Federal Budget 2024: How Life Insurance Can Protect Your Wealth from Rising Capital Gains Tax

Canada’s Budget 2024 introduced significant changes to how capital gains are taxed. If you own a business, have substantial investments, and/or assets like a secondary property, these changes could significantly impact your wealth accumulation strategies. While traditional approaches may no longer be optimal, life insurance offers innovative solutions to protect your assets and mitigate the new capital gains tax burden. In this blog post, we’ll explore how life insurance can be a powerful tool for tax optimization in the post-Budget 2024 landscape.

Understanding the New Capital Gains Tax Rule

Canada’s Federal Budget 2024 introduced significant changes to capital gains tax implications, impacting how individuals and corporations handle profits from the sale of capital assets. Understanding these changes is crucial for effective wealth management in the current landscape.

Previously, capital gains in Canada were subject to a 50% inclusion rate, meaning only half the profit was taxed. This applied to individuals, trusts, and private corporations. However, the new tax regulations have complicated things.

Here’s a breakdown of the changes:

• Individuals: A Tiered System: For individual taxpayers, there’s now a tiered approach:
  • The first $250,000 of capital gains in a year remains taxed at the 50% inclusion rate.
  • Any capital gains exceeding the $250,000 threshold are taxed at a higher 67% inclusion rate.

• Trusts & Corporations: Universal 67% Rate: Trusts and corporations now face a flat 67% inclusion rate on all capital gains, regardless of the amount.

Example 1: Business Owner A business owner sells their company for $2 million, having originally purchased it for $500,000. With a total capital gain of $1.5 million, and as a corporation, the full amount is now subject to the 67% inclusion rate. This results in a significantly higher tax burden compared to the previous system (a $1,050,000 taxable gain now, versus $750,000 under the old rules). 

Example 2: Investor An investor sells a rental property for a $500,000 capital gain. The first $250,000 of this gain is taxed at the 50% inclusion rate, resulting in $125,000 being subject to tax. The remaining $250,000 is taxed at the 67% inclusion rate, adding another $167,500 to their taxable income for a total capital gains tax liability on $292,500 (compared with $250,000 before).

These examples highlight the potential impact of the changes. For individuals and corporations facing substantial capital gains, navigating these new tax rules is essential for making informed financial decisions.

Now that you understand the new capital gains tax rules, let’s explore how life insurance can be a powerful tool for tax optimization. For an in-depth analysis, watch this video from the Taxevity Insurance team:

Why Life Insurance is a Smart Tax Strategy

The increased capital gains tax rates introduced in Budget 2024 make it more important than ever to explore tax-efficient strategies. Traditional approaches to wealth management may no longer be as effective. Here’s where life insurance offers unique advantages:

• Tax-Free Payouts: One of the primary benefits of life insurance is that the death benefit paid to beneficiaries is generally tax-free. This can be especially valuable in offsetting the potentially significant tax burden on your death, preserving more of your estate for your heirs.

• Flexible Products for Wealth Building: Permanent life insurance policies whole life and universal life offer more than just protection. They include a cash value component that grows tax-sheltered over time. You can access these funds tax-free during your lifetime with loans, providing flexibility for:
  • Investment Opportunities: Supplementing investment strategies to further optimize your wealth accumulation.
  • Retirement Income: Enhancing your retirement lifestyle with an additional income source.

• Tailored Solutions: Choosing the right life insurance strategy for your specific circumstances, financial goals, and risk tolerance is crucial to maximizing its benefits. Your family team at Taxevity can help you select the policy type and structure best suited to optimize your tax situation.

Life Insurance for Business Owners and Incorporated Professionals

Business owners and incorporated professionals face unique challenges following Budget 2024’s tax changes. Life insurance offers innovative solutions to address these concerns, helping protect both your business and your personal wealth.

• Challenge 1: Preserving the Small Business Deduction (SBD). Every $1 of Passive investment income within a corporation above $50,000 annually claws back $5 of the $500,000 SBD, leading to higher taxes on active business income. At $150,000 of annual passive investment income, all active business income is taxed at the highest rate.
  • Life Insurance Solution: Since investment growth inside a permanent life insurance policy is tax-sheltered, it doesn’t count towards the passive income limit, helping to protect your SBD.

