As part of the 2013 budget, the federal government is proposing changes to eliminate what it says are “unintended tax benefits” relating to two leveraged life insurance arrangements: so-called 10-8 strategies and leveraged insurance annuities.
The 10-8 Strategy
A 10-8 arrangement involves investing in a life insurance policy and borrowing against that investment to create an annual interest-expense tax deduction for an extended period of time. In the absence of the tax benefits, the investing and borrowing would not be undertaken, the government contends.
Under the proposed changes, if a life insurance policy or an investment account under the policy is used as security for a loan, and either the interest rate on the investment account under the policy is set by using the interest rate payable on the loan or the maximum value of an investment account under the policy is set by reference to the loan, then the following income tax benefits will be denied:
1. The deductibility of interest paid or payable on the loan that relates to a period after 2013;
2. The deductibility of a premium that is paid or payable under the policy that relates to a period after 2013;
3. The increase in the capital dividend account by the amount of the death benefit that becomes payable after 2013 under the policy and that is associated with the loan.
In order to facilitate the termination of existing 10-8 arrangements before 2014, Budget 2013 also proposes to alleviate the income tax consequences on a withdrawal from a policy under a 10-8 arrangement, made to repay a borrowed amount under the arrangement, if the withdrawal is made on or after March 21, 2013 and before January 1, 2014.
Leveraged Insurance Annuities
The federal government has also proposed eliminating some of the tax benefits associated with leveraged insurance annuities (LIAs).
Budget documents define an LIA as “an investment product that is acquired with borrowed funds and provides fixed and guaranteed income to an investor until the death of an individual.” Upon the insured individual’s death, the capital invested is returned as a tax-free death benefit.
Currently, there are multiple tax benefits associated with the individual part of a leverage insured annuity, according to budget documents. For example, these annuities allow a portion of the income earned on invested capital to be tax-free, interest on the money used to purchase the annuity is tax deductible, as is a portion of the invested capital.
Under the federal government’s proposed rules, an LIA policy will be subject to annual accrual-based taxation and will no longer qualify for a deduction on any portion of paid premiums.
These rules will not apply to funds borrowed to purchase an LIA before March 21, 2013.