Woman, 62, in estate planning mode needs to ask herself if she really needs more insurance to cover taxes at death
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By Julie Cazzin with Allan Norman
Q: I have a whole-life policy I bought 34 years ago. It has paid-up dividends/cash value, a principal amount of $100,000 and I pay a premium of $1,000 annually. The life insurance amount has grown to $300,000 through paid-up dividends and there is a cash value as well. I am now in the process of estate planning and wondering if it makes financial sense to add to the principal of this life insurance policy. Is that possible? Or is a better option to simply buy a new term life (or other) insurance policy? I’m 62 and would love to add to this policy to cover taxes at death, but I wonder what the best and cheapest way of doing this is at my age. — Thanks, Julia
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FP Answers: Hi Julia. You won’t be able to add additional life insurance to your existing policy. It’s possible to reduce the death benefit on an insurance policy, but not increase it.
Your question has me wondering: What is your rationale for wanting to cover taxes at death? It sounds like something you should do, and life insurance is often presented as the solution to do it, but do you really need to cover your taxes at death?
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If your taxes are the result of a registered retirement income fund (RRIF) account or capital gains on an investment portfolio, you can pay the taxes with the proceeds of the investments. Purchasing an insurance policy means having less money for yourself while trying to create a larger estate for your beneficiaries.
On the other hand, if you have rental properties, a cottage or other assets you don’t want to be sold, you will have to cover the tax and an insurance policy may be the best solution. Before jumping to insurance, estimate the projected value and associated taxes of your assets at death. Is there anything in your estate you don’t want liquidated or divided evenly between beneficiaries?
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Will there be enough money to cover the tax when everything is liquidated and converted to cash so you can keep the assets you don’t want sold and equalize the estate? For example, this is the case if you are leaving the cottage to, say, Mary and compensating Bill.
If your anticipated future liquid assets are enough to cover the taxes, maybe you won’t want the insurance. My colleague, Jeff Cait, an insurance specialist, may ask, “But do you want to die neatly?”
Relying on selling assets at an anticipated future value can be messy. You may have some tax-free assets (house, tax-free savings accounts), taxable assets (RRIF) or assets paid outside the estate with the estate responsible for the taxes (RRIF). Asset values may be different than expected and it may take longer than expected to sell these assets and for the estate to settle. There may also be possible conflicts with beneficiaries.
Using insurance adds certainty to estate planning. What options do you have with your existing policy? The original death benefit on your policy was $100,000 and it has grown to $300,000, and it will keep growing as long as you are alive and paying premiums. Find out how much it might grow by requesting three policy illustrations from the insurance company.
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- Continue to pay premiums;
- Offset the policy at the anniversary date, which means there is enough money in the policy to pay for the premiums on its own, although it’s not guaranteed it will be able to pay for itself forever;
- Offset the policy at the second anniversary date.
If you keep paying the premiums, what will the policy death benefit be at your anticipated death, and will that amount cover future anticipated taxes?
If you offset the policy and stop paying premiums, it may still grow a little, and you can redirect your current premiums to a new policy. Having the second offset illustration allows you to measure the value of one more premium payment on the projected death benefit. This will help you decide if you should continue making premium payments.
A new $300,000 whole life policy has a premium of about $12,000 per year, or if you went with a 10- or 20-year term, the premium would be about $1,600 per year and $3,000 per year, respectively.
With whole life, you know the money will be available to cover taxes, whereas with term, once the term is up, it is done, unless you renew to a new term or convert to a whole life or permanent policy. But those options are only permitted up to a certain age, and the term eventually expires.
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Julia, what is your estimated tax issue? Is it as big as you think? Do you have to cover it all? If you must cover all the taxes, what are your options? If it is by using insurance, how can you best use your existing policy? If you choose a new policy, do you want to fully commit with a whole life policy or instead hedge your bets by using your existing policy and some term insurance you can convert if wanted?
Allan Norman, M.Sc., CFP, CIM, provides fee-only certified financial planning services and insurance products through Atlantis Financial Inc. and provides investment advisory services through Aligned Capital Partners Inc., which is regulated by the Canadian Investment Regulatory Organization. Allan can be reached at [email protected].
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