Cut tax while cashing in a whole life policy

Q: My question is about whole life insurance. My wife and I both have policies. her cash surrender value with paid up additions is around $200,000. My policy is about $190,000. We have no children. We both have pension plans and comfortable assets. We are looking at surrendering one if not both insurance plans. Do you have any suggestions to help minimize the share the taxman will get?

—Roy

A: Roy, to start I would verify the Adjusted Cost Base of the policy and the amount of the Taxable Gain if the policy is surrendered. You can get the information from the insurance company that sold you the policy and I would request a response in writing. This is just good practice and the insurance company is less likely to make a mistake if you put it in writing.

You may also be able to to do a dividend withdrawal which allows you to maintain the coverage and still take out money from your policy. In general, whole life policies have two parts—a guaranteed cash value (that you need to cash in the policy to get, or alternatively, get a loan against) or “dividends”, which is an amount that has built up over the years that you are able to withdraw without surrendering the policy. Remember, even though they are called “dividends” they are taxes as interest income. Once again I would recommend you verify in writing the taxable gain from the potential transaction from the insurance company.

You should also request an inforce illustration from the insurance company and analyze the projected growth of the cash value and death benefit and determine if you could do better by surrendering the policy and investing in an alternative investment. To get an accurate assessment and evaluation, I would take this to your financial planner or a fee-for-service advisor so they can evaluate if you would be better off in the long-term by cashing in the policies and investing your money elsewhere. Remember though, that whole life insurance policies are low-risk and have very low volatility, compared to other investments which may offer more in returns but are much more volatile. When your planner is doing this evaluation, also keep in mind your death benefit is growing tax free and is paid out tax free.

Another option worth exploring is changing your designation to a Registered charity. This would create some tax relief as well and guarantee that your estate is maximized for tax relief before designated charities and other beneficiaries inherit it.

Lorne Marr, is the founder of LSM Insurance, an independent Canadian Life Insurance Brokerage company in Markham, Ont.

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