Transfer of a life insurance policy to a child - requirements for a rollover
Over the years the CRA has considered many questions about the requirements for the rollover of a life insurance policy to a child. Refer to this article on the CRA’s commentary on requirements for child rollovers.
When the requirements are met, the policy is disposed of for proceeds of the disposition (PD) equal to the adjusted cost basis (ACB) of the policy. This brings about a rollover of the policy with no tax consequences arising from the transfer.
Question 3 at the 2018 Conference for Advanced Life Underwriting (CALU) Canada Revenue Agency (CRA) roundtable asked if the requirements for the rollover are met where the child to whom the policy is transferred is a different child than the child who is the life insured under the policy. The CRA said that yes, the requirements for a rollover would be met and that is how the rollover provision reads. The CRA referred the matter to the Department of Finance (Finance) to examine whether this is an appropriate result.
Other than the referral to Finance there is nothing interesting about this question. But the back story is interesting We already knew the answer to the question posed. But it was not the original question, which involved the parent
transferring the policy to two children jointly so that one child (who was not the life insured) could assist the other child
(who was the life insured) in managing the life insurance policy. It’s important to remember that nothing can be done with a policy that is jointly owned unless both owners sign off on the transaction. If the CRA had responded to the original question, their response would have been that the requirements for the rollover would not have been met and there would be a disposition under 148(7) of the Income Tax Act which deems the PD to be the greatest of:
the cash surrender value;
the ACB, and
the fair market value of consideration given in respect of the transfer.
Often parents want to ensure that the funds in a policy purchased on a child are dealt with responsibly. To that end they’ll try to install checks and balances by having a sibling involved in the ownership of the policy along with the child who is the life insured. But doing that results in the potential for tax consequences on the transfer to both children (because there would be no rollover) and it creates a problem if, for example, the child who is not the life insured dies. There would be a disposition at that point that may also be subject to tax.
Here are some alternative approaches to consider.
Have a trust own the policy. Granted, this approach is more complex, but it would allow for control over the policy as well as the opportunity to distribute the policy to the trust’s capital beneficiary on a roll-out basis. The trust needs to be set up when the insurance is purchased or early on in the life of the policy since transferring the policy to a trust later does not
qualify for a rollover. Life insurance is not subject to the 21-year deemed disposition rule within a trust since it is not capital property for tax purposes.
Another alternative involves a rollover to the life-insured child with the “responsible” sibling designated as an irrevocable beneficiary. As an irrevocable beneficiary, the responsible sibling would have to sign off on these transactions involving the insurance policy:
an alteration or revocation of the beneficiary designation;
assigning the policy;
changing the policy coverage.
One downside of an irrevocable beneficiary designation would arise if the irrevocable beneficiary is ever incapable of providing their consent (for example due to a mental incapacity). That would freeze the ability of the owner to deal with the policy. Also, a policy can lapse without the irrevocable beneficiary’s knowledge. The policy owner has the right to receive policy dividends and is entitled to exercise reduced, paid-up options without the irrevocable beneficiary’s consent.
There is no one perfect solution but there are options.