The Clock Is Ticking

There is a rule in tax planning that says, “If it is good, it will go away.” This situation is good, so be ready to see it go away.  Likely in the April 2015 federal budget.

There is an anomaly in the income tax act where the fair value of a personally owned life insurance policy exceeds the cash value of the policy and the policy owner sells it to a controlled corporation.  The advantage can be worth a great deal in some cases.

The way it works is generally as follows:

  • Sell the policy to the corporation at Fair Market Value.  (FMV)
  • The tax act deems proceeds of sale to be the Cash Surrender Value (CSV)  (It is possible there will be some tax to pay if the proceeds are greater then the adjusted cost basis of the policy.)
  • The excess amount is not taxable to the person selling.
  • The difference between the higher FMV and CSV is a debt of the corporation and can be withdrawn tax free.
  • Upon death the same amount or more becomes a capital dividend and can be withdrawn tax free again.

The fair value of an old policy can be quite large and so there can be a significant advantage.

Here’s what to look for:

  • An old policy that you own personally
  • Preferably a non-par policy like term to 100 or universal life with level cost coverage  (other formats will work but usually not as well)
  • Any policy if you are uninsurable now or if a new policy would be rated for health.

Here’s what to do.

Talk to your accountant to be sure there are no liability or other reasons that would make it inadvisable.

Get a professional valuation of the policy.  I use Dennis Serre at Serre Financial.   Most unusually, they will provide you with an estimate of the value for no charge.  The most recent one I saw had a fair value $425,000 higher than the cash value.  Easy cost/benefit analysis.   The fee to get all of the documentation you will need and a professional valuation is about $2,000 per policy.

Pay attention. This is not a do-it-yourself project.

In an old Wizard of Id cartoon, the king has a peasant on the gallows ready to be hung. The peasant cries, “My lawyer said there is a loophole.” The king replies, “You’re wearing it.”

This transaction is technically based and will work only if done correctly.  There should be a non-tax reason.  Usually Key Person coverage to benefit the corporation is reasonable.  You will require the overall guidance of a competent tax professional, the supporting documentation, and a professional valuation of the policy.

Do not go cheap here.  In the right situation, the cost benefit is exceptional.

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. Contact: 

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