A key aspect of estate planning is the creation of an integrated financial plan that maximizes the benefits available to you and your heirs, and minimizes the amount of tax payable to both during your life and at death. The goal of an estate plan is to have more of your money available to yourself and your survivors, and less available to the government and outsiders.
Life insurance is an important part of many estate plans. Upon death of the life insured, it provides cash that can be used for any purpose, including providing income for dependents, to pay a tax liability or an outstanding bank loan, or to make a gift to charity. Life insurance is an effective planning tool because it ensures funds are available when required. It is an affordable alternative to other methods of funding, and proceeds may be protected against claims of creditors if structured properly.
Many estate plans include the use of joint last-to-die life insurance. This type of insurance generally insures two people under the same policy; the death benefit is paid when the second life insured dies. Such coverage is desirable in situations where the individuals’ insured share a common liability that will only arise upon the death of the survivor.
Many estate-planning strategies defer the payment of tax for as long as possible. For example, upon death, a taxpayer is deemed to dispose of all capital property at fair market value. If the property has increased in the value from when it was acquired, the increase is a capital gain subject to taxation. The Income Tax Act allows for a rollover of capital property, at cost, between spouses or common-law partners when one of them dies. This mean that the increase in value is not taxed at the first death. As a result, the payment of income tax on the capital gain is deferred until the death of the surviving spouse or common-law partner (or until the property is disposed of). Joint last-to-die insurance is the perfect solution for funding this tax liability because the funds become available exactly when they are needed, upon the second death.
Joint last-to-die insurance is not appropriate in situations where the need for cash occurs upon the death of either person. For example, in a situation where both spouses work, if life insurance is required to provide the surviving spouse with cash that will be used to replace the income earned by the deceased, joint last-to-die insurance will not meet the needs of the spouses. A separate policy on the life of each spouse, or a joint first-to-die policy, would be more appropriate.
In the Canadian insurance market place there are significant differences in the cost of joint last-to-die insurance. In determining the cost of this coverage, life insurance companies generally convert the ages of the two lives insured into an equivalent single life age (also referred to as the “ESLA”). The price of the policy is determined through an actuarial calculation preformed by the insurance company. Because it is a calculation done by each company, however, the ESLA determined by one company may be different from another. For example, the ESLA for a 60-year-old male non-smoker and a 58-year-old female non-smoker may be age 48 with one insurance company and age 46 with another. Because the cost of the policy is based on the ESLA, the company with the lowest ESLA generally charges the lowest premium.
The use of life insurance as part of the estate plan is very common. But it is important to understand that life insurance must be structured properly to ensure that funds are available when they are needed. Therefore, it is important to ensure that joint last-to-die insurance is only used in situations where the liability or need for cash arises upon the death of the last person insured.