(image by ZLC Financial)
One of the few things in life that we can absolutely count on is change. Therefore, no matter what age or stage in life, just about everyone has a need for insurance. It is especially important to have a review-revise-repeat approach when it comes to planning for you, your family and your ever-changing lifestyle and situation.
Do you have assets that you don’t plan on spending in your lifetime? Do you want to leave an inheritance but are worried about leaving your family with a large tax burden? A cascading life insurance strategy is a simple way to preserve your wealth for the generations to come.
Cascading life insurance is an intergenerational transfer of wealth, allowing grandparents to provide a significant legacy to their grandchildren without giving up control during their lifetime. It is an efficient tax-advantaged way to preserve your wealth for those you love by taking advantage of the tax-sheltered features of permanent life insurance.
The best way to be prepared is with a well-thought-out plan. Let’s take a closer look at how to use cascading life insurance. Here’s how it works.
Purchase a permanent life insurance policy with your grandchild as the life insured. If your grandchild is not the age of majority, their parent (your son or daughter) can be the contingent owner. When a contingent owner is named, the policy ownership will automatically transfer to the contingent owner without tax.
You or your son or daughter can be named as the beneficiary. Similar to the ownership structure noted above, you can be the beneficiary and your son or daughter can be the successor beneficiary.
Some of your non-registered assets will be used to fund the policy, thus reducing your future annual tax burden. The funds invested in a life insurance policy will allow for accumulation of cash value inside the policy, and you don’t have to pay income tax on its growth. Upon your death, the ownership of the policy is transferred to your adult child as contingent owner (or your grandchild, if the age of majority) without your estate paying any tax on the cash value growth. The transfer is free of probate, executor and legal fees.
The cash value in the policy remains completely accessible and in your control while you’re alive in the event that you do require additional income.
Meet Brian and his family
Brian is 66. He has $300,000 invested that he doesn’t need to meet his own costs of living. Brian wants to minimize the amount of tax he pays on his non-registered portfolio. In addition, he wants to shelter those assets from tax and probate fees when the assets are transferred to his grandson James, Janet’s son, who is a minor today.
Brian purchases a permanent life insurance policy and deposits the $300,000 into the policy over a 10-year period. Brian is the owner of the policy, and he names Janet as the contingent owner. The insurance is placed on his grandson James’s life and his daughter Janet is the beneficiary of the policy.
When Brian dies, Janet will become the owner of the policy, since she was named as the contingent owner. Janet can continue to own the policy indefinitely or transfer the policy to James when she thinks he is fit to be the owner.
The cash value will continue to accumulate in the policy and will be eventually owned by James.
Now, here’s the important part: the policy, when transferred from Brian to Janet and eventually from Janet to James, will pass along with its cash value, free of tax and probate fees.
James will have a few options:
- Access cash value from the policy (a taxable event),
- Borrow money using the investments in the policy as collateral, providing him with tax-free cash flow, or
- Change the beneficiary to his children, ultimately creating a lasting legacy passed down through four generations.
Insurance is a valuable and creative tool that can help provide peace of mind for you, your family and their financial future. The cascading life insurance policy provides several benefits:
- Permanent life insurance protection and control of capital in a tax-exempt life insurance policy.
- The ability to accumulate tax-exempt cash within the life insurance policy.
- The ability to transfer the policy’s cash value growth tax-free to your grandchild, who is the only life insured on the policy.
- Death benefit proceeds are paid out tax-free to named beneficiaries at the death of the life insured.
- Probate fees are not applicable on the life insurance proceeds upon the death of the life insured with a named beneficiary other than the estate.
The cascading life insurance strategy is designed for individuals who have annual tax obligations from non-registered investments, who would like to reduce the tax burden upon their death and are interested in legacy planning (family and charity).
Philip Levinson, CPA, CA, is an associate at ZLC Financial, a boutique financial services firm that has served the Vancouver community for more than 70 years. Each individual’s needs are unique and warrant a customized solution. Should you have any questions about the information in this article, he can be reached at 604-688-7208 or [email protected].