Why life insurance for wealth transfer should be allocated and adjusted like any other long-term holding, and how that compares with the way it is sold today.

Life insurance answers two different questions. The first is protection: if I die tomorrow, will my family be all right? The second is wealth transfer: how much of what I will have do I want to go to other people as cash, and how do I keep that right as my life changes? The way life insurance is sold today was built for the first question. It is now used for both. For the second question, I think there is a simpler and more logical way to do it, and it borrows the logic investment advisors already use for portfolios.

Where the capital dividend account does its work.

If you advise on life insurance, the investment Holdco is arguably where the product fits best. The money is already set aside, the owner usually has an accountant, and the tax rules give a death benefit there an advantage over most of the alternatives. What advisors often lack is a simple way to explain why, one a client can follow before going to the accountant for the details.

Here it is: three kinds of money, one theory of integration, and the capital dividend account. Then the numbers, and the assumptions that move them.

An investment holding company usually holds three kinds of money, and they have not all paid the same tax. In round numbers: money that came up from an operating company’s active business income has paid about 12%. Business income above the small business limit has paid about 25%. Investment income earned and taxed inside the Holdco has paid about 50%.

Canada’s tax system is built on integration. Whatever route income takes, by the time it reaches the shareholder the total tax should come to roughly the same amount - call it 50%. So the 12% money and the 25% money still owe the difference. It is paid when the money comes out as a dividend, during life or at death. Until then it sits in the corporation, which is why it is sometimes called trapped surplus.

The corporate estate bond, compared to what?

A corporation may have money in it that the shareholder cannot access for personal use without paying tax. Their planning includes transferring some or all of it to others. The industry recommends a corporate estate bond. Potential purchasers of life insurance should consider moving some of that surplus into a life insurance contract, and most of what comes out at death comes out as a capital dividend rather than a taxable one.

The arithmetic is real. Making it simple enough for a consumer to understand whether it is something they should consider is the challenge. Here is how we can compare it, using the approach TAN is working to generally accept: “ROI” is currently positioned as slide 3 of 5 Slides Only. At this stage, we offer to compare the return on investment, personally owned, and add a corporate button.

The way we show the math follows CLHIA illustration guidelines: a spread of results rather than one. So we take a range of probable dates of death and compare the financial results as a return on investment. The internal rate of return (IRR) comes from the life insurance company’s own illustrations. On its own terms, that analysis is now complete.

Compared to what is another question. To keep decision making simple, an advisor may select a single rate of return for the alternative, making a presentation easy to follow, and most start there. This page adds two things: a rate beside every dollar figure, and assumptions the consumer can move. Then anyone looking at it can see whether the conclusion depends on the product or on the assumptions for the alternative.