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tax matters

Have you ever considered buying life insurance on one of your kids? Maybe it depends on the lifestyle of your child. I think about the young man who, a few years ago in Stafford County, Va., would dress himself up in camouflage gear, lie across forest trails and wait to be run over by all-terrain vehicles. Despite being hit twice, the man wasn’t arrested because he wasn’t breaking any law. The young man told police it was his way of relaxing.

Even if your kids aren’t into extreme sports or activities, buying life insurance on them can make good sense. The idea is called “cascading insurance” and has a number of benefits. Let me explain.

The tool

The first thing to understand is that life insurance has certain attributes that make it unique as a financial planning tool. I’m talking specifically here about permanent life insurance (whole life or universal insurance in particular). Each dollar of premiums that you pay on a whole life or universal insurance policy is split so that some of that dollar covers the cost of the insurance on your life, and a portion of the dollar goes into a growing pool of investments – often called the accumulating fund.

Similar to the tax sheltering you get from investing inside a registered retirement savings plan (RRSP) or tax-free savings account (TFSA), the income and growth on the funds inside the insurance policy will not be subject to tax in your hands. Then, when the individual who is insured dies, the accumulating fund along with the face value of the insurance policy is paid out tax-free to the beneficiaries named on the policy.

In addition, subsection 148(8) of our tax law will allow you to transfer the ownership of a life-insurance policy to any of your children on a tax-free basis, provided the life insured under the policy is one of your children. As an aside, a “child” includes any natural or adopted child, a grandchild, stepchild or a son- or daughter-in-law.

So, when can it make sense to insure the life of your kids? If you have assets you don’t plan to spend in your lifetime, want to minimize tax annually on any income earned on those assets and want to transfer those assets to the next generation free of tax and probate, then you should consider this idea. Interestingly, the same tax-free transfer to your kids can be accomplished by your kids as they transfer those assets to their own children – hence the cascading effect.

The idea

Let’s take an example. Consider George, who is 68 today. He has $400,000 invested that he won’t need during his lifetime. George wants to minimize the tax he’s paying annually on this portion of his portfolio. He also wants to shelter these assets from taxes and probate fees that could apply when the assets are eventually transferred to his son, Jake, who is age 35 today, and ultimately to his granddaughter, Sarah, who is Jake’s daughter and is a minor today.

George purchased a permanent life-insurance policy and deposited the $400,000 into the policy over a seven-year period of time. George is the owner of the policy and has named Jake as the contingent owner. The insurance was placed on Jake’s life and his granddaughter, Sarah, is the beneficiary of the policy.

When George passes away, Jake will become the owner of the policy since he was named the contingent owner. When Jake receives the policy, he becomes the owner of the accumulating investments inside the policy. The policy, along with its investments, transfer to Jake free of taxes and probate.

What will Jake do with the policy once he takes ownership? He’s got a few options. He could withdraw funds from the accumulating investments in the policy (which could create some tax for Jake), borrow money using the investments in the policy as collateral (which can provide him with tax-free cash flow) or he could reserve the policy for his daughter, Sarah (she’ll receive the insurance proceeds free of taxes and probate when Jake dies).

The nuances

It’s possible for the child named as contingent owner to be different than the child whose life is insured. The transfer to your child can be tax-free provided that child is 18 or older when receiving the policy and the transfer takes place as a freebie (that is, for no consideration). You don’t have to give up control over the assets in the policy until you transfer ownership and you can access the accumulating fund if you need to.

Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at