On June 25, 2024, the capital gains inclusion rate rose from 50% to 66.7% for gains over $250,000 realized on or after that date. Introduced in the April 16 federal budget, the increase has had the effect of turning the spotlight on individual permanent life insurance. It is one of the few ways to mitigate the impact of the new tax on the wealth of individual business owners.
The new inclusion rate also applies to companies and trusts. Individual earnings of $250,000 or less in a given year continue to benefit from the 50% inclusion rate.
The new tax rules that came into effect on June 25 are also keeping financial advisors on their toes. “It has a big influence on the discussions we have with clients,” said Valérie Ménard, senior partner at Ménard & Associés, in an interview with Insurance Portal. Her firm specializes in business clients.
Insurance versus taxation
When we sit down with our customers to review their insurance needs, capital gains tax is definitely the number one topic - Valérie Ménard
“Many families' tax bills have just gone up,” observed Ménard. She adds that, in terms of estate planning, the next generation will be affected as the beneficiary of an individual who didn't realize all their gains during their lifetime. “When we sit down with our clients to review their insurance needs, capital gains tax is definitely the number one topic,” she adds.
Terry Zavitz, President of Toronto-based Zavitz Insurance and Wealth, also observes that life insurance now plays a much more important role in estate planning. The biggest impact of the capital gains tax inclusion rate of 66.7 % will be when clients trigger the capital gains tax when they sell shares. “Peoples will be impacted at different times, depending on when they sell their assets,” she said.
Zavitz points out that with the increased inclusion rate, estate taxes will be higher. “Insurance is one thing that we can use to reduce the client’s estate taxes, but it’s based on the clients’ needs.” For example, the client might want to make a charitable donation, instead. “With a donation of securities or mutual funds, capital gains tax does not apply.”
It's all in the financial needs analysis
For her part, Valérie Ménard encounters two situations when reviewing a client's insurance needs as part of estate planning. In the first, the client has insurance with a fixed amount of protection, such as Term-to-100 (T100). “If he wants to increase his coverage, he'll have to take out a new policy when he reaches that age, which will cost him more than it did five years ago,” she illustrates.
In the second case, the customer has participating whole life insurance. According to Valérie Ménard, he will be less affected if his expected tax bill has increased, because he can use his dividends to purchase an additional amount of protection. “He's a little better protected against the tax increase,” she explained.
Ménard will always offer the customer two choices: the less expensive T100 and the more expensive whole life. If the customer eventually has to absorb a tax bill, she will make them aware that this bill may increase over time. Ménard points out that the T100 may, on the other hand, be suitable for a client who has done an estate freeze, since the capital gains on his company's shares are crystallized. In the freeze, the owner immediately realizes these gains at once. There is no subsequent increase in the value of the shares.
“It's all in the financial needs analysis,” she underlines. Ménard focuses on three angles: the client's age, his or her state of health and the degree of maturity of his or her business. “A whole life insurance policy payable in 10 years may not be the best choice for the owner of a start-up company, because he or she may not have sufficient liquidity,” explains Ménard.
A role for each product
Every customer has unique needs. Whether through insurance or another strategy, the key is to have a clear vision of your estate goals - Terry Zavitz
In an estate planning case, Terry Zavitz says that the life insurance policy should remain in force for a long period of time. “I’d use permanent insurance: sometimes universal life, sometimes whole life. It depends on the situation, on the comfort level withthe premiums.”
Zavitz adds that whole life insurance is generally more expensive than universal life insurance with an annually renewable cost of insurance (minimum cost). Some customers opt for permanent insurance because of the more affordable premiums, or because they don't want a cash value to develop. “Universal Life has the kind of policies that don’t have a cash value. For most cases, I find that whole life participating policies work better,” adds Zavitz.
She stresses the importance of a personalized approach: “Every client has unique needs. Whether through insurance or another strategy, the key is to have a clear vision of your estate goals.”
The miracle of life insurance
It's hard to predict solutions. That's where what I call the miracle of life insurance comes in - James McMahon
If there's a death tomorrow morning, capital gains taxation kicks in immediately, James McMahon, a financial planner with Planif-Globale Inc. pointed out in an interview with Insurance Portal. “The deceased is presumed to have disposed of his assets 24 hours before his death. It's difficult to foresee solutions. That's where what I call the miracle of life insurance comes in. It solves the problem,” he said.
Jean-François Salvail, a life insurance advisor and McMahon's partner in this type of insurance planning, asserted during the interview that capital gains taxation particularly hurts owners of a company owned by a management company.
In the case of a company with net disposition proceeds of $10 million, realizing this value results in a net capital gain of $10 million. The taxable portion of this gain was $5 million before June 25, 2024, and the tax on this gain was $2.5 million, based on the 50% inclusion rate. Since June 25, the 66.7% inclusion rate has increased the taxable portion of the gain to $6.67 million. The tax payable will be $3.33 million, or $833,333 more than before June 25,” explained Salvail.
Not only will the company pay more tax, but its shareholder will have a lower tax exemption - Jean-François Salvail
In addition, the non-taxable portion of the capital gain will no longer be $5 million, but only $3.33 million. Bad news for the Capital Dividend Account, a theoretical construct created to avoid double taxation of capital gains. Whereas the non-taxable gain would previously have created a tax exemption of $5 million, this is now reduced to $3.33 million, in Salvail's example. “Not only will the company pay more tax, but its shareholder will have a lower tax exemption. The total tax impact for the company will be about $1.2 million higher than it would have been before June 25.”
