Buying or selling a vehicle for $1
Have you ever bought or sold a car for $1? I have done both and never paid any taxes. However, that was likely because there wasn’t much value left in the vehicles and it was under the nuisance threshold of the Canada Revenue Agency. Technically, there could be a taxable gain during a vehicle transaction. This got me thinking about life insurance policies and how they can be bought and sold too.
The industry commonly calls this a policy transfer. This usually happens when there is a divorce, sale of a business, retirement of an insured shareholder or by way of a gift. I will caution you now that transfers may trigger taxes and nobody likes taxes so I hope this article saves you taxes.
Every life insurance policy has three main factors to consider when calculating the taxes triggered from a transfer. The first is FMV – fair market value. The FMV should not be confused with the death benefit. A formal valuation gives assurance of the FMV and requires a look at various aspects such as the health of the insured person, contractual features, the policy’s cash value and loan value if applicable, replacement value of the policy and so on.
The second factor is CSV – cash surrender value, and it’s often stated as the equity of an insurance policy. Generally, significant CSV is only present in permanent insurance policies although some term to 100 policies may have guaranteed cash values as well.
The third factor, the ACB – adjusted cost basis, is not commonly understood. From a high level, it is the premiums into the policy minus the mortality costs. Over time the ACB tends to diminish and can even go into negative territory.
Generally, when transferring a policy, the policy holder is deemed to receive proceeds that are the greater of FMV, CSV and ACB. If the deemed amount is greater than the ACB, then there is a gain considered to be a policy gain that is 100 per cent taxable as income. That can be a harsh reality for the unsuspecting policy owner.
I urge you to pause before making policy transfers and consider the tax consequences. Your accountant will require the policy information above and can consult with your insurance professional to determine what appropriate fact pattern applies in order to plan for any taxes triggered. The insurance company will request detailed information about the transfer transaction so that it can report and issue a T5 slip if necessary.
However, I just transferred a policy, and the insurance company issued the T5 incorrectly.
The complication was transferring a jointly-owned insurance policy fully to one of the existing policy owners. A T5 was issued for a full gain but should’ve been only be for half. I am happy that we caught it and had it corrected, resulting in the taxpayer saving significant money.
My point here is that even the large companies struggle with properly calculating the taxable nature of policy transfers because there are so many variables in the tax act. The larger the policy, and the longer it has been in force, tends to increase the potential problem and need for accuracy.
On the bright side, there is potential to transfer policies to spouses and children and even grandchildren without tax. Essentially a rollover of the policy at its ACB can be done. This requires a more detailed explanation on another day and has some unique considerations as well. However, it’s a teaser for you and your tax professional to consider when you meet with him or her this tax season to CRUSH TAX!
Steve Meldrum B.Mgt. CFP CLU is the founder of Swell Private Wealth Ltd. For further information or tailored advice, contact him at 403-487-0490 or steve@swellwealth.com.