David Weinberg, a financial advisor in Toronto, has been known to bring some of his high-net-worth clients to tears – and he’s okay with that.
It happens when he asks them to write a short note to their grandchildren, which he then places inside a universal life-insurance policy file.
The letter reads, in part: “Grandma and I were thinking of you and planning for your future long before you could consider doing it for yourself. We got you this little gift to help you, and protect you and your family all throughout your lives.”
Except these gifts aren’t so little. Mr. Weinberg’s clients are using cascading life insurance, a tool that transfers money free of tax and probate to subsequent generations. It shifts ownership of an insurance policy to a child – or, to be precise, any natural or adopted child, grandchild, stepchild or even a son- or daughter-in-law – when the owner dies. These policies can hold tax-sheltered investments inside them, similar to a registered retirement savings plan (RRSP).
Here’s how it works: A grandparent might purchase a universal life insurance policy and funnel $250,000 into it over five years. This client is the policy’s owner but he has named an adult child the contingent owner, and the policy is actually placed on that person’s life instead. Meanwhile, the grandchild is the beneficiary.
Once the grandparent dies, the son or daughter becomes the owner and has access to the investments that have accumulated, tax- and probate-free. The adult child can then draw from the policy or simply reserve it for the grandchild, who will receive the money upon the parent’s death.
“There are no taxes, there is no fee, there are no lawyers, there is no trust and there are no accountants,” Mr. Weinberg explains. “[Cascading insurance] is such a powerful strategy for the right people in the right place.”
One reason that cascading (also known as “waterfall”) insurance can be a good idea is that whole life policies become difficult to obtain and expensive as people age and their health declines, says Justine Zavitz, an advisor at Zavitz Insurance Inc. in London, Ont.
“This is really about, ‘We have so much money and we need to find a way to get it to the next generation in a really tax-efficient manner, but I’m too old and unhealthy, whole life insurance is too expensive and I can’t get it. So I’m going to start buying it on my children,’” she says.
Cascading insurance offers other benefits, too. Not only do the primary owners have control over how the money is distributed upon their death, but investments inside the policy are protected from creditors. That’s an advantage for high-net-worth clients who own businesses, says Cindy David, president and estate planning advisor at Cindy David Financial Group Ltd. in Vancouver.
But it’s not for everyone, she says. It’s really a form of estate planning, not a way to ensure the grandchildren will be able to, say, buy a house at age 30. This is because those grandchildren will have to wait for the grandparent, and possibly the parent, to die. Not exactly something they can set a watch by.
“There’s a timing issue here. If you want to help with down payments, park that money aside somewhere else, like gifting your tax-free savings account to your grandchildren,” advises Mr. David.
TFSAs and RRSPs are more flexible tax shelters than life insurance policies, and it makes sense to use these first, he says.
Also, just because Grandma wants to leave legacy funds to her children doesn’t mean she automatically can. At least not from the insurance company’s perspective.
“If you had a child who is a total failure and still lived on the bank of mom and dad even though they were 40 years old, you’d have to make a financial case as to why you’d want to buy a life insurance policy on that person,” cautions Ms. Zavitz. The insurance company might cap the amount based on the person’s net worth, income and other factors, she says.
There are also limits on how much you can deposit into a policy. They are dependent on the size of the death benefit and age of the policy, along with other factors per the Income Tax Act.
New rules under the tax act that went into effect Jan. 1, 2017, have resulted in less flexibility, however, so in some cases there has been a reduction in the maximum amount of premiums people can put into a policy and a change in the amount of cash that can accumulate.
In other words, there’s no one-size-fits-all rule for cascading insurance.
The picture becomes even more muddy when you combine it with all other aspects of estate planning for the wealthy.
“Complicated” is how Helene Meyer, an independent life insurance broker and financial planner in Toronto, describes setting up an insurance cascade against the backdrop of a family’s entire financial plan. “I would never do it without consulting the lawyers and accountants of that particular family that I’m dealing with.”
There is a silver lining to all that complexity, though, Ms. David says. It can force families to come together and talk about estate planning, a conversation that some wealthy families tend to avoid or put off.
“It’s a great opportunity,” she says. “A lot of times parents hold their personal finances close to their chests. This gives us the opportunity to talk about what the plan is and include the family.”