Generate Income for Grandkids

Increase capital for the third generation by taking advantage of the tax-deferred features of a universal life insurance policy

by Chris Ireland, Mar 24, 2011

For high-net-worth individuals, there are a number of ways to provide capital to future generations, such as using a discretionary trust to own shares in the business and contributing to their RESPs. Another alternative is to utilize the tax-deferred features of a universal life insurance policy.

1 Establish a life insurance policy on the life of a grandchild.

A grandparent can own the policy or a trust can be created for the grandchild with the grandparent as the controlling trustee. Attribution rules aren’t an issue because the income earned within the policy is not subject to tax, since the tax rules make the policy exempt.

2 Make annual deposits for at least 10 years.
When the time is right, the ownership of the policy could be transferred to the grandchild. A transfer of a policy from a grandparent to a grandchild is subject to “rollover” treatment (so, no gains are recognized on the transfer), if the grandchild receiving the policy is the insured.

If a trust is the owner of the policy, it could continue owning the policy. The benefit of this is the policy would not be subject to the 21-year deemed disposition rule, which stipulates that assets held in trust are deemed to be sold every 21 years. When the trustee decides to transfer the policy to a beneficiary, any gains will not have to be recognized for tax purposes. The cash that has built up in the policy can be extracted by the grandchild over a number of years.

Case Study
To illustrate, let’s look at an example.

Philip Smith owns a construction company in B.C. He establishes a universal life policy on his five-year-old grandson, Michael. The initial base benefit of the policy is $2 million with $20,000 in annual deposits made over 15 years. The rate of return is 2.5 per cent for the five years and increases to 3.5 per cent in subsequent years. Assume the cash accumulates to $450,000 when Michael is 29 years old (an age predetermined by Philip). Michael can then extract approximately $13,000 per year on an after-tax basis for the next 55 years (assuming his life expectancy is age 85) before completely depleting the policy. This withdrawal amount assumes the grandson, Michael, is taxed at the highest marginal rate of tax in B.C. for each year of extraction.

If the rate of return was increased to five per cent in the first five years, and 6.5 per cent for the remaining term, the amount of cash in the policy would increase to almost $750,000 by the time Michael is 29, and the annual after-tax withdrawal amount for 55 years would be approximately $33,500.

Alternatively, the Smith family may want to provide Michael with some larger amounts of money over a shorter period of time to assist in a larger purchase, such as a house.


Chris Ireland is a senior vice-president, planning services, PPI Advisory.

This article originally appeared in Canadian Capital. It is reprinted with permission.

These resources are provided for reference only and do not necessarily represent the opinions of Guilfoyle Financial Inc. Please consult your own tax and legal advisors.