The lack of clarity from Ottawa regarding the tax treatment of critical illness insurance with return-of-premium options can be particularly problematic for advisors who sell group plans. Advisors would like to know how they can safely structure the group products.

The federal Income Tax Act does not contain any mention of critical illness insurance. The confusion is compounded by the fact that some of the insurance vehicles geared toward employees that could include CI insurance, such as health and welfare trusts, are also not mentioned.

Employers commonly provide HWTs for a select group of employees, such as top executives, says Florence Marino, assistant vice president of tax and estate planning at Manulife Financial Corp. in Kitchener, Ont.
The trusts usually contain supplemental benefits or benefits that replace standard health coverage.

While the tax act doesn’t provide direction about how HWTs must be structured, the Canada Revenue Agency has provided some guidance through its interpretation bulletins, says Marino.

Advisors can glean from the interpretations, she says, that an HWT can include a group sickness and accident plan and/or a group term life policy. It can also include a private health services plan (PHSP).

There is a definition for PHSPs in the act that states that such a plan must be a contract by one person, an employer, to indemnify another person, an employee, for hospital and/or medical expenses as well as a medical care and/or hospital care plan.

The specific nature of a PHSP — that it covers medical expenses only — disqualifies it from being used by insurers and advisors for CI insurance inclusion, says Terry Zavitz, president of London, Ont.-based Terry Zavitz Insurance Inc.

A CI insurance policy provides the client with a lump-sum payment when the client is diagnosed with a specific illness. However, the policies don’t dictate how the benefit must be spent. The money could go toward medical expenses or a client could use it, for example, to pay off the mortgage.

Ron Sanderson, director of policyholder taxation and pensions at the Toronto-based Canadian Health and Life Association, says using CI benefits to pay off bills might be reasonable because it would make other monies available to cover medical expenses. Sanderson suggests it may be helpful if clients could provide the CRA with receipts for expenses deemed non-taxable under CI policies. “Part of the problem,” he says, “is we then get into the broader discussion of what public support should go toward private health-care needs.”

Meanwhile, Zavitz is concerned some advisors are confusing accident and sickness plans with PHSPs.

The CRA has stated that CI insurance without a return-of-premium provision would generally be considered to be an accident and sickness plan, Zavitz notes. Therefore, it would be OK for an advisor to build a “grouped” accident and sickness plan that includes CI without an ROP provision.

Like disability insurance in a grouped accident and sickness plan, Zavitz says, CI premiums are tax-deductible to the business and not a taxable benefit to the employee.

“Where critical illness differs is that the benefits at time of claim may be tax-free if received as a lump sum, which is the usual way a CI benefit is paid, as opposed to periodic payments,” Zavitz says. “This tax treatment is similar to that of a PHSP, and may account for some of the confusion over PHSPs and critical illness plans.”

Zavitz notes that a “grouped plan” should not be confused with the ordinary meaning of a group plan. To set up a grouped accident and sickness plan that will qualify for positive tax treatment, Zavitz says, there must be at least two people insured, a board resolution establishing the plan and benefits at the time of any claims must flow to the insured. “Be careful not to set up a grouped plan that includes only shareholders,” she cautions. “It will be deemed to be a shareholder benefit.”

She says the preferential tax treatment for CI without ROP provisions may not last: “The CRA may make changes in the future; though, if changes are made, the CRA may allow for grandfathering to protect current plans.”

With HWTs, Marino says, an employer’s contributions to the trust are deductible, provided they are reasonable to the employees’ circumstances. IE