If you have ever thought that life insurance was something you wouldn’t need after you reached a certain level of financial security, you might be interested in knowing why many wealthy individuals need life insurance and still carry large amounts of life insurance. Consider the following:
- A life insurance advisor in California recently placed a $201 million life insurance policy on the life of a tech industry billionaire;
- Well, known music executive, David Geffen was life insured for $100 million;
- Malcolm Forbes, the owner of Forbes Magazine, was insured at the time of his death in 1990 for $70 million.
While life insurance is most often looked upon as a vehicle to protect one’s family or business, the question that springs to mind is why individuals with wealth would need life insurance?
The most common factor connecting people of wealth is that they have a substantial amount of deferred income tax that must be paid upon death. Also, they often have a strong desire to make a substantial donation to a favourite charity or educational institution.
“Life insurance is an efficient way to transfer money to your heirs.” – Malcolm Forbes.
In Canada, individuals are deemed to have disposed of all their assets at fair market value when they die, which often results in taxable capital gains and other deferred taxes coming due. Paying premiums for insurance that will cover these taxes is almost always less expensive and more efficient than converting assets.
When allocating your investment dollars, it is helpful to understand what investments have the highest exposure to income tax.
Fully Tax Exposed Investments
Investments which are taxed at the highest rate of income tax:
- Interest bearing instruments such as bonds, savings accounts, guaranteed investment certificates;
- Withdrawals or income from registered plans such as RSP’s or RPP’s.
Investments which are taxed at lower rates of income tax:
- Investments which are taxed as a capital gain;
- Flow-through share programs;
- Prescribed annuity income.
Investments on which income tax is deferred until the asset is disposed of or the investor dies:
- Registered Savings Plans;
- Individual and Registered Pension Plans;
- Investments producing deferred capital gains.
Registered plans, in addition to having the growth tax-deferred also have the added advantage of the contributions being tax-deductible.
Certain investment assets are totally free of income tax:
- Principal residence;
- Tax-Free Savings Accounts;
- The death benefit of life insurance policies.
Life Insurance as an Investment
While the death benefit of life insurance policies is tax-free, it is important to recognize that this also includes the investment gains made on the cash value portion of the policy. With this in mind, many investors have discovered that by allocating a portion of long term investments to a Universal Life or Participating Whole Life policy, the results can be significant when compared to tax exposed or tax-advantaged investments.
Life Insurance for Estate Planning
One of the main objectives of estate planning is to maximize the amount we leave to our families or bequeath to our favourite charities. What many wealthy families have learned is that one of the easiest ways to accomplish this is to reduce the portion of the estate, which is lost to the government to pay taxes at death.
While this helps explain why many individuals of wealth maintain life insurance, it also underscores the advantages of life insurance to anyone who will have taxes or other liquidity needs at death. Besides, using life insurance as part of a charitable giving strategy can provide significant benefits to both the donor and the charity.
As Malcolm Forbes alluded to, for providing capital to protect your family’s future financial security, paying taxes at death and creating a charitable legacy, nothing is more efficient or effective than life insurance.
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Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolve from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.
Wealthy individuals need life insurance