Tax Planning And Transfer Of Wealth Using Life Insurance

Tax Planning And Transfer Of Wealth Using Life Insurance



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There has been a substantial increase by corporate and individual taxpayers alike in Canada of the use of Life Insurance products to facilitate the minimization of tax and effective transfer of wealth.  This article reviews 2 of the most effective uses of life insurance to transfer wealth to future generations:


  1. The Waterfall Concept

Also called the Cascading strategy, the Waterfall Concept is a strategy where a parent or grandparent uses a tax-exempt permanent life insurance policy to accumulate wealth tax-deferred, then transfers it to their child or grandchild as a gift without tax consequences to use throughout their lifetime. There are many variations of the  Waterfall Concept, so it can be tailored to meet an individual’s objectives. It is referred to as a “waterfall” because, like a waterfall, the transfer can flow downward only — i.e. for the gift not to be taxable, the life insured on the policy must be a child’s, and the policy must be transferred to a child. The provisions in subsection 148(8) of the Income Tax Act (ITA) govern the rollover. Under this subsection, a child is defined as the transferor’s child or grandchild, their son- or daughter-in-law, their spouse’s child from a previous marriage, their adopted child or their child from a common-law relationship. The term “child” is not restricted to a particular age, and the life insured and future policyowner don’t have to be the same child. In addition, the gift of the policy to the child must be made without consideration of any type.

Many permanent life insurance policies have unique features and tax attributes that make them ideal vehicles to facilitate the transfer of wealth between generations. This insurance transfer strategy is popular because the transfers can be done in a tax-efficient manner without giving up control of the gift, and in most cases, without the assistance and cost of lawyers. Therefore, it can be rightly said that this particular corporate owned life insurance tax considerations are less complicated.

How does it work? The transferor purchases a tax-exempt permanent life insurance policy on the life of a child and contributes to it, typically for three to five years. The policy grows on a tax deferred basis and is eventually transferred to the child of the transferor for no consideration. According to the provisions in subsection 148(8) of the ITA, the child becomes the new policyowner without any immediate tax consequences. However, any time the child withdraws funds from the policy, the funds are taxed in their hands — not the transferor’s — at their effective tax rate. The benefits of this strategy are that the child’s tax rate will most likely be much lower than the transferor’s, and taxes are deferred until the withdrawal actually occurs.


Dealing with potential issues

The Waterfall Concept is very simple and becoming more popular given our aging population and the massive number of wealth transfers anticipated in the years ahead. However, there are a number of issues that should be considered when setting up this arrangement to ensure your client’s objectives are realized.


Death of the policyowner:  Whenever the policyowner is older than the life insured, there is a real possibility that the policyowner will pass away before the life insured. If this happens, the policy will become part of the deceased’s estate, and the gains in the policy will be taxable to the deceased. Probate fees may also apply. The larger the age difference between the policyowner and life insured, the greater the risk of this outcome.


Income attribution:  For the gift to be non-taxable, we rely on a rollover provision in the ITA. A rollover prevents tax from arising as a result of the transfer, but has no impact on the taxation of transactions that occur after the transfer. As such, if funds are removed from the policy in a situation where the income attribution rules apply, any taxes payable will be attributed back to the transferor. Loss of control over the policy:  The legal age to be able to negotiate a contract is 16 in all provinces except Quebec, where the age is 18. If the policy is transferred to a child under the legal age, the child does not have legal authority to deal with the policy until the child reaches the legal age to negotiate; thus, a court application for the appointment of a trustee will be required if a transaction needs to be executed. Control over the use of funds:  If structured right, the transferor can retain some control over the policy after it has been transferred to the child. Otherwise, the child gains control upon transfer.

Most of these issues can be dealt with by utilizing the  features available in the insurance policy: The policyowner can name a child as the contingent owner: If a contingent owner is named, then upon the original policyowner’s death, the policy will be transferred to the contingent owner outside of the estate. Because the transfer is to a child and the life insured is also a child of the original owner, the rollover provisions apply.

This strategy is particularly useful in cases where the transferor wants the gift to skip a generation. For example, if a grandparent acquires a policy on the life of a grandchild and names the child’s parent as the contingent owner, upon the grandparent’s death, the policy will roll over to the parent on a tax-free  basis, and the parent can then transfer the policy to the child at the appropriate time.

This doesn’t eliminate the risk of the policyowner dying before the life insured, but it reduces it. Given that these policies are usually transferred shortly after the child reaches age 18, there is a very good chance that the parent will be alive at this time.

The policy’s transfer can be deferred until the child  reaches age 18: This avoids concerns about income  attribution and loss of control.

An irrevocable beneficiary can be placed on the policy prior to transferring it to the child: The irrevocable beneficiary must consent to policy withdrawals of any type before the child can access the accumulated value in the contract. The irrevocable beneficiary acts like a trustee to ensure the original owner’s wishes for the use of the funds are realized. The irrevocable beneficiary must be a trusted individual to ensure they allow the child to use the policy as originally intended.



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What are the advantages of the Waterfall Concept?

