Take advantage of life insurance trusts for estate planning

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1 March 2007 In this issue: Take advantage of life insurance trusts for estate planning Avoid probate fees, pay less income tax p. 2: Selling critical iillness insurance it s all about need Insert: Pensioners to save $1 billion What if your clients ask whom they should name as the beneficiary of a life insurance policy? Their children, to avoid probate fees and provide creditor protection? Or their estate, so the insurance proceeds receive the beneficial tax treatment of a testamentary trust? The answer is, the client can accomplish both goals with a life insurance trust. (In Quebec, a civil law trust differs significantly from a common law trust. This article does not cover trusts under Quebec law.) Life insurance trusts offer fer flexibility lexibility, tax advantages, creditor protection and control. Trusts are increasingly popular for estate planning because of their flexibility, tax advantages, creditor protection and the control they allow after death. They involve a threeparty agreement, in which the person who creates the trust (the settlor) directs property to trustees, who as trustee hold and manage the property for the benefit of the beneficiaries. Trusts must have three certainties: certainty of intent (intention to create a trust), certainty of subject matter (property) and certainty of objects (beneficiaries). There are two types of trusts: inter vivos trusts, created during the life of the settlor, and testamentary trusts, created after the death of the settlor. For tax planning, testamentary trusts are generally preferable, because income retained by the trust is taxed at graduated rates. To meet the definition of a testamentary trust, in subsection 108(1) of the Income Tax Act (Canada) (ITA), the trust can only receive property from an individual, on or after and as a consequence of that person s death. Establishing a life insurance trust A properly structured life insurance trust ensures the trust qualifies as a testamentary trust and the life insurance proceeds do not flow through the estate. Canada Revenue Agency confirmed this point in technical interpretation # , dated Dec. 17, There are several ways to set up a life insurance trust. 1. Life insurance declaration in the will 2. Life insurance trust structured outside the will 3. Hybrid arrangement see back page for details... We publish Strategies four times per year to provide value-added information about Canada Life TM insurance and investment solutions you need for your business and clients. Help us help you! If you re moving, changing your address, or wish to receive Strategies electronically in addition to, or instead of, a printed copy, please let us know so we can update our distribution list. By By fax: By mail: Canada Life, 330 University Ave., S9, Toronto ON M5G 1R8 Attn: Vanessa Funtera or Vivienne Leong (national accounts)

2 The NEAT team Selling critical iillness insurance It s all about need Brenda McEachern, B.Com, LL.B, TEP. British Columbia regional marketing centre Ph# (800) brenda_mceachern@canadalife.com Neil Horne CA, CFP, TEP. Prairie regional marketing centre Ph# (888) neil_horne@canadalife.com Critical illness (CI) insurance sales become easier when two key points are understood by financial advisors and their clients. For clients, it s understanding the need for CI relative to improving odds of surviving serious illnesses such as cancer, heart attack and stroke. For financial advisors, it means knowing clients have personal and emotional priorities that will motivate them to buy. CI a product for the future Because this is a relatively new product, it s still rare for clients to approach financial advisors with a good understanding of why CI is essential. Rather than being a challenge to overcome, the newness of CI can help open doors for you. It can also help open clients minds to the need. CI can be positioned as a product that has emerged as medical diagnostics, treatments and chances of surviving serious illnesses continue to improve. Here are a couple of examples for starting the conversation in a compelling way: We stand a much better chance than ever of surviving a serious illness. This is very good news. Unfortunately, now we stand a better chance than ever of having to live with the effects of that illness (physically and financially). Critical illness insurance was first developed by a doctor, not an insurance company. He got the idea when he watched a cancer patient work until she died rather than having a choice to be at home with her family. He realized how important it was for patients diagnosed with a critical illness to have financial assistance at a time when they need it most. Every client has different motivators instead of talking about every potential expense that can be associated with a critical illness, find out your clients priorities. Frank Abate, CA, CFP Toronto City regional marketing centre Ph# (877) frank_abate@canadalife.com What motivates your client to buy? Motivation varies with each client. Rather than trying to educate clients about every last expense associated with treatment of a hypothetical critical illness, find out what your clients personal and emotional priorities are and you will uncover their motivation to buy. The Critical Illness Personal Needs Analysis Tool available, on RepNet or from Canada Life your regional marketing centre, can help uncover clients key concerns. Critical Illness Personal Needs Analysis Tool 2

