Make insurance part of your estate planningAugust 13, 2020
Article written by:
Rob Lamka, CPA, CA
The Targeted Strategies Group
There is a common belief that wealthy people do not need insurance. This is a reasonable premise. Insurance companies are profitable – the obvious conclusion being that the expected value of purchasing insurance must be negative – your loss and the insurance companies’ gain. So, unless you need insurance to cover liabilities, or maintain the lifestyle of your dependents – which very wealthy people typically do not – why would you ever buy insurance?
In my role with The Targeted Strategies Group, I work with some of the wealthiest families in Canada. Guess what – they all own permanent life insurance. Why? Were they sold something they did not need? Not likely – they tend to be very savvy people. There are several very good reasons why wealthy families buy insurance. I will cover a few in this article.
A friend and long-time client of mine, let us call him Brian, is the founder of a very successful company. Based on the last valuation of his company, Brian is a billionaire. His company is well established, and he has been able to withdraw some $50M in cash from the company. No doubt he is wealthy.
Notwithstanding his wealth, Brian has a need for insurance. In his leisure time, Brian likes to motorcycle with his wife. What happens if they have an accident and perish together? Brian’s shares in his company would pass to his children. However, the value of those shares would be subject to capital gains tax – at a rate of about 25%. While Brian is a billionaire, his assets are not liquid enough to pay the estate taxes.
Financial readiness and response are all about timing and in my experience, timing usually works against you. As I write this, Canada is in the middle of its COVID lockdown. While selling a portion of Brian’s company could help fund his estate tax liability, in the current economic environment there is a risk the sale would be on unfavourable terms, and it would result in Brian’s children having a partner in the company. Lack of liquidity and poor timing could result in a significant economic loss to Brian’s family.
Permanent insurance and joint-last-to-die policies on Brian and his wife would be a good solution for liquidity risk. While the premiums on a policy large enough to protect Brian’s family and business would be significant, they would pale in comparison to having a fire sale on the company. Further, the present value of the expected death benefit would likely provide a significant economic return (more on this below).
Insurance as an asset class
I tend to think of permanent insurance as being like a Tax-Free Savings Account (TFSA). Like a TFSA, there is typically no deduction for contributions, but the amount invested grows on a tax free basis and is paid out on death, tax free. While this may not benefit the insured, it can help with the insured’s legacy.
Wealthy people tend to leave a legacy – whether it be for their family or charitable purposes – and in that regard insurance can be a huge wealth builder. Most Canadian insurers offer participating policies. The return on these policies consists of investment returns, as well as a share of the profitability from the policies themselves. Canadian insurance companies have a solid history of providing stable returns from their investments. As Canadians live longer, gains arise in life policies as there are fewer death benefit payouts. Participating policies share most of these gains with their policyholders. If you prefer more control over your investments, Universal Life Policies offer a host of investment options, providing policy holders complete flexibility in how they invest.
Whether they are participating or universal life, permanent insurance policies provide families like Brian’s with strong and tax-efficient economic returns.
Many of the wealthy families I work with, like Brian and his family, have concerns about their economic future. Typically, they have faced financial difficulties they will not soon forget, or they have most of their wealth invested in their businesses, with little diversification. These factors can cause them to hesitate before investing funds in a life policy that will not be accessible until after they die.
While the death benefit of a life policy will not be accessible until after Brian dies, the value in the policy is not inaccessible. Life insurance policies also provide policy holders with the ability to leverage. The cash surrender value of a policy is a secure asset as it is guaranteed by very stable insurance companies. Banks are more willing to lend against the cash surrender value of a policy, often with up to 100% margin. This provides a level of comfort that, should something unforeseen arise, the money invested in a policy is accessible. Leverage is not always ideal. If a policy is leveraged, some of the death benefit will need to be used to repay the associated debt. But knowing leverage is available can be very comforting when it is time to pay the annual premium.
How insurance fits into estate planning
There are numerous way insurance fits into an estate plan. Among other things, insurance can finance tax liabilities on death, provide funds for buy-sell agreements, and provide for income replacement needs. When a family has significant wealth many of these needs go away, but not all. In the current economic environment, many wealthy families are also struggling to find reasonable returns in their portfolios. Insurance can be a key part of a well-diversified portfolio, providing outsized returns compared to the risk involved.