Life insurance is an effective tool for estate planning in Canada, and there are many options to provide an effective plan to pass on wealth. Life insurance is able to stay out of the probate process, so the amount of the policy remains intact to serve its purpose out in full.
On this page, we look at how life insurance differs from and works alongside a will for estate planning. We also discuss the different options available for estate planning and how they can apply to different situations.
When most people think of estate planning, a will is the first thing to come to mind. A will is a document in which an individual states their plans for distributing assets, both physical and financial, as well as outlining any desires after death. These might include:
The assets of the estate are put in probate, and they stay there until the estate is handled. During this time it is assumed that the individual sold the assets for fair market value, and taxes and fees are calculated appropriately, including:
These fees can reduce the value of the estate by anywhere from 25 to 50 percent, meaning that half the assets of the estate can end up going to the government.
There are ways to transfer assets outside of this probate process, effectively bypassing any fees attached to the estate. One of these is life insurance.
While life insurance cannot dictate wishes for much, it does provide an effective way to transfer wealth to a beneficiary without incurring taxes or getting stuck in probate. The policy is effective the moment it is purchased, and it lasts either until:
In all, a life insurance policy is an effective way to balance out any expenses of the estate, cover any existing debt, and provide wealth to heirs.
There are more variations in these policies, and you can utilize as many as you can afford, but understanding differences will help you decide the best route to get started.
A single life insurance policy operates by insuring one individual and payout out the death benefit upon the death of that individual.
Joint last-to-die policies are useful for marriages or common-law partnerships because they defer the payout of the insurance proceeds. Instead, assets roll over to the surviving spouse and any deemed disposition or calculation of the final tax bill is deferred until their death.
By putting off the payout of life insurance proceeds the rest of the family can have access to the funds at a more convenient time to handle the taxes and fees on the deemed disposition of the assets.
Premiums on joint last-to-die policies are likely to have a discount on premiums of anywhere up to 40 percent when you compare them to a similar single policy. This is because the insurance company gets a break by waiting for both spouses to pass away before paying out, and they can pass the savings on to the policyholder.
Both whole life insurance and universal life insurance policies are permanent life insurance policies, meaning that they are active as long as the policyholder stays current with premium payments. These can be paid monthly or annually for life, or prepaid over 10 or 20 years.
Both plans develop a cash value, but whole life policies offer a guaranteed return at a lower rate. Universal life policies can provide a higher return, but it is not guaranteed. You can also forego contributing to the investment portion of a universal plan.
In both of these policies, you can access the cash value of the policy as long as it does not go under a certain amount. You can also cancel the whole life policy to receive the cash surrender value, but this is not effective for most estate plans.
Term life insurance is not often recommended for estate planning because it does not feature a cash value and it expires after a certain period, but it has its uses.
One use is to provide supplemental coverage and increase the potential payout without increasing premiums by much. This can be useful if an individual has enough to cover term premiums but not an increase or additional permanent premiums.
Another use for term life insurance is to cover a debt that has the same term. An example of this would be purchasing a 30-year term policy that covers the amount due on a 30-year mortgage. This provides the peace of mind that the debt can be paid if the insured dies before completing mortgage payments.
Life insurance is a great tool for financial planning in an estate, but it does not take the place of:
A life insurance policy can provide the funds necessary to facilitate other documents and transfers of assets by providing the funds when they are needed. It also allows you to organize these finances and control them until the date of distribution.
Life insurance can be applied to almost any estate planning situation, but to explore your opportunities in full you should get in contact with an experienced life insurance and financial planning advisor.
Estate planning can be difficult, but it is not something you need to do alone.
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