As we’ve discussed a number of times, most likely it’s going to suck to be dead. And while there isn’t too much you can do other than deferring that reality, fortunately, there’s a lot you can do to mitigate the financial effects. (Not for you, mind you. You’re not going to need money where you’re going.)
The concept of life insurance largely predates what we think of as modern society. As early as 5,000 BC, sailing ships in China came up with the idea of protecting one another from pirates at sea using shared risk for their cargos. The idea was if pirates slaughtered a crew for its cargo, at least some of the assets being shipped would make it to port via another vessel. Good for the business, but maybe not so much for the family of the poor sailors. We need to go forward another five millennia to find a better example of life insurance that leaves the surviving family members in a better place.
The burial club…for military men
The modern concept of life insurance seems to date back to about 100 BC, in Rome, where Caius Marius created a “burial club” for his troops, where everyone pitched in to pay for the funeral costs of fellow troops, and provide a stipend to surviving family. This was driven by a concern that Romans not buried with proper funeral rites would come back as ghosts and angrily haunt their friends and family.
It probably wasn’t hard to get the troops to buy in to this plan. We’ve all worked with someone who we really, definitely don’t want to be working with for eternity. Still, I don’t know about you, but I for one am glad that workplace clubs have gotten a bit more “positive” in nature over the last two millennia!
Life insurance today
While rules around insurance have changed a lot in the last 2000+ years, the basic concept has remained: you die, someone else gets money. Here in Canada, the key piece of this is that the government treats inheriting insurance money as a tax-free payout, hence the power and purpose of using life insurance for planning your estate. If you stop to think about it, relatively few assets are subject to zero tax in Canada: Your principal residence, your tax free savings account, and that, quite frankly, is about it. Everything else you might own has some kind of tax consequence. That leaves us with a lot of neat and interesting options.
(Still, it sucks to be dead. I suppose that goes without saying.)
Ryan’s top three reasons to have insurance as part of your estate plans
- Replacement of lost income, or a guarantee there will be money for your beneficiaries.
There is absolutely no way to know how much money you’ll have when the grim reaper comes knock-knock-knockin’ at your door. As much as you have money today, you might not have any when the doorbell-of-doom rings and a guy with a cowl and scythe comes looking for you. Insurance will ensure (See what I did there?!) that your family has funds no matter what.
This is particularly important for families where there are young dependants, or situations where you’re providing for someone else. It’s especially important if you have a family member with a special need or disability, and funds absolutely must be in place for their protection.
- It’s often a cheaper way to pay the tax on your estate.
We often set up policies that pay taxes that come due on the death of the second spouse. In many cases, especially the younger you start, the insurance may be a lower cost-per-dollar to cover tax costs than actually paying the eventual tax bill itself.
These taxes most often arise from your RRSP, RRIF, defined contribution pension plan, or taxable capital gains (from investments, secondary properties, business assets, etc.), all of which get added to your income in your year of death. For many people this can be a very substantial amount of money.
As a quick proxy, add up all of your registered money in RRIFs, RRSPs and defined contribution pensions, as well as one half of the capital gains of your non-registered investments. Now, divide that number in half. That will give you a pretty close approximation of your worst-case tax owing on your estate in most provinces.
(You can take this strategy a step further, and use the insurance proceeds as a charitable gift as well, but that’s an article for a whole other day.)
- If you have a corporation which holds significant passive investment assets, life insurance can be an extremely tax-efficient way to transfer funds out of your company, through your estate, tax free to beneficiaries.Under the current small-business rules, the insurance grows tax-free in your corporation, and eventually will pay out tax-free via your capital dividend account. It also helps to avoid some double-taxation traps on transfers of private companies. While the recent tax proposals might have an effect on this, at the moment, from what we know, this appears to continue to be a valid and viable planning strategy, and not affected by the proposed changes to date.One immensely important thing: generally, the beneficiary of your corporate owned-insurance policies should almost always be the corporation, not your family or any other beneficiary. If you don’t follow this rule, the tax consequences can be very, very severe.
Choosing the right type of life insurance
There are a whole pile of different types of insurance you can use, but for most estate planning purposes, it’s important to choose something that will last as long as you do. That usually means one of three options – a universal life, whole life, or term-to-100 policy.
Most importantly, it means you should work with someone who really understands how these policies work and compare. It often is misleading to compare these types of different insurance policies, and insurance companies solely on premium price and projected illustrations. A competent, trained specialist can help you sort through the otherwise mind-numbing features and benefits available, and the pros and cons of each in light of your own circumstances.
For most of us, life Insurance is not a whole lot of fun to think about, but it sure can make a big impact in your own estate planning. We’ve come a long way from pirates and burial clubs, but at the end of the day, doing it right and boring with insurance sure makes sense for most estates.