Opinion: Life Insurance As a Wealth Transfer Tool

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Picture of By <span>Matthew Roberts</span>
By Matthew Roberts

Updated on October 22, 2024

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Picture of By <span>Matthew Roberts</span>
By Matthew Roberts

Updated October 22, 2024

Visit author page

4 minute read

Article Contents

A life insurance policy can be a safety net to ensure your loved ones are financially secure in the event of your passing. But what many Canadians may not know is that it’s also an efficient tool for passing on your wealth to the generation. The rest of your estate will be subjected to fees and taxes like capital gains tax and estate tax, but that’s not the case for a life insurance policy. 

Life Insurance for Intergenerational Wealth Transfer at a Glance

  • There are several ways you can use life insurance to retain as much of your estate’s value as possible to pass down to your heirs, such as establishing a trust, earmarking the tax-free death benefit for covering estate expenses, or using a cascading life insurance strategy. Talk to a qualified financial adviser or lawyer to determine which plan is best for your financial situation.
  • A policy’s death benefit can cover estate taxes and outstanding debts, so your heirs aren’t forced to sell off real estate or other assets at unfavourable prices to pay these costs.
  • Permanent life insurance is generally preferred over term life insurance for estate planning purposes, as it provides coverage for your entire lifetime.

With careful planning, a life insurance policy is a valuable component for providing for the next generation. Read on to learn why you should consider getting life insurance coverage as part of your estate, as well as its tax advantages for your beneficiaries.

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How Can I Use Life Insurance for Estate Planning?

Life insurance can help with estate planning by addressing financial needs that arise when you pass away. Here are some of the ways that you can use a life insurance policy to maximize the amount that passes down to your heirs and provide for them when you’re gone:

Replace lost income:

This point is especially important if you’re the breadwinner for your family. Life insurance provides a death benefit that can replace lost income. This can cover everyday living expenses or obligations like mortgage payments,  giving your loved ones financial stability.

Preserve assets from liabilities and fees:

Your beneficiaries can use your life insurance policy’s benefits to cover capital gains tax and other liabilities, preserving as much of the estate as possible for the next generation. This is a key consideration if you have properties that may appreciate in value.

Cover final expenses:

Final expenses like burial costs, outstanding debts, and end-of-life medical care bills can quickly add up and take a significant chunk out of an estate. A life insurance policy’s benefits can help cover those costs, ensuring your beneficiaries receive a larger total value and won’t pay those expenses out of pocket.

Bypass probate for swift liquidity:

Probate can take anywhere from six months to two years to settle. Life insurance policies bypass probate, giving heirs faster access to funds. This is key for helping the next generation cover immediate expenses.

What Are The Tax Advantages of Using Life Insurance for Estate Planning?

When a person passes away, their assets like homes, personal possessions, and investments form their estate. An estate is subject to taxes like capital gains tax and needs to cover outstanding debts before it’s transferred to the heirs, which can be a significant financial burden that may leave them out of pocket.

A life insurance policy can be a valuable component of an estate without the same tax burdens. Here’s a quick breakdown of life insurance’s tax advantages for passing down wealth:

When structured into your estate plan correctly, a life insurance policy’s death benefit is typically excluded from your taxable estate. This allows your beneficiaries to receive the full value of the policy without incurring any tax liabilities. You can do this by directly naming beneficiaries instead of making the estate a beneficiary, or by transferring the ownership of the policy to a life insurance trust.

Permanent life insurance policies accumulate cash value on a tax-deferred basis. This means the growth of the benefit’s cash value isn’t subject to tax while it remains in your policy. Policyholders can even access this cash value through withdrawals, providing a financial resource with minimal tax consequences compared to other options like conventional loans.

The value of your assets may vary, often resulting in some heirs receiving a more valuable asset like real estate or family business than others. This can be balanced by placing your life insurance policy in an irrevocable life insurance trust, which effectively removes it from your taxable estate.

This type of trust gives you control over how the death benefit is distributed amongst beneficiaries, so you can give a larger share of the death benefit to heirs who don’t receive other assets to equalize their inheritance.

How to Use Cascading Life Insurance for Wealth Transfer

Another tax-efficient way you can use life insurance to transfer wealth is by planning cascading life insurance. Here’s how this strategic approach works:

  1. Parents or grandparents purchase a permanent life insurance policy on the life of their child or grandchild: Apart from being used for wealth transfer, this locks in life insurance rates for the child or grandchild while they’re still favourable. This ensures that they’ll pay more affordable premiums later on when the policy is transferred to them by the policyholding parent or grandparent.
  2. The parents or grandparents then fund the life insurance policy with assets that they plan to leave to the child or grandchild as a legacy or for funding specific purposes: This allows parents or grandparents to place these assets into a tax-advantaged life insurance policy.
  3. The policyowner names the child or grandchild as the contingent policyowner: By naming them, this allows a tax-deferred rollover of the policy when the policyholder dies. Note that this depends on whether the child meets the legal definition and standard of “child” under the Income Tax Act.
How to Use Cascading Life Insurance for Wealth Transfer

Cascading life insurance then allows the child or grandchild to access the policy’s cash value through policy or collateral loans if needed. Its death benefit is also generally passed down to the child’s named beneficiaries tax-free, bypassing that child’s estate probate and providing immediate liquidity.

Key Advice From MyChoice

  • Get a life insurance policy in place early for lower premiums. Qualifying for an affordable policy gets harder as you age because your health risks increase, making it riskier for a life insurer to insure you.
  • There are different types of permanent life insurance policies you can choose from depending on preferences like flexibility and potential investment. Talk to an estate planning attorney and qualified financial adviser to find the best one for your needs.
  • Many people underestimate the value of their estate, which includes not just real estate and investments, but also cars and personal belongings like artwork or unique collectibles. Generally, if you have dependents, you’ll need to plan your estate to determine who receives what and reduce the costs they’ll have to cover.
  • If you want to support a charitable cause without burdening your estate or creating a tax liability for the charity, you can simply name the charity as a beneficiary in your life insurance policy

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