at the time of his death. In Canada, an estate's tax liability is assessed as if the deceased person sold all of his assets in the moment before he passed away. Therefore, in addition to income taxes, the estate will also owe capital gains on any applicable property such as shares in privately held corporations, investment accounts, and recreational or revenue property. The estate's tax liability can be significant, even if the deceased always kept his personal taxes up-to-date. Many people purchase a life insurance policy payable to their estate in order to cover the taxes that will ultimately be owing.
This is an important step if one of the testator's goals is to protect legacy assets, such as a family cottage, from having to be sold in order to satisfy the outstanding taxes . The value of a family cottage can have grown exponentially between the time when it was acquired by the testator, perhaps decades earlier, to the time of the testator's death. Half of that growth is taxable from the estate and one can see how the taxes owing on such a piece of property could easily become too significant for the estate or the beneficiaries to bear. A life insurance policy, naming the estate as the beneficiary, will provide a tax-free sum to the estate to cover the taxes and allow the beneficiaries to use and enjoy the property as the testator had intended.
Another way in which a testator can use life insurance to preserve a legacy is to benefit a charity or community organization. The testator or donor can purchase a life insurance policy naming the charity as beneficiary, and that charity will receive the gift tax-free upon the donor's death. Charitable organizations generally prefer to receive an insurance policy instead of a specified gift in a will, because the life insurance policy can be paid out much faster and ensures that the charity does not need to become involved in any disputes among the beneficiaries in the estate administration process. Likewise, the charity will not have to deal with or supervise the executor. Another significant benefit to establishing a charitable donation in this fashion is that, if set up properly, the donor can claim the annual insurance premium payments as a charitable contribution and therefore; can receive the benefit of the tax credit while they are still living. This is an efficient and effective way to leave a legacy in the community and support the organizations that were important to the donor during their lifetime.
Life insurance is often a crucial component of succession planning for entrepreneurs. Many of us are familiar with insurance policies on "key people" in the organization, which will provide funds to stabilize and support the corporation in the event of the untimely passing of one of the principles. Life insurance is also a central element of many shareholders' agreements, in which the corporation is named as the beneficiary on life insurance which is placed on shareholders. When the shareholder dies, the proceeds from the life insurance policy allow the corporation to purchase his or her shares from the estate.
Finally, life insurance can be a very effective way to facilitate the transfer of a small or family-owned business from one generation to the next. Business owners will often use an estate freeze, which "freezes" the value of the parent's interest in the business by converting the parent's common shares into preferred shares which have a fixed value. Any future growth in the business will accrue to the next generation of owners, who have the new common shares. Generally, an estate freeze will set out a timeline or schedule for the corporation to redeem the preferred shares, therefore providing retirement funds or a continuing income stream to the first generation. However, an insurance policy on the life of the parent shareholder, naming the corporation as a beneficiary, is often required, as well. In the event of the unexpected and untimely death of the parent shareholder, the corporation will have to ensure that it has access to sufficient funds to purchase the remaining preferred shares from the parent's estate. Insurance proceeds can also pay out those family members who are not intended to remain involved in the business operations, but were still intended to receive a benefit from their parents' estate.
Estate planning involves not only your will, but also a review of the other components of your financial planning and future goals. In conjunction with legal advice, properly placed life insurance can be an essential tool to help you achieve your goals and plan for the future efficiently and effectively.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.