A tool to pass down wealth through generations

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As older Canadians, including leading edge baby boomers, begin a massive intergenerational wealth transfer, many are looking for ways to do so in a tax-efficient way while reducing risk.

Experts look at one strategy that is not for everyone but can combine insurance protection with wealth preservation to subsequent generations.

The ideal candidate for this type of strategy – ‘cascading’ or ‘waterfall’ insurance – is typically in the top tax bracket and would like to retain control of their assets, but also leave a sizable legacy to their children, minimize the risk of will contestability, and maintain privacy over their financial affairs, explains Daniel Walsh, senior vice-president and head of individual insurance at BMO Insurance at the Bank of Montreal in Toronto.

“It’s not for everyone,” says Henry Korenblum, president of Korenblum Wealth Inc. in Toronto. “But for certain individuals, where they generally have more than enough funds for their own lifestyle funding requirements, it can be a useful intergenerational wealth transfer tool.”

A multigenerational tool

Cascading insurance typically involves three generations. The first generation (G1), say grandparents, will purchase a life insurance policy on the life of their child in the second generation (G2), with their grandchild in generation three (G3) being the beneficiary of that policy.

G1 benefits by creating a legacy, having effectively repositioned assets by using life insurance to grow wealth tax efficiently, on a tax-deferred basis. “They may be able to leave more to their family than would be the case if they were just investing on a taxable basis,” says Korenblum.

Furthermore, “It can be fairly straightforward planning in the sense that there is no need to create any complicated trust structures or corporate structures. This is all personally owned insurance,” he explains.

Cascading insurance policies covering multiple generations are funded with personal non-registered assets where there will be no, or limited, tax or costs resulting from converting those assets into insurance premiums, says Walsh.

Grandparents get satisfaction of passing on wealth

Grandparents with enough money, and with a desire to spread wealth to future generations, get the satisfaction of being able to pass along money to family in a tax-effective manner, in addition to providing life insurance as a risk management strategy to ensure that their grandchildren will be looked after in the event of the untimely death of their parent, says Mark Halpern, chief executive officer of WealthInsurance.com Inc. in Toronto.

“It also means that G2 didn’t have to come up with the money to buy their own life insurance. G1 is doing it for them, which is kind and very generous,” he adds.

Normally the type of insurance that would be acquired to insure subsequent generations through a cascading insurance policy would be permanent participating whole life insurance, although such a policy could also be set up with universal life insurance, which is less common, says Halpern.

Cascading insurance can be employed in many ways.

For example, the cascading policy could be designed to skip a generation whereby upon the death of the grandparent, the ownership would be transferred to the adult child. Then, upon the parent’s death, ownership would transfer to the grandchild whose life is insured, says Walsh.

A transfer of ownership could also be made during the lifetime of the original owner. For example, if a policy was purchased when the grandfather was 70, ten years later at age 80, they could decide to transfer the ownership to their adult child who was insured under the policy, who would inherit ownership without any tax being triggered, Walsh explains.

Yet another option is for the grandparent to take out a policy directly on the life of their grandchildren.

But whether the policy is on the life of a child or a grandchild, the basic idea is the same: lock in life insurance when people are still relatively young and presumably healthy, when insurance is cheaper and attainable to cover them at a time when they have financial responsibilities and the need to protect a young, growing family.

Tax advantages

The tax advantages may also be quite substantial.

In Ontario, for example, in general, personal investable accounts attract a taxation rate of 53.53 per cent at the top marginal rate, so it can be very appealing from a tax standpoint to accumulate wealth on a tax-deferred or tax sheltered basis by funding a cascading, intergenerational life insurance policy, says Korenblum.

With a cascading insurance policy, “if you don’t create any disposition, make withdrawals, [or] ask for a policy loan, and you just let the policy grow, then it grows on a tax-deferred basis,” says Walsh.

As long as the grandchild is at least 18 years old, any potential policy gain triggered by a disposition would be taxed in their hands once ownership has passed. Presumably, they would also be in a lower tax bracket than their parents or grandparents.

When G1 transfers the policy ownership to G2, the transfer may occur on a ‘rollover’ basis such that no tax gain is triggered. The death benefit is received tax-free, and if there is a named beneficiary, other than the estate, probate fees may be avoided, says Korenblum.

How cascading insurance protects the family

Another advantage is that when a family member is a named beneficiary on that policy, the money is protected from litigation and creditors. It would also be protected under matrimonial law in the event of marriage breakdown, provided the beneficiary was made irrevocable, notes Halpern.

Experts note that families who purchase a cascading insurance policy need to be committed to this insurance strategy. “It’s not a short-term investment strategy. It’s really something long-term that you want to put in place to transfer assets from one generation to the other,” says Walsh.

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Inter-generational cascading insurance “is a planning strategy that many Canadians are not aware of. I think it’s a great planning tool for certain clients and for the right set of circumstances. It can be a very clean and elegant way to transfer wealth on a tax-efficient intergenerational basis,” says Korenblum.

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