What is so special about a whole life policy? In the right scenarios, this truly unique asset class sets policy owners up with a win-win strategy and cash options.
How does it work?
A whole life policy is a permanent life insurance product that earns dividends by participating in the profits of the insurance company. Benefits of these dividends:
- Money in your policy’s pocket: Once a dividend is paid, it is 100% vested and cannot be called back
- Only positive returns: There is no such thing as a negative dividend or negative return. Returns are not market driven but are partnered with the insurance company’s profits based on the company’s:
- claims experience
- investment returns
- expenses and other relevant factors
Historically insurance companies consistently pay dividends at a rate of 4% to 6%, even during downturns in the market. These tax-deferred dividends accumulate inside the policy and to maintain this status, the dividends can be used to buy more life insurance. In this scenario, your initial $1M life policy could possibly be worth $3M to beneficiaries tax-free when it pays out.
Who Benefits?
A whole life product is very appealing to the high-net-worth client. The best-case scenario:
- The client is a business owner with retained earnings in the corporation
- Life insurance is needed and can cover:
- Estate tax liabilities.
- Estate equalization: in blended families or families where not all the children are involved in the business.
- Large charitable donations, etc.
- Insurance costs are minimized by:
- A joint last-to-die policy with spouse
- Premiums paid with corporate dollars and the corporation is the beneficiary. Note that the premiums are not tax deductible to the corporation.
How do I access the cash?
How do we access the cash value of the policy in a tax efficient way now? Owners may want cash for investing in other ventures or their company, emergency funds, or supplementing retirement income. What are the options?
Option 1
Collapse the policy and take the cash (at any time). This could trigger some taxation and insurance coverage will be lost.
Option 2
Request a policy loan from the insurance company. This could trigger taxation as well as a higher interest rate for the loan, but the coverage stays intact.
Option 3
Request a partial withdrawal of the available dividends from the insurance company. This will lower your overall policy coverage and could trigger taxes.
Option 4
A collateral loan with one of the specialized banks who are familiar with these whole life policies, such as Manulife Bank. This does not trigger any taxation, insurance stays intact, and you could get favourable interest rates.
Any of these options can work based on your need, but Option 4 is the best choice for the high-net-worth client! Keep in mind that this option only works well with policies that have an annual premium of at least $50,000.
Planning Strategically
If planned strategically, this client can have their cake and eat it too by paying the first year’s premium and then leveraging the total amount back out again to profitably invest elsewhere such as: real estate, company operations, and/or non-registered investments. The client can leverage:
- 100% of the policy cash value with no extra collateral OR
- 100% of the premium paid but extra collateral may be necessary
Benefit: the client can deduct the interest paid on the collateral loan and the increased insurance portion remains intact.
If the client does this every year and only pays the interest on the loan amount, when the insurance claim is accessed, the loan balance is deducted, and the rest goes to the beneficiaries. The bank is happy, and the client’s family is happy – this is the strength of a whole life policy!
Keep your small business tax rate low
Business owners with retained earnings generating more than $50k of passive income in the corporation can trigger an increase in their small business tax rate. By moving some of this money into a whole life policy the lower tax rate can be maintained. Strategic planning can also supplement a client’s retirement income while providing secure, tax-sheltered growth and preserving the company’s small business tax rate.
Wrapping It Up
When used properly, a whole life insurance policy can accomplish many things but works the best for a high-net-worth client. There are many ways to access the policy cash value depending on your needs. I encourage all business owners to take a closer look into adding this unique asset class to their investment portfolio which can provide a win-win scenario. FYI, rumor has it that Jim Pattison started his empire by accessing the cash value in his whole life insurance policy
Joey San, Financial Advisor
For the past thirty years Joey has established a practice based on relationships and trust with his clients. The majority of his clients are families and small business owners. Historically his practice has been focused on risk management to provide a solid foundation and security for clients. Since then Joey has expanded his practice to help educate clients as they navigate towards retirement and provide support in tax and estate planning. Joey is actively working on getting his Certified Financial Planner designation to better serve his clients.
Joey’s active lifestyle often finds him golfing, fishing or spending time with his family during his spare time.