3 The NEAT team Tom Pilkington, CA, CLU, CH.F.C., CFP, TEP Toronto City regional marketing centre Ph# (877) The CI Needs Analysis Tool lets you crunch some numbers with clients to help determine their financial needs in the event of a critical illness and release their buying trigger. Suzanne Desy, LL.B, D.D.N., Pl. fin. Eastern regional marketing centre Ph# (800) suzanne_desy@canadalife.com The tool has three sections: 1. Capital requirements potential lump-sum payments such as outstanding mortgages, credit card debts or education funds 2. Expense requirements expenses directly associated with the illness such as travel expenses or home renovations 3. Income supplement calculates how much of a lump sum clients would need to replace their or their spouse s income for a predetermined period of time. By working through the tool with leading questions, you can encourage clients to come up with their own answers about how much money they might need to manage each expense. How can you convert a needs analysis into a sale? One approach is to ask, Of all these expenses, what are you most worried about? In answering, clients will reveal their priorities as well as their personal and emotional motivators to buy. If a client is most worried about paying the mortgage (whether it s a year of mortgage payments or paying the mortgage off completely) and keeping the house, then the help that CI can provide for this is the value of it to that client. Or, perhaps a client s primary concern is replacing or supplementing income so a spouse can stay home to act as caregiver. Work with your clients to discover their personal and emotional motivators armed with this information your CI sales can increase while helping your clients with a valuable part of their total financial security plans. Christopher Britton, CA Eastern regional marketing centre Ph# (888) chris_britton@canadalife.com Convert a needs analysis into a sale by asking what expenses are the biggest concern in answering, clients will reveal their priorities plus their personal and emotional buying triggers. 3

4 continued from page 1 Life insurance trust strategies Life insurance declaration in the will The declaration provides that life insurance proceeds are paid to trustees in a separate life insurance trust. The wording ensures trustees hold property for the benefit of designated beneficiaries. It clearly identifies the life insurance policy, revokes previous beneficiary designations and indicates the life insurance trust is separate from other trusts established by the will. Life insurance trust structured outside the will The life insurance trust is set up before death, but the life insurance proceeds actually settle the trust. It s extremely important from a tax perspective that the trust arise as a result of death. This approach provides confidentiality. Hybrid arrangement The life insurance declaration is made outside the will, but the terms of the life insurance trust are set out in the will. These terms are incorporated by reference in the declaration. Life insurance trusts can meet the dual objectives of avoiding probate fees and preserving the graduated income tax advantages of a testamentary trust. A trust must file a return each taxation year (ITA section 150 [1] [c]). If your clients are considering a life insurance trust, it s important you recommend they consult with a legal advisor experienced in estate planning to establish the plan properly. By Bruce Chegus, LL.B., CFP, TEP, Advanced Sales, Life and Living Benefits, and Chris Britton, CA, National Estate and Tax Planning (NEAT) Consultant, Canada Life Eastern regional marketing centre Strategies is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. Individual circumstances may vary and specific legal and tax advice is recommended. The information presented is based on current tax legislation. Future tax changes and market conditions may affect this information. Canada Life contacts RepLine RepNet Tech Support Toll-free: RepNet Regional marketing centres Eastern Ontario Prairie British Columbia Helping people achieve more TM is produced quarterly by the Marketing and Communications teams of Canada Life. Please direct all comments and inquiries to: dean_askin@canadalife.com URL: Mail: 330 University Avenue, S9 Toronto, ON M5G 1R8 Attn: Dean Askin 4 Canada Life and design and Helping people achieve more are trademarks of The Canada Life Assurance Company

