James Piper - Entries on Estate Planning

Thursday, February 19, 2009

...What is your proceeds of disposition on a life insurance policy?...

he following circumstances result in proceeds of disposition for a policyholder and therefore a potential capital gain: (a) full or partial surrender of the policy, (b) a policy loan, (c) policy dividends, and (d) certain transfers of ownership of the policy.

The full surrender of a life insurance policy results in a capital gain equal to the policy's cash surrender value (CSV) less its adjusted cost base (ACB). Where there is a partial surrender, there is a pro-rated capital gain if the total CSV exceeds the ACB.

Loan amounts received from the insurer under the terms of the policy are included as proceeds. Loans and debts with third-parties are not included, nor is the assignment of the policy as collateral for a loan or debt.

Policy dividends are included as proceeds; however, where the dividend is used to pay premiums, the amount is not included.

With certain exceptions, the transfer of a policy to another owner is a disposition with proceeds equal to the CSV.

Posted 2009/02/19 at 17h17ET in Estate Planning. [View single entry]

Wednesday, February 18, 2009

...What is the ACB of a life insurance policy?...

ost people consider permanent life insurance a tax-free investment vehicle with a death benefit. In many cases that is true; however, there are instances where a taxpayer receives, or is deemed to have received, proceeds of disposition (POD). The result is a capital gain if the proceeds exceeds the adjusted cost base (ACB) and any selling expenses.

The ACB of a life insurance policy is defined in subsection 148(9) of the Income Tax Act.

While there are a number of factors that go into determining the ACB of a life insurance policy, the two main factors are: premiums paid and something known as the Net Cost of Pure Insurance (NCPI).

The premiums paid under the policy increase the ACB and over the life of the policy this amount grows. Where the policyholder receives a dividend from the policy and apply it as a premium, that premium is not added to the ACB.

The NCPI is the amount at risk for the insurer times a mortality factor. The calculated amount reduces the ACB. As the insured person ages, the mortality factor increases and so does the NCPI.

Early in the life of the policy, the ACB is usually positive since the premiums exceeds the NCPI. As the insured person ages, the NCPI grows faster than the premiums and the ACB approaches zero.

The ACB cannot become negative.

The good news is the insurance company will provide with the ACB amount.

The bad news is that depending on what that amount is, proceeds on the policy may give rise to income taxes.

Posted 2009/02/18 at 18h01ET in Estate Planning. [View single entry]

Tuesday, February 17, 2009

...Thinking of buying permanent insurance?...

here are, broadly speaking, two forms of life insurance: term and permanent. With permanent insurance, sometimes called whole life insurance and other variations, the premiums paid to the insurer create an investment fund for the policyholder. The fund earns investment income and is generally not subject to federal or provincial income tax provided the policy qualifies as an "exempt policy" under the Income Tax Act.

The rules on what is or isn't an exempt policy are complex and best left to the insurer; however, before signing a policy be sure the agreement specifies the insurer will monitor your policy's status and they will ensure it maintains its exempt status.

Why do this? If your policy loses its exempt status it will be subject to income tax and would therefore create a significant tax problem.

Posted 2009/02/17 at 12h06ET in Estate Planning. [View single entry]