Clockwise from top left are Eric Benchetrit of Sage Advisory Corp. , Michael Godsoe of Langhaus Financial, Trevor Shaw of Unity Insurance, and Dustin Schneider, also of Unity Insurance.
Real-life situations show how people with complex financial needs use insurance to achieve their goals
For anyone who can afford it, taking out a life-insurance policy to protect the financial future of dependent family members is a no-brainer. But families of means use insurance in other, more creative ways.
“I think there’s a misconception that wealthy individuals don’t need life insurance, but I think the role of life insurance increases as wealth does,” says Eric Benchetrit, founder and president of Sage Advisory Corp. and a tax and estate specialist at the insurance brokerage HUB International (Canada) in Thornhill, Ont.
Here are four real-life examples showing how individuals and families with complex financial needs used insurance to achieve their goals.
Insurance used in individual estate planning
Toronto-based Michael Godsoe is president of Langhaus Financial as well as president and principal owner of Godsoe Financial Capital. He says life insurance is “one of the best tools you can have in your box. Because there’s a specific beneficiary, it avoids probate: you can direct that money right into the hands of the individual.”
This serves two purposes. It provides the beneficiary with unencumbered capital, and it also potentially reduces estate costs such as probate fees, which can range as high as $1.4 million to $1.7 million per $100 million, in addition to the tax bill in some provinces.
Godsoe gives the example of a male non-smoking corporate owner, age 60, with assets worth $100 million. With no planning, at age 85, his gross net worth of $197 million would shrink by some $52 million in probate fees and taxes. But the purchase of a $62 million life-insurance policy would reduce costs substantially, protecting about $14 million for the estate.
Insurance also serves as a hedge against capital gains, saving beneficiaries from having to sell off real assets at fire-sale prices to pay taxes owing.
Benchetrit describes one client couple of about age 60 who expected to pay at least $10 million in capital gains, or as much as $30 million should they live to a normal life expectancy.
“They had suggested setting aside $500,000 annually in a sinking fund for the next 20 years to cover the tax,” he says. “When we ran the numbers and compared the same allocation into insurance, the policy ended up being worth $30 million tax-free at age 90.” A traditional investment would have had to generate a net return of 11.5 per cent to reach the same total.
Another need is philanthropy, Godsoe notes. “People can help charitable foundations if they have excessive capital. It’s a tax-free advantage.”
Insurance used in corporate tax planning
Dustin Schneider is president of Unity Insurance in Winnipeg. His colleague, Trevor Shaw, a partner with the firm, is based in Ottawa. The two have seen several examples of a family enterprise using insurance to protect the company against the unexpected loss of a shareholder.
In one such situation, says Shaw, “a family and their family office are responsible for a large multi-generational family business, and their goal is to maintain control of their business without having to sell shares in the case of the unforeseen death of a shareholder.”
He explains that if someone were to pass on, there would be a deemed disposition of their shares that would trigger capital gains, possibly at an inopportune time. “Life insurance is the perfect solution,” he says, to cover capital gains and ensure the future of the business.
Schneider mentions a case in which “one of two siblings was actively involved in the family business, and the other not involved at all. The way the will was written, there were going to be some fairly extreme tax consequences for the daughter that was involved in the business, but at the same time no liquidity; it would actually have put the ongoing business in jeopardy,” he says.
Schneider’s firm advised the sisters how to restructure the will and use insurance “in a very tax-efficient way to equalize the non-involved daughter. Now they will have the capital available to meet their tax obligations.”
Insurance as an alternative asset class
Insurance is also an investment tool in its own right. “Insurance has some unique properties in its ability to grow tax-free when it’s in the insurance-policy shell,” says Schneider.
Benchetrit points out that insurance can allow a policyholder to participate in the market indirectly: “It’s creditor-protected if it’s structured properly, and it’s probate-free,” he says, citing the case of a “very savvy” hedge-fund manager of about 40 years old with a young family.
“Because he was so successful, he also needed something to cover his tax liabilities down the road,” he says.
The initial plan was to purchase a policy simply for its value in terms of income replacement and to pay down debt. However, “when he started to look at insurance as an alternative asset class – given that he’s a fund manager as well – he saw it as a way to have his cake and eat it, too.”
Benchetrit says this can be done in either of two ways. The first is a universal life policy that acts “almost as a self-directed investment approach” that sees the insurer presenting the purchaser with a wide choice of funds in which the policy could be invested, including public-market securities, mutual funds, ETFs, stock-market indices and private debt and credit funds.
The second possibility is whole life insurance, in which the policy is entirely invested and managed by the insurer. “Being a regulated industry, it has to be managed in a way that will provide very predictable returns over the long term,” Benchetrit says.
With whole life, “you’re usually going to get a higher yield than in a traditional bond portfolio. The insurance company effectively manages their gains and losses over a number of years, which actually provides smooth and stable returns of 5.5 per cent to 6.5 per cent,” he says.
In addition, the insurer will most likely have exposure to asset classes not normally available to individual investors or even family offices, such as commercial and residential mortgages and government funds dedicated to investment in infrastructure.
Thus, although the hedge-fund manager was intending to invest in a U.S. growth-equity fund earning interest of about 6.5 per cent net, “with the tax-efficiency ratio, the actual return was only about 4.5 per cent” because of taxes. Instead, with insurance earning 6.5 per cent, even factoring in a service fee of 50 basis points, “the client would still be ahead, with a net return of about 6 per cent. He got the benefit of managing his own account on a tax-free basis.”
Insurance as collateral
“Life insurance has very high collateral capacity when compared to other investment assets,” Benchetrit says. “Lenders will lend 90 per cent to 100 per cent of the cash value of the policy. They’re quite comfortable in lending against insurance because it’s regulated.”
He explains that real-estate families – builders and developers, for instance – often don’t want to liquidate their assets because they have accrued huge capital gains. These families use insurance policies as collateral to set up lines of credit.
The interest can be tax-deductible, he says, and “the Income Tax Act allows you to deduct a portion of the premiums. Even if one is in their 60s or 70s, the amount of life insurance is enough to cover the capital-gains tax, so the estate has liquidity. The one caveat is that you need to be comfortable with debt, because at the end of the day this line of credit is going to be there until the day you die.”
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