By: Florence Marino B.A., LL.B., TEP | Vice President, Tax & Estate Planning
When is joint last-to-die life insurance the right fit? And when is it not? Here are some considerations when thinking about this. Weighing the pros and cons of joint last-to-die life insurance and educating the client on them with an insurance advisory firm that consciously addresses these issues is best practice.
Why is joint last-to-die coverage commonly used?
Often, joint last-to-die coverage is recommended where there is an expectation that an ultimate tax liability will arise on the death of the last of two spouses assuming that a rollover takes place on the first death. For example, if private company shares of a deceased are transferred to a surviving spouse or common law partner or a spousal trust pursuant to subsection 70(6) of the Act. The death benefit proceeds under a joint last-to-die policy would arrive at the time the tax liability arises if the shares are held until the death of the surviving spouse.
It is generally less expensive than having single life coverage on each of the spouses. Due to cost alone, many insurance advisors default to joint last-to-die life insurance for clients over 55. The cost is lower because only one death benefit will be payable and would take into account two people having to die for the proceeds to be paid out. Probability-wise, that is more remote and will end up taking longer, making joint coverage less expensive.
Joint last-to-die coverage can be issued even if one of the spouses is most likely to be heavily rated for single life coverage on their own. Because the coverage only pays out on the last death, if the other life is healthy this will carry the day.
Things to think about
The following are a few considerations that come to mind based on common situations we’ve encountered.
Relationship breakdown
There, we said it.
Having joint last-to-die coverage assumes the relationship will continue, a rollover will happen on the first death, and a liability will arise on the second of the deaths. Joint last-to-die insurance cannot be divided into two single life coverages. For the very reason explained above – it is not the equivalent of two single life coverages.
Where a joint last-to die policy is personally held jointly by the spouses and relationship breakdown occurs, subsection 148(8.1) contemplates a tax-free rollover during life from one ex-spouse to another in settlement of rights arising out of their relationship. But the problem here is the nature of the insurance is probably not relevant anymore.
If there is a desire to maintain the last-to-die policy, say, to benefit their mutual children, and they retain joint ownership post-breakdown, the problem arises that upon the first death, when the deceased ex-spouse’s interest passes to the surviving ex-spouse by right of survivorship, they are no longer spouses and there would be no rollover at death under subsection 148(8.2) of the Act. This would result in a disposition of the policy “by operation of law” and subsection 148(7) would deem the proceeds on the disposition to be the greater of the policy’s adjusted cost basis (ACB), cash surrender value (CSV) and fair market value of consideration given on the transfer. In this case the operative factors would be CSV and ACB. If the CSV exceeds the ACB there would be a taxable policy gain and a T5 issued.
Where a joint last-to-die policy is held by a private corporation and there is a relationship breakdown this gets even more complex. Often the exercise is to understand if there is a desire to retain the policy for personal purposes (such as for the mutual children of the ex-spouses) and if that desire is worth the tax cost of transferring the policy out of the corporation.
There would a disposition of the policy by the corporation and again, the proceeds of the disposition would be deemed to be the greater of the policy’s ACB, CSV and fair market value of consideration given on the transfer. The corporation would have taxable income should the proceeds exceed the ACB of the policy.
And, the second half of the story is that the shareholder would have a taxable shareholder benefit under subsection 15(1) for the amount by which consideration given, if any, does not reflect fair market value of the policy. If the policy is transferred out to one ex-spouse what happens on the death of that ex-spouse should the other ex-spouse survive them? Again, no rollover at that point should there be a successor owner designation and a transfer of the policy made to that ex-spouse.
Repurposing joint last-to-die coverage is a challenge whether personally held or corporately held. Upon acquisition of coverage, really think about whether joint last-to-die insurance should be purchased in the circumstances. If so, the consequences of a potential relationship breakdown should be expressed. Relationship breakdown is a highly relevant contingency that could significantly impact the planned use of joint last-to-die life insurance.
More often than not, joint last-to-die coverage is surrendered at the time of relationship breakdown. It’s a clean break and the tax cost of disposition is the price that is paid for that decision.
Need for single life coverage even where no chance of a breakdown
Even in situations where there is zero risk of relationship breakdown (if that is ever possible), it may be prudent to have at least a layer of single life coverage on each spouse. Life insurance provides liquidity at a time when it is needed the most. If joint last-to-die coverage is the only coverage put in place for a couple, this would ignore the very real need for liquidity on the first death whether it be for maintaining and supporting the surviving spouse, or to ensure that the assets can be preserved for the next generation without encroachment.
Spousal roll and redeem?
Joint last-to-die insurance would not allow for a spousal roll and redeem strategy to be used. Where private company shares of a deceased spouse are transferred to a surviving spouse/common-law partner or testamentary spouse trust under subsection 70(6), there would be no capital gain to the deceased shareholder. Where there is single life corporate-owned coverage on a deceased shareholder who rolls their shares to a surviving spouse, death benefits in respect of the deceased shareholder could redeem the shares held by the surviving spouse using capital dividends. The stop-loss rule (limiting the amount of capital dividends that can be paid to 1/3 of the gain or loss otherwise determined) in draft subsection 112(3.2) would not be applicable since, there is no loss being carried back to the deceased shareholder to stop. In order to qualify for the rollover under subsection 70(6) the shares must vest indefeasibly within 36 months of death. This means that the shares cannot be subject to a mandatory redemption. Rather, the shares may be subject to a put and call option. With the increase to the capital gains inclusion rate, keeping this planning avenue open may be an important consideration.
Lots to think about
These are just a few considerations that come to mind when thinking about the utility of joint last-to-die insurance. While the cost savings can sometimes drive the conversation, it still has to be the right fit. We continue to stress to clients and their advisors that it is important to deal with an insurance advisory firm that explores all options and addresses the pros and cons of all aspects of insurance planning.
FOOTNOTE:
This publication is protected by copyright. Tompkins Insurance is not engaged in rendering tax or legal advice. TOMPKINSights contains a general discussion of certain tax and legal developments and should not be construed as tax or legal advice.
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florence@tompkinsinsurance.com
