Budget 2012: Government wants to change criteria for exempt life insurance policiesBy Hubert Roy | April 17 2012 08:22PM
The federal government is launching consultations in order to change the rules governing the criteria for exempt life insurance policies. Federal Finance Minister Jim Flaherty made the announcement in his budget presentation on March 29. He added that changes to tax provisions from these consultations will apply to life insurance policies issued after 2013.
In the supplementary information related to the budget, the Government points out that life insurance policies can offer both a protection (insurance) and a savings component.The income earned by the savings component of a life insurance policy that qualifies as exempt under the Income Tax Act is not subject to income tax.
The government also emphasizes that the exemption criteria used to determine whether a life insurance policy is exempt or not were implemented in early 1980s. The purpose of the criteria was to distinguish life insurance policies focused on protection from those focused on saving.
Since the criteria for exemption were established nearly thirty years ago, the government has examined them to make sure they have remained consistent with their intended purposes. This review shows that technical improvements are required in order to simplify the criteria and to bring them up to date. As a result, the government is proposing the following changes:
- measuring the savings in an actual policy and the benchmark policy using the Canadian Institute of Actuaries 1986-1992 mortality tables and an interest rate of 3.5 per cent to better reflect mortality rates and investment returns while improving consistency between the measurement of the savings in an actual policy and the measurement of the savings in the benchmark policy;
- increasing the endowment time of the benchmark policy from age 85 years to age 90 years to reflect increased life expectancy;
- measuring the savings in an actual policy using the greater of the cash surrender value of the policy (before the application of surrender charges) and the net premium reserve in respect of the policy to capture all savings in an actual policy while improving consistency between the measurement of the savings in the policy and the measurement of the savings in the benchmark policy; and
- reducing the pay period of the benchmark policy to 8 years from 20 years to better reflect current industry practices and the pay period used in other countries.
In the budget, the government also proposed that the Investment Income Tax (IIT) levied on life insurers be re-calibrated to neutralize the impact of the technical improvements proposed for the IIT base.
Currently, a life insurance policy is an exempt policy when the cumulative savings it generates do not exceed those generated by a benchmark policy. In general, the benchmark policy is one where the death benefit is payable at death or at age 85 (the endowment time), whichever comes first, and where the premiums are payable for 20 years after the issuance of the policy (the pay period).
Depending on the type of protection, the savings generated by the benchmark policy are calculated using mortality rates and prescribed interest rates, the rates used to determine premiums, or the cash value of the police in particular. The savings generated by a specific policy are measured by an amount that is equal to the greater of the cash surrender value of the policy and the modified net premium reserve in respect of the policy.