What is an estate bond?
The “estate bond” concept or strategy is the use of life insurance to preserve and accumulate wealth and defer taxes and thus increase the value of your estate for your heirs. The policy owner purchases a life insurance policy using surplus cash, with the option of depositing funds into a tax-exempt (that is, intended primarily for protection) life insurance policy in excess of what is needed to pay the policy’s premiums. The extra funds grow tax-deferred inside the policy, increasing the death benefit payable under the policy when the insured dies. The beneficiaries receive the proceeds of the policy tax free.
What are the benefits?
The estate bond strategy shelters asset growth from tax, provides a tax-free payout when you pass away, reduces probate costs and offers creditor protection – the latter two assuming you have named a beneficiary for the insurance policy. It achieves these goals by holding funds in a tax-exempt life insurance policy rather than in non-registered investments.
Who is the strategy best for?
Estate bonds are suitable for higher net worth investors over about age 50 who
- need life insurance
- have maximized their RRSPs
- have assets or income they will not need during their lifetime
- wish to leave a larger amount to their heirs or to charity.
Owing to the lower liquidity of life insurance policies, the strategy is not suitable for people who may need the funds involved to be more liquid.
How does it work?
Here’s an example of the estate bond strategy: A couple, both aged 50 years, has four children. The parents wish to set aside $20,000 per year for the next 10 years with the aim of providing their children with a significant gift after the parents die. With that premium they can purchase a universal life contract paid for 10 years with $579,000 in coverage.
The value of using this strategy can be seen when you look at the estate value from a life insurance policy that combines protection and investment growth and compare it with the value that would come from a similarly funded non-registered investment. If we assume an annual return of a conservative 3%, after 10 years the insurance policy in our example will be worth $579,000, compared with simply investing the $200,000, which would give us $232,108 net estate value after taxes.
If you contribute to the insurance policy more than needed to cover the premiums, the excess funds accumulate tax-free for the rest of your life, within the policy, and are paid out tax-free on your death. The excess funds are managed by the insurance company and you can place them in the investment options used inside the policy. Note that there are limits on how much you can over-contribute, especially after the policy is 10 years old.
Meet with your financial planner and insurance broker to discuss whether the estate bond arrangement is appropriate in your circumstances. Taxation rules for accumulating funds inside insurance policies changed in 2017, so make sure you are taking the new rules into consideration.