Since 2020, the number of Canadians aged 65 and up has risen from about 6.8 million to about 7.8 million. This means that a growing number of people are coming to a time of life when they are thinking about how to transfer, either while living or at death, at least some of their wealth to their loved ones.  

Which raises a question: what’s the best way to do this from a tax perspective?  

Taxes: a significant expense 

It’s a fact that few investments escape the bite of the tax collector. Funds accumulated in a Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF) are taxed when withdrawn during the holder’s lifetime or liquidated after death, as are capital gains realized on unregistered investments. As a result, children might only receive a portion of the assets accumulated by their parents. 

This is where life insurance can make a difference, especially with a strategy known as “cascading life insurance.” 

The basics  

To understand this approach, it’s useful to review some of the basic concepts of life insurance. 

• Policyholder 
  The person who bought the life insurance and pays the premiums. 

• Insured person, or simply “insured”  
  The person whose death will trigger the payment of the sum insured. 

• Beneficiary 
  The person designated in the insurance contract to receive the sum insured, or “death benefit.”  

• Permanent life insurance  
  Type of life insurance which, in addition to providing a death benefit, allows the accumulation of value within the policy. 

Lastly, keep in mind that life insurance death benefits are tax exempt. 

Cascading life insurance 

Cascading life insurance is a strategy that applies to several generations of the same family. How it works is relatively simple, as shown in the following diagram. The grandparent buys a permanent life insurance policy on the life of a child and designates that child’s own child as the beneficiary. 

This means that the grandparent pays the premiums, but the child’s life is insured. When that child dies, the grandchild will receive the death benefit. 

A range of scenarios 

However, since value – known as the cash surrender value – can accumulate within a permanent insurance policy and be available for use before death, this strategy presents other advantages than simply coverage for the grandchild named as the beneficiary.  

For example, policy ownership could eventually be transferred from the grandparent to the child. Whether this is done during the grandparent’s lifetime or at death, it would generally be tax free. At that point, the child might decide to continue paying the premiums and keep the insurance in force for the benefit of the grandchild. But the child could also use all or part of the accumulated surrender value for personal needs, such as buying real estate or guaranteeing a loan, for example. (Note that any cash surrender value withdrawn will be partially taxable). In another scenario, the child might decide to stop paying the premiums and draw on the surrender value to maintain coverage for the grandchild (this is known as “paid-up insurance”).  

Another possibility as time goes by, the parent could transfer the policy to his or her child and name his or her own grandchild as the beneficiary. In this way, the policy could continue to grow in value, tax free, for generation after generation. 

Of course, the grandparent who initially set up the cascade could also decide to use the cash surrender value during his or her lifetime, if still the policyholder. 

Other advantages worth noting 

Another advantage of this approach is that it enables a parent to purchase permanent life insurance on his or her child’s life when the child is still a young adult. This protects the child’s future insurability, and also results in level premiums that are lower than if the policy were purchased later in life. 

As we can see, the cascading life insurance strategy can be looked at from many different angles. To be sure you grasp them all, talk to your advisor!