Monique Santandrea, BDO Dunwoody LLP
The Milk Producer
June, 2008
Only two things in life are certain, death and taxes. While we cannot stop our ultimate demise, we may be able to plan for it and plan for ways to minimize the amount that the tax-man milks away.
At the time of your estate, additional funds are typically required to fund not only final expenses but also income taxes. Income taxes are the result of the disposition of RRSP and RRIFs, and/or from the sale of the farming operations to a non-related third party. The tax-free death benefit proceeds from a life insurance policy can be used to replenish the estate after paying the income taxes. Life insurance can also provide estate equalization if one ore more of your children are not interested in continuing to run the farming business. Some people get caught up by the cost of annual premiums and opt-to purchase the least expensive products without considering the advantages of the more costly alternatives.
Did you know that there is a tax deduction for up to the premiums paid on term or permanent life insurance if the insurance policy is required to be assigned to a financial institution to cover a loan that is used to generate income? Business loan or mortgage insurance is not eligible for this deduction as the financial institution is the owner of the policy. Another pitfall of loan insurance is that it is not convertible into permanent life insurance at a later date. In most cases, term insurance is most comparable to loan insurance as its premiums are less expensive in the earlier years. Beware, term insurance premiums can increase dramatically during subsequent renewal periods.
Term insurance should be purchased to cover temporary needs such as covering a loan as mentioned above. Term insurance can be used to bridge the gap between total required amount of insurance and the amount of permanent insurance in place. Usually the intention is to convert the term to permanent insurance at a later date.
Although permanent life insurance is more expensive than term insurance, it also has an investment portion which term insurance does not. The cash value of a permanent life insurance policy grows on a tax-advantaged basis meaning that the growth is not reported on an income tax return as long as it within specified limits. Policyholders are able to access this cash value while alive for purposes that may include:
- expansion of farming operations,
- purchasing new equipment,
- supplementing cash flow available during retirement, and
- providing funding to buy-sell arrangements.
Depending on the method chosen to access the cash values, the tax implications will vary.
There are two main types of permanent life insurance policies; Universal life (UL) insurance policies and Participating (Par) life insurance polices. UL is more flexible with respect to varying annual premium deposit amounts than Par. However, UL also requires a more “hands-on” approach to the investment portion whereas insurance companies have people who look after that from a Par policy perspective. Working with your financial advisor should assist you in determining which product is the best fit for your needs.
You can own insurance personally or through a farm corporation, if applicable. From a corporate standpoint, at the time of your estate there is an opportunity to receive funds tax-free from the corporation as result the capital dividend account credit generated by the corporation receiving the death benefit proceeds as beneficiary. As well, the corporation pays the insurance premiums using after-tax dollars which can be an advantage if the corporate tax rate is lowered as a result of the small business deduction limit.
As stated, two things in life are certain, death and taxes. What about illness? What will happen to your family or your farming operations should you become seriously ill? You can access your life insurance policy but likely with tax consequences. Insurance companies now offer a critical illness (CI) product that provides a tax-free lump sum payment to you and your family in the event of serious illness. Each insurance company’s products vary but they may cover events such as cancer, heart attacks, strokes, Alzhiemer’s disease, and organ transplants.
The tax-free lump sum payment could be used to hire someone else to run the farm while you recover and to supplement your income should profitability decrease as a result of your illness. If you decided to sell your farm to a third party, you could also use the funds to pay for any capital gains tax that may result.
Although no one ever feels like it will happen to them, most of these illnesses and diseases are increasing in presence in our society. It is best to invest in CI coverage sooner rather than later as most insurance carriers won’t provide coverage if you have a pre-existing condition.
Work with your group of advisors to see if you have the right mix of insurance in your financial plan to stop the leakage that may occur as a result of poor planning.
