What is estate preservation?

Estate preservation entails using tax strategies to protect as much of your estate as possible from income tax and other costs when you and your spouse have passed away. Some assets, such as RRSPs and jointly owned property, can pass to your spouse tax-free, but much of your estate could be exposed to taxation, either when you die or when your spouse dies. Estate preservation strategies aim to reduce that portion so that your heirs, or charities you wish to support, receive as much of your estate as possible.

Strategies for family

If assets do not pass directly to your spouse when you die – that is, if they pass into your estate – or if registered assets such as RRIFs will enter your estate when the second spouse dies, your heirs could find that your estate owes significant income tax and probate fees, depleting what you had hoped to leave to them. Some assets, such as a family cottage, could trigger capital gains tax. If the cottage has been in the family for decades, it has likely increased dramatically in value and the capital gains could be significant. Your heirs could have to sell it just to be able to pay the capital gains tax.

You can greatly reduce income tax and probate fees by using life insurance. First, the proceeds can be used to cover taxes and fees on your death. Second, by moving some of your assets out of cash accounts and unregistered investments to purchase the insurance, the proceeds of which will be paid to your heirs tax-free, you can also preserve the value of your estate by sheltering assets from income tax on death.

Another advantage of transferring wealth with life insurance is that on your death, the policy is immediately liquid, providing your family with funds very quickly, reducing the likelihood that they would have to sell assets to cover probate fees, income tax and capital gains tax. Life insurance proceeds are also protected from your estate’s creditors.

Strategies for charitable contributions

There are several ways you can make a significant contribution to a charity through life insurance.

One way is to make a bequest in your will giving the charity the proceeds of the insurance policy (which would be paid to your estate). If you make such a bequest, the value of the gift will be a tax credit for your estate, thus reducing the total taxes owing on your final tax return. The premiums you paid on the policy are not deductible and because the proceeds of the policy pass through your estate, they may be subject to probate costs and are exposed to creditors and estate litigation. But you as owner of the policy retain control of it during your life, and you can also adjust your will to change the beneficiary if you choose.

You can also contribute to charity on death by naming a charity as the beneficiary of a life insurance policy. This method also does not provide a tax deduction for premiums paid, but does provide a charitable tax credit in the amount of the policy on your final tax return. Note that with this method, the life insurance policy cannot be owned by a corporation. With this method, the policy owner retains control of the policy and can change the beneficiary if they wish.

Finally, you can donate a life insurance policy to the charity during your lifetime. In this scenario, the premiums you pay on the policy after transferring it to the charity are tax credits as charitable donations. If you donate an existing policy, you can take advantage of a tax credit for its value. In this case, your estate receives no further tax deduction when you pass away.

Who are these strategies for?

Using life insurance to preserve the value of your estate could work for your family if you

  • wish to increase or preserve the value of your estate
  • are still in generally good health
  • hold significant registered assets and/or capital property
  • are in a high tax bracket.

Be sure to discuss your plans with your financial advisor or insurance professional before changing the beneficiary designations on your life insurance policies. These estate preservation strategies can be complex, so seek professional advice to avoid unintended consequences. Your advisors can help you project the future value of your assets and then choose a life insurance plan to suit your needs.