The long lost forgotten brother returns...and is rich beyond his wildest dreams

You ever eat something as a kid and you absolutely hated it and so you go through life believing you hate it?

I didn’t like onions as a kid.

I hated olives, and I still do for some kinds.

But I read that overtime your taste buds change. Things you once hated become more appealing. You are simply changing.

I say all this to set the stage for something I want to talk about this morning. And you’ll see why in a second.

I’m going to share with you something that I didn’t think I liked and didn’t look good, until recently I guess.

Before we go there, I need to get everyone up to speed on capital gains on corporations.

Now you might be reading this and you know plenty about this, but for the initiated here, this will be a quick lesson.

If you’re a business owner/shareholder/investor who owns shares a corporation and you died, there could be some taxes owed.

We typically call this capital gains at death.

For example, if you own shares of a company that is worth $10,000,000 and you build it from scratch (ie, $0 cost basis), then there will be a $10,000,000 capital gain right?

Yes.

And here’s how the tax works.

We take the $10,000,000 less the Adjusted Capital Base ($0, in this case). That means there is a $10,000,000 capital gain on the estate.

Currently, we only need to include 50%, so that means the capital gains becomes $5,000,000.

Then, we take that $5,000,000 and multiply it by the tax rate, I’ll assume 50% in this case.

This means that if the company was worth $10,000,000, the tax payable on the death is $2,500,000.

$10,000,000 × 50% (inclusion rate) * 50% (tax rate) = $2,500,000

And, I should note that the capital gain is owed personally, not corporately. So, we could run into a double taxation issue (where we need to pay a dividend to pay the capital gain). But, let’s not get too far ahead of ourselves here.

That’s just the way it is.

Now, there are ways around this. Accountants typically recommend something called a wasting freeze, which stops the growth of the company and buys back the shares.

But, this doesn’t eliminate the tax bill completely, it just limits the amount of tax.

And that’s not a bad idea. But, what I’m about to walk you through could be used in conjunction with that and result in a whole lot less taxes too.

But before we go there, we need to talk about what increases the value of those shares.

Buying real estate that appreciates will increase the value of your shares. Buying stocks that go to the moon will appreciate the value of those shares.

Heck, buying GICs and simply reinvesting the money will grow the value of those shares.

It seems like there is no way around not growing the value of those shares long-term. Which is why accountants go to the estate freeze/wasting freeze strategy.

But what if there was an asset I could put my money into, that would not only NOT GROW the value of those shares, but would immediately eliminate it.

POOF, like it never existed.

Well we know we can’t do that. If we take money out the company it’s taxable. And if we leave it in there and grow it, the share value grows.

Except, in what I’m about to show you.

Now, just a note on permanent insurance. Although cash value and death benefit grows on a tax-advantaged basis in a corporately owned policy. When you calculate the capital gain at death, the cash value is listed as an asset on the balance sheet that increases the values of shares.

This still makes it advantaged, but won’t help with eliminating the tax liability.

So, I’ve been doing some presentations the last few days with a colleague and he went over this concept that I’ll be honest, I never spent any time considering. It didn’t make sense, but it does right now.

I’ve been more excited about this idea than the Advisors we have given the presentation to. Maybe it’s because they don’t see the full value in this, but I do.

OK, are you ready?

It’s called an insured annuity.

I can already feel the disappointment in your voice. But what actually gets me excited is the corporate insured annuity.

Let’s first explain what an insured annuity is.

You buy a life annuity by paying a lump sum deposit and the insurance company pays you monthly until you die. Once you die, they never pay you again.

The risk to this is you could die tomorrow or sooner than expected. There are features in an annuity contract that can minimize and/or eliminate that risk. But where the insured part comes in is that you combine it will a life insurance policy.

For example, you would dump $500,000 into a life annuity and then also buy a $500,000 life insurance policy at the same time. You’ll want to buy the insurance first as it’s tough to reverse an annuity purchase in the event of a decline, etc.

If you die, $500,000 get returned to your beneficiaries and you get to live on the income difference between the payout less the insurance costs while living.

