Understanding the Nuances of Corporate Estate Bond

The Corporate Estate Bond concept compares the estate value of a corporate-owned life insurance policy to an alternative corporate-owned investment. In making this comparison, the concept assumes that, at death, a dividend is paid out to the deceased shareholder’s estate.

For the insurance solution, the dividend is based on the insurance proceeds received and for the alternative taxable investment the dividend is based on the liquidation value of the investment. Then, the net estate values take into account any balances in the capital dividend account (CDA) and refundable dividend tax on hand (RDTOH).

The Corporate Estate Bond presentation includes an “Important Information” page. The second bullet indicates that the presentation does not reflect the implications of any post- mortem estate planning that may be available in the particular circumstance. It also does not reflect any capital gain on the shares of the corporation as a result of the deemed disposition at death. What is the reason for this disclosure?

In many situations, post-mortem estate planning is done to minimize the tax liability on extracting the value of corporate-owned assets at death. This may include planning techniques that convert what would otherwise be a taxable dividend into a capital gain. As well, if stop-loss applies, then there will likely be some capital gains tax on the shares at death. The Corporate Estate Bond presentation does not reflect these issues in the analysis. As a result, in certain situations the insurance benefits shown may be overstated and the benefits shown for the alternative taxable investment may be understated. Why doesn’t the presentation reflect these issues?

The Corporate Estate Bond presentation is based on a specific set of assumptions. It would be very difficult to create a concept that anticipates all the different circumstances that could impact the illustrated results. For example, the type of shares held by the shareholder, the PUC and ACB of the shares, whether there are other assets in the corporation, etc. could all impact the calculation of the estate value. As a result, the calculations used in our Corporate Estate Bond presentation are based on simple

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assumptions so that it can be used to market the concept in a way that your client can understand.

These issues are not unique to Manulife presentations. Some of our competitor’s presentations that illustrate corporate-owned insurance address the issue of stop-loss by reducing the net estate value arising from the insurance by applying capital gains tax to 50% of the cash value. Although this calculation may have some validity if you are dealing with common shares, it will be incorrect if the client holds frozen shares. This illustrates that there are no simple solutions to the issues

So, what can you do to deal with these issues? If possible, we suggest you keep the focus on the death benefit as compared to the investment balance (including the deferred gains balance if applicable) at the corporate level. If the comparison between the life insurance and the alternative investment favours insurance at the corporate level, then it will also be favoured after taking into account any post-mortem planning and capital gain arising at death. The CDA that life insurance provides normally makes insurance solutions even better, so what we are talking about here is really “how much better.”

Remember as well that the actual facts and circumstances at the time of death may differ substantially from the facts you are dealing with today. Intervening events and changes in tax rates can drastically impact the planning, so it is best not to get too bogged down in numbers which are, at best, an approximation of one possible scenario.

We felt it was important to bring these issues to your attention so that you are prepared if they are raised by a client or their professional advisor. For more details on post-mortem planning and the stop-loss rules, refer to the following additional resources available on the Tax and Estate Planning website (www.manulifetep.ca)

FAQs:

What is the effect of stop loss on the estate values shown in concepts that illustrate corporate owned life insurance?

What is the impact of post-mortem planning on net estate values?

Tax Topics:

Dealing With Private Company Shares at Death – Post-Mortem and Insurance Planning

Stop-Loss Provisions and Grandfathering Rules

If you need additional support, contact your wholesaler to gain access to the Tax & Estate Planning Group who can help you deal with these issues in the context of specific cases and fact patterns if it becomes necessary.

December, 2009