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Can life insurance fund RRSP estate tax erosion?

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Compliant content provided by Adviceon® Media for educational purposes only.


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When planning your estate. It is important to consider how taxation will affect the future distribution of your estate.  For individuals that are married, when the first spouse passes away, the assets generally are able to rollover free from taxation to the surviving spouse. However, when the last surviving spouse passes away, all assets are deemed to have been sold at the time of passing, and this includes RRSP or RRIFs.

Leave more wealth to the next generation. As such, registered assets are taken into income in the year of the surviving spouse’s death and taxes must be paid.  These taxes will be due after the death of the second spouse where there are no dependent children. For example, a $500,000 RRSP or RRIF would be reduced to about half the sum after the death of the second spouse (assuming the highest tax rate).  How can this be avoided? How can you leave more of your wealth to the next generations?

A joint last-to-die life insurance policy may be a solution. A joint last-to-die policy insures two lives, usually two spouses for the purpose of paying for an estate’s tax liabilities such as capital gains on a cottage or business. Where there also exists significant family wealth in registered retirement savings plans (RRSPs) or registered retirement income funds (RRIFs), taxes will eventually be due upon the second spouse’s death.  At that time, the entire remaining RRSP or RRIF funds are brought into income. Though this is not creating a liability as such, the taxation of large holdings of registered monies can deplete a family’s overall wealth.

By purchasing a joint last-to-die life insurance policy, the taxation of assets in a family’s estate plan can be offset by tax-free life insurance proceeds.  In the above example, a joint last-to-die life insurance policy for $250,000 would replace the estate value lost to taxation, therefore helping to preserve the estate’s net worth more fully for the family. This is especially true of the RRSP or RRIF owner is expecting to leave the entire amount to his or her heirs.

What about the life insurance premiums?  The premium for the life insurance policy to pay for the estate’s tax loss through RRSP or RRIF final estate taxation is usually a small percent of a significant registered investment portfolio—when compared to the much larger tax bite. The death benefit is tax-free. A joint last-to-die policy can also be structured to pay back all of the premiums that have been paid into the policy, thereby minimizing the cost to the estate for a strategy designed to save money.

Note: It is recommended that you get qualified tax advice concerning taxation of your registered retirement plans if you consider this strategy.

 


 

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