• Challenge 2: Offsetting Taxes on Retained Earnings. When business owners retain earnings within their corporation for investment purposes, those investments generate taxable income subject to high tax rates (e.g., 50.17% in Ontario).
  • Life Insurance Solution: Retained earnings can be invested in a life insurance policy where the growth is tax-sheltered, reducing the overall tax burden.

• Challenge 3: Retirement Planning and Liquidity. Business owners and incorporated professionals often have a significant portion of their wealth tied up in their business or practice. This can create challenges for retirement income and accessing funds.
  • Life Insurance Solution: The cash value within permanent life insurance policies can be accessed through collateral loans. This provides liquidity and can supplement retirement income.

• Additional Benefit: Succession Planning. Life insurance can be a valuable tool for business succession planning. It can provide funds to buy out a deceased partner’s shares or facilitate a smooth transition to the next generation.

Estate Planning and Wealth Preservation

Canada’s deemed disposition on death means that upon your passing, you are considered to have sold many of your assets at fair market value, triggering a potentially significant tax liability for your estate. This includes assets like cottages, investments, and shares in your private corporation. The entire balance of your RRSP or RRIF is also included and taxed as ordinary income. Life insurance offers a strategic solution to mitigate these taxes and ensure a smooth transfer of wealth to your beneficiaries.

• Challenge: Deemed Disposition Tax Burden. The resulting tax bill can diminish the assets you intend to leave to your heirs. For a deeper dive into this concept, see our blog post on the deemed disposition.

• Life Insurance Solution 1: Covering Tax Liabilities. The tax-free death benefit from a life insurance policy can provide the liquidity your estate needs to cover the taxes arising from the deemed disposition. This protects your assets from forced liquidation and ensures more of your wealth is preserved for your beneficiaries.

• Life Insurance Solution 2: Utilizing the Capital Dividend Account (CDA). When a life insurance policy is owned by a corporation, the death benefit flows into the corporation tax-free. It can then be channelled through the corporation’s CDA, allowing for tax-free distribution to beneficiaries as capital dividends. To understand how the CDA works, see this post: The Capital Dividend Account: Extract Corporate Cash Tax-Free. This strategy minimizes the overall tax burden on your estate.

Protect Your Wealth: Answers to Your Budget 2024 Questions

Budget 2024 has raised questions about how to best protect your wealth in light of the new tax rules. Here are some common concerns and how life insurance can provide solutions:

Q: I’m not incorporated. Does life insurance still make sense for me in light of these tax changes?

A: Absolutely. Even without the additional benefits of corporate ownership, life insurance can still be a valuable tool. The tax-free death benefit can help cover the significant tax liabilities that can arise from a deemed disposition. Contact us to explore how a personalized strategy can protect your estate for your loved ones.

Q: I already have some life insurance. Is that enough, or should I consider more?

A: It’s great that you have protection in place! With the changes introduced in Budget 2024, it’s wise to review your existing coverage. Life circumstances and tax rules change over time, so it’s important to ensure your insurance aligns with your current needs and financial goals. We can offer a comprehensive assessment.

Q: Aren’t insurance premiums expensive, especially as I get older?

A: Life insurance premiums are based on factors like your age, health, and the type of policy chosen. While premiums generally increase with age, there are strategies to manage these costs. One option is “joint-last-to-die” coverage for couples, which often has lower premiums than individual policies. Ultimately, it’s essential to evaluate the value life insurance offers in terms of wealth protection and peace of mind.

Protect Your Legacy and Secure Your Family’s Future.

Budget 2024 introduced significant changes to how capital gains are taxed.  Don’t let these changes erode your hard-earned wealth.  Life insurance offers powerful tax optimization strategies. Contact your family team at Taxevity Insurance to explore how personalized solutions can protect your assets and preserve your legacy.

Promod Sharma (FSA, FCIA) and Jeevan Sharma (CFP) YOUR FAMILY TEAM

At Taxevity Insurance, we’re passionate about bringing clarity to complex financial decisions. Let us empower you with personalized strategies to achieve your goals. We focus on life and health insurance solutions to protect your business, your family, and your legacy.