For a long time, annuity rates weren’t as good as they are now.

In the numbers I’ve seen, a client could get about a 5% return in an insured annuity concept. And, the difference between that and a GIC, is that the return is guaranteed for life. So, essentially, you could lock in a life GIC at 5% right now.

That’s all fine and dandy, but that doesn’t excite me that much, but I wanted to make sure everyone was up to speed on what an insured annuity is.

Now, let’s talk about corporate.

It works exactly the same. A client could take corporate assets and doing an insured annuity in the corp and guarantee a lifetime of income of about 5% in the numbers I’ve seen (depending on age, etc of course).

But, here’s where it gets interesting.

The CRA has said in many instances that the value of the annuity on death is….0.

Think about it this way. If we calculate the value of an annuity one minute before a person dies, how much would you pay for it? Nothing, of course.

Because we know that when that client dies, the annuity is worthless. It never pays again. Only while they are living. So, it has no inherent value.

So, the business owner could drop whatever amount they want into an annuity today and get that guaranteed income stream, but the value on the balance sheet (and thus how capital gains taxes are calculated) becomes 0 on death. Thus, massively reducing the value of those shares and thus the tax liability.

And, if you combine that with a life insurance policy, all the capital will be refunded back to the corporation. And, all that death benefit (or the majority) can be paid out through the Capital Dividend Account (CDA) tax-free.

But we run an issue with all of this don’t we? If we fund a life insurance policy, all the cash value in that life insurance policy will be captured on the balance sheet and thus increase the tax liability back up, right?

NO. Err…well kind of.

But, we don’t use Par. Instead, we use UL. Specifically, level cost of insurance option.

And why do we use that product?

Because it has no cash value. CRA has again confirmed that using an insurance policy with no cash value will not increase the value of those shares.

So stick with me for a moment.

Imagine we had a business owner with $10,000,000 of cash assets and nothing else in his company. The value of the company would be $10,000,000. But, imagine we bought a $10,000,000 annuity with a $10,000,000 Level 100 UL contract.

The value of that company would drop immediately from $10,000,000 to $0, less any annuity payments.

And, if we could also guarantee a 5% lifetime return on that annuity stream, this starts to look very compelling.

Obviously, no one would ever drop all their money into a corporate annuity, that’s crazy. I just use that to illustrate what is happening here.

But here’s my question in all of this. I’ve been doing this insurance thing for a while and I’ve never, ever, ever seen a corporate annuity.

I know they’ve been out of favour for a while. But, because we haven’t done this in a long time, I don’t think Accountants or Advisors are looking at this strategy at all. I think most don’t even know about it.

To summarize, you can use the corporate annuity concept to do 3 things:

1. Eliminate an excess capital gain (not minimize, not defer, eliminate)

2. Guarantee a solid guaranteed lifetime return

3. Extract all excess capital through the CDA to pass onto the next generation.

There are only 2 objections that I can see coming out of this idea (for the right age group 60-75):

1. Lose access to capital. You’ll be on the receiving end of a lifetime income stream, but you don’t have the capital.

2. Using a Level 100 UL has no cash value, so if they want to exit, that money would be lost.

I think I can manage both those objections.

First off, you aren’t going to put all your money into this strategy. You’re going to figure out how much you don’t need an allocate that chunk.

Second, I think business owners would love to have a guaranteed income stream in retirement.

Third, we are eliminating taxes on both the capital gain and the wealth transfer.

This should be a tool presented alongside estate freezes and all other insurance planning.

And, what makes it different right now is that annuity rates are incredibly attractive to where they’ve been historically.

I’m sure you want to know a lot more about this, so here is a link to a presentation that Marco D’Aversa from Canada Life did. Click the link below and scroll to the bottom and you’ll see the video.

And a final note. You can surely use corporate annuities with Par of course, but UL has the advantage of not increasing the value of the shares, unlike Par.

However, Par could deliver a better long-term IRR. You’ll have to do the calculation to see if the value exists.

And with that, I’ll leave you to your weekend activities.

As always, let me know if I can help you in anyway grow your business.

Andrew