  • The transferor can provide a valuable gift and legacy for their child or grandchild.
  • The transferor avoids annual taxation on the investment income generated on the gifted amount.
  • They also avoid taxes when they transfer the funds to their child or grandchild. And when the child withdraws funds from the policy, as long as the transfer has been properly structured, the funds are taxable to the child, not the transferor, at the child’s tax rate.
  • Probate fees can be avoided and the transferor’s privacy respected by ensuring the transfer doesn’t go through the estate.
  • A trusted individual can control the use of the funds in the transferor’s absence.
  • All this can be done through the life insurance contract, without the need for legal intervention.

It’s a gift a child or grandchild will never forget Passing on wealth using the Waterfall Concept enables grandparents or parents to give funds to a child to use for university, a wedding or any other important reason. They can give the child the right start and help them create a  valuable insurance policy, at very reasonable rates.  The child may also keep the policy in force if they want, avoiding possible insurability issues down the road.


Corporate-Owned Life Insurance

Life insurance solutions available for corporate business owners are fundamental to protecting your family, business interest and continuity. Business owners have the option of owning life insurance policies personally or inside of their corporation. Corporate ownership has advantages and disadvantages, and deciding on where to own a life insurance policy involves serious consideration prior to making any decisions.[1]

Funding a corporately owned policy

Generally life insurance premiums are not tax deductible as the premium payment is not considered an outlay for the purpose of gaining or producing income from a business or property. Therefore the premiums will be paid with after-tax dollars so a business owner may want to utilize dollars that generate the least amount of taxes payable.

There are three ways to fund a policy with corporate dollars:

  1. The corporation pays a dividend to the business owner who then pays the premium and owns the policy personally.
  2. The corporation pays an increased salary to the business owner who then pays the premium and owns the policy personally.
  3. The corporation pays the premium directly and owns the policy.

From these three options usually the most tax-efficient strategy is to have the corporation pay the premiums directly and own it corporately. This is due to the fact that corporate tax rates are usually lower than individual tax rates. Furthermore this is a major factor in owning a life insurance policy corporately versus personally. One of the prime reasons why there has been substantial growth in corporate owned life insurance tax considerations.


Tax-exempt growth

Corporately owned tax-exempt life insurance provides tax deferred growth, which is especially attractive for business owners who have maximized their total contribution room to their registered accounts. Specifically, the cash surrender value grows on a tax deferred basis in addition to a tax-free death benefit. This gives rise to a tax minimization strategy whereby a business owner reallocates funds, within the corporation, that would otherwise be subject to tax, into a corporately owned life insurance policy.

Cash value options A corporately owned tax-exempt life insurance policy can provide more than a tax-free death benefit. In fact, during the life of the policy, the cash value can provide funds to the business owner for personal or business reasons. There are three options when accessing the cash surrender value:

  1. Partial of full withdrawal of funds within the cash value account.
  2. Obtain a policy loan against the cash value from the insurer.
  3. Collaterally assign the policy to secure a loan.

With the first two strategies, there would be a deemed disposition that could result in a taxable policy gain. Collaterally assigning the policy to secure a bank loan is not considered a disposition and will not affect the policy’s ability to grow on a tax deferred basis. The bank loan can be structured in different ways including no repayment until death enabling more possible solutions for the business owner. Even while the loan is outstanding, the policy continues to grow on a tax deferred basis which could produce a higher return than the interest rate on the loan. For these reasons the most efficient manner to access cash values usually is to collaterally assign the policy to secure a loan. A potential downfall of cash value within a corporately owned policy is that it may not be fully creditor proof.


Death benefit and beneficiary designation

A corporately owned policy should also have the corporation as the beneficiary. When a corporation receives the death benefit from a life insurance policy it will receive a credit to its capital dividend account (CDA) in the amount of the total proceeds of the policy less the adjusted cost basis. The CDA is a notional tax account that tracks tax-free surpluses accumulated inside the corporation. The corporation can then issue tax free capital dividends to the intended shareholders.


Other corporate considerations

  • The cash surrender value of the life insurance policy shows up on the balance sheet of the corporation and in turn affects the value of the corporation.
  • It is possible to transfer a policy from your personal ownership into your corporation. Care         should be taken to determine the effect of such a transaction, which is considered a disposition of the policy for tax purposes. A resulting gain in the transfer may create tax consequences.



Both of these strategies utilizing life insurance provide for tax-free transfer of wealth.  Life Insurance, by virtue of the tax-free character of the payout, provides for a substantially greater rate of return on premiums paid than on other non-registered investments. Learn more about corporate owned life insurance tax considerations with us at Burgess Kilpatrick.


If you have any questions or want to speak further about your corporation or estate planning matters, contact Nicholas Kilpatrick at


Nicholas Kilpatrick is a partner with the accounting firm of  Burgess Kilpatrick and specializes in tax structuring and business development for his small and medium business sized clients.  Please visit our website at or on Facebook at Kilpatrick for more information on our firm.






[1] RBC Wealth Management; Understanding corporately owned life insurance.

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