Canadians are taking advantage of certain life insurance policies to secure tax-exempt benefits for themselves and their loved ones. Two of the most common Canadian life insurance policies, participating whole life and universal life insurance, include tax-exempt proceeds for beneficiaries.
Today we’ll discuss what constitutes tax-exempt insurance and the different aspects of both whole life and universal life insurance policies in Ontario.
Unlike income from your pension, RSP, or mutual funds, tax-exempt life insurance provides tax-deferred growth and tax-free distribution of funds once the policyholder passes away.
These proceeds are given directly to beneficiaries and can be used for any expense from funeral costs to tax liabilities.
The federal Income Tax Act states that assets accumulating within tax-exempt life insurance policies are free of annual taxation accrual. This makes tax-exempt life insurance an excellent investment to grow your funds tax-free in Canada while protecting your loved ones from the risks associated with your death.
Participating whole life insurance (PAR) allows participants to deposit amounts larger than the cost of their insurance for investing. These extra deposits move into the PAR fund, separate from the insurance carrier’s general assets.
Your investments in the PAR fund may include bonds, equities, real estate, and mortgages. Your portion of return from the PAR fund comes in the form of dividends. You can select to take the dividends in cash, accumulate them at a fixed interest rate, or have them offset your later premium payments.
While the dividends are not promised within the policy, once they are credited to a policy, they are guaranteed to stay. PAR dividends do have a long and stable performance history in Canada.
The most popular way to use PAR dividends is through Paid-Up Additions (PUA). PUAs are extra amounts of permanent insurance that create additional amounts of dividends, compounding the effect and increasing your estate’s benefit. The biggest bonus is that all of the growth within this benefit is tax-free.
PAR insurance offers certain guarantees to its policyholders. They are guaranteed an annually increasing cash value, which is the net amount they would receive if they decided to end their contract.
As previously mentioned, dividends are also guaranteed once dispersed, providing relief for risk-averse policyholders.
While it includes an excellent life insurance and investment opportunity, PAR’s requirements may be too rigid for some individuals. The premium requirements are inflexible and, if your needs change during the policy, it can be difficult if not impossible to change the details of your coverage. If you do manage the change, the tax consequences can be painful.
For those who wanted more flexibility in choosing the components of their PAR, Universal Life insurance (UL) was born. While the client can control more aspects of the policy, the investment risk, therefore, falls into their hands.
Much like PAR, policyholders are required to pay a minimum premium that includes the insurance cost, admin fees, and premium taxes. If the policyholder is only interested in maintaining their death benefit with no additional investments, this is all they would contribute; however, this does not increase their universal life policy with tax-deferred growth.
Alternatively, there is a maximum contribution amount for those who want to grow their policy. Anything you add past the minimum will contribute to tax-deferred growth within your account.
Instead of moving this extra money to a PAR fund, like in participating whole life policies, UL allows you to invest in a variety of options. Some include leading equity and bond indices, guaranteed interest, and mutual funds.
Policyholders build their own diversified portfolio where the growth of their options is credited to their plan.
This policy type does include a fee for mutual fund investments, which is deducted before your gains are credited. This fee is determined by the underlying investment company.
While policyholders get more of a say within their UL policy than they would in participating whole life policies, this comes with its own set of risks. Like any other investment, returns on universal life options can be positive, negative, or neutral.
Your investments are subject to the volatility of the markets, which may not be ideal for those who are risk-averse.
Portfolio performance may also affect the sustainability of your initial coverage, which is something you should discuss with investments advisor and insurance agent Sim Gakhar before moving options or changing your policy.
Both PAR and UL life insurance policies are excellent options for sheltering and growing tax-exempt assets for your future.
PAR is best suited for risk-averse clients, especially those who enjoy slow, but stable returns. These clients are happy to leave their investment decisions in the hands of professionals, sticking to their policy and not expecting much change during this period. PAR clients look for long-term investment approaches. Those with PAR policies are likely to shift funds into the policy from other stable portfolios to increase tax exemption.
UL clients, on the other hand, are more comfortable with normal investment risk. They want to have a more hands-on experience with their life insurance investments and value the option to change their policy if need be. UL clients are more likely to fund their policies directly from their income.
Choosing between PAR and UL depends on a myriad of factors. Clients need to consider their risk-aversion, health, income, financial goals, and age, among other factors.
For professional guidance, Ontario clients can confide in Sim Gakhar. Sim has years of experience as both an investments advisor and as a certified insurance agent servicing the Ontario area.
Sim knows that the ideal insurance policyholder is informed, so she will sit down with each of her clients to guide them through the insurance process with ease. Sim is experienced in questioning her clients to ensure they are receiving the appropriate coverage, from the death benefit to the invested cash value component.
Reach out to Sim’s office to schedule your first meeting to get you on track with your financial goals today.
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