5 Pensioners to save $1 billion Many of you will remember Hallowe en 2006 as the day Federal Finance Minister Jim Flaherty announced the tax fairness plan. The taxation of income trusts outlined in the plan, caused an immediate decline in their prices on Nov. 1. But seniors benefit from the plan because it increases the age amount nonrefundable tax credit for federal taxes and it offers opportunities for pension income splitting between spouses. Here are answers to some common and expected questions clients may ask you: What are the new rules? The age amount tax credit is increased to $5,066, already reflected on the 2006 tax return forms. The pension income splitting rules are not clear at this point as there has been nothing published further yet. The most conservative tax commentators are banking on nothing until the tax fairness plan passes into law, while a more liberal group expect this to pass regardless of the timing or result of the next election. Assuming the announcement becomes law, we expect it to apply to pension income starting Jan. 1, Does my income qualify to be split? It will qualify for pension income splitting if it also qualifies for the pension income tax credit. Over age 65, pension income includes: Income from a defined benefit or defined contribution pension plan Income from a registered retirement savings plan (RRSP) as long as it s an annuity Payments from a registered retirement income fund (RRIF), which includes locked-in plans such as life income fund (LIF) For income recipients under age 65, the list shortens to only income from a pension plan. How will the rules affect fect my tax retur eturn? n? The person transferring income will report less, and the receiving spouse will report the transferred amount on his or her return. The Canada Revenue Agency (CRA) could facilitate this in several ways a separate income line, a worksheet, a schedule are some possibilities. Unfortunately we won t know exactly how until the 2007 tax packages are available early in While the details are not final, it s widely anticipated the amount transferred would qualify for the pension income credit of the receiving spouse. In households where the spouse receiving an income-split allocation didn t have pension income before, it increases the amount of pension income eligible for the credit, reducing taxes further. How much tax could it save me? For Canadian pensioners wondering how much applies to them specifically, the result is similar across provinces around $3,000 per couple. In the accompanying charts, we re using the example of an Ontario couple over age 65 who earn a combined income of $70,000. One spouse earns $10,000 in income, which is not eligible for the pension income credit. The other spouse earns $60,000 with $50,000 of it qualifying as pension income because it s either pension or RRIF payments. We have assumed Ontario will allow pension income splitting for provincial taxes as well, however there s currently no draft legislation. continued... Pension income splitting Case study

6 Pension income splitting Case study These rates and values are for general illustration purposes only. Each person will have a different amount of taxes owing based on exact income, different tax credits, contributions, donations, etc. Before pension income splitting Spouse A Spouse B Total Income $60,000 $10,000 $70,000 Federal tax $10,745 $1,525 Non-refundable tax credits* ($2,341) ($2,121) Net provincial tax* $4,287 Total tax payable $12,691 $12,691 Net income after tax $47,302 $10,000 $57,309 With pension income splitting Spouse A Spouse B Total Income $35,000 $35,000 $70,000 Federal tax $5,338 $5,338 Non-refundable tax credits* ($2,317) ($2,317) Net provincial tax* $1,642 $1,642 Total tax payable $4,663 $4,663 $9,326 Net income after tax $30,337 $30,337 $60,674 *Includes basic personal tax credit, spousal amount, age amount, pension income amount, transfer of unused age amounts, Ontario Health Premium. The information in this article is current as of February 2007 and is for illustrative purposes only. It is not to be considered tax advice. Please consult a professional tax advisor for advice related to your situation. Planning implications Lower tax The government anticipates this move will save pensioners $1 billion in federal taxes. Clients might leave gross redemptions unchanged and enjoy higher after-tax payments, or adjust their payments, if possible, to draw less from their investments while leaving after-tax income unchanged. As a result, retirees will be able to enjoy one or more of these benefits: Higher after tax income Money lasting longer Need to work less to supplement income Higher balance to leave to heirs Old Age Security (OAS) clawback If a pensioner s income is above $62,144 (indexed higher for 2007), OAS clawbacks kick in. If pension income can be reduced to $62,144 or less by allocating some to a spouse, the household will keep more of the OAS payment. Spousal RRSPs There s debate about the future and purpose of spousal RRSPs, with income splitting allowed. Spousal RRSPs can still serve a purpose if your clients plan any of the following: Drawing income prior to age 65 Splitting more than 50 per cent of pension income (which could be done to equate income depending on how much non-pension income each spouse reports) Contributing to an RRSP past age 69 (if their spouse is younger) Contributing to a post-death RRSP that goes to the surviving spouse via a spousal RRSP. This results in one final RRSP deduction on the terminal tax return. Using RRSPs to buy a house or fund education under the Home Buyers Plan or Lifelong Learning Plan. Spousal RRSPs could double the amount clients are able to withdraw. March 2007 Helping people achieve more TM TM Canada Life and design and Helping people achieve more are trademarks of The Canada Life Assurance Company.