Transferring a universal life insurance policy between generations is one of the few remaining ways you can pass on capital to your descendants and save taxes at the same time.

You can benefit from this strategic planning tool

All you have to do is take out a universal life insurance policy in your child's name. This type of policy has both an insurance portion and a savings portion.

You can accumulate savings tax-free under the policy, up to a ceiling set by the Canada Revenue Agency (CRA).

Anytime after your child's 18th birthday, you can transfer ownership of the policy to your child without attribution rules applying. Your child can then take money out of the policy to finance major expenses such as tuition fees or a home purchase. Any resulting gain would be included in your child's taxable income, not yours. Remember, at this age the child usually has lower income and thus a lower tax liability is achieved.

Special tax exemptions

You should know, however, that even though no money changes hands, you may have a taxable gain to pay on the policy when you transfer it. That's because you're deemed to have disposed of it so that somebody else (in this case, your child) can enjoy the benefit of it.

Fortunately, though, the Income Tax Act provides for certain exemptions for transfers between parent and child. As long as the value of the policy transferred to the child remains under a certain level*, you can exempt the money earned from the policy.

* Based on a calculation that changes depending on the cost of the policy and the capital insured. Inquire with your insurer.

Your child benefits in other ways, too

Not only does life insurance provide the opportunity to save substantial sums of money tax-free for your child's future, it also has other significant benefits:
 

• Since your child is the one who will be taxed on any withdrawals from the policy once it is transferred if there is any tax to pay at all the tax rate will in all probability be much lower than if you had withdrawn the money yourself. That's because parents generally have much higher incomes than their young adult children.
• What's more, your child's insurance coverage is guaranteed. That means that if your child develops health problems like asthma later in life, it will not cost any more to maintain the insurance policy.
   

Points to keep in mind

For you to take advantage of this special tax-minimizing strategy, certain conditions must be met:
 

• The policy transfer must be made freely.
• Your child and your child only must be the person whose life is insured on the policy.
• You must completely pass on your policyholder rights to your child.
   

Transfers apply only to insurance policies and are not intended for annuity contracts.

Grandchildren qualify, too

When we say child, we mean your natural child or adopted child, your spouse's child, a grandchild, great-grandchild, a daughter-in-law or son-in-law, or any person who, before attaining the age of 19, was entirely in your care and therefore in the policyholder's custody and surveillance in law and in fact.

Take a look at the difference insurance makes

The table below compares an annual investment of $4 000 over a 10 year period on a tax-exempt life insurance policy for $400 000 with a similar$4 000 investment that is taxed annually.

At the end of the 10 years period when the child turns 18 and goes to university, the grandparent either transfers the life insurance policy or gives the child the investment, depending on the initial investment choice.

Over the next 5 years, the student withdraws $5 000 annually from the savings portion of the life insurance policy to cover tuition expenses.

Compare the benefits:

Life Insurance vs. Regular Taxable Investment

We have assumed a 6% rate of return on all investments in calculating these figures. The grandchild's tax rate is 22.20% and the grandfather is 37.16%.

*After tax capital accumulated

The advantages of a life insurance savings plan are plain for all to see! The higher the return, the greater the benefit you enjoy with Universal Life Insurance.

One of the few tax shelters available

Life insurance is an important part of estate planning. It offers one of the few opportunities available today to shelter your savings from tax.

Taking advantage of the Canada Revenue Agency's policy transfer provisions between generations is a great way to pass on wealth to your children during your lifetime. It can also be an excellent companion strategy to a Registered Education Savings Plan in minimizing the tax cost of providing for your children's educational needs.

In these days when true tax savings are so hard to come by, this is one tax planning tool you'll want to make generous use of!

Warning: This example is aimed at supplying general information only and does not to presume to offer legal counsel of any sort. It is advised that you consult a legal and taxation advisor to adapt these recommendations to your particular circumstances.