Life insurance and annuity tax rules are changing in 2017
By Tom Pilkington, CPA, CA, CFP, TEP – Tax & Estate Consultant, Scotia Wealth Insurance Services Inc.
This article focuses on tax rule changes affecting life insurance policies and prescribed annuity contracts that will take effect on January
1, 2017, and explains why we are encouraging clients and their advisors to consider implementing insurance and annuity planning
before 2017 to benefit from the generally more advantageous current tax rules. This article provides an overview of the new rules and
the implications for planning but is not intended to be an exhaustive review of all of the technical changes.
Introduction
Life insurance and annuity products are valuable tools for tax, business, retirement, charitable gift and estate planning. The current tax
rules for life insurance and annuity products have generally been in place since 1982. Only minor changes have been enacted since
that time even though the design of these products has continued to evolve over the years. The result has been inconsistent tax
treatment on similar products between insurance companies and the view in some circles that some of these products generate overly
generous tax benefits. Under legislation enacted December 16, 2014, the life insurance and prescribed annuity tax rules are being
modernized to reflect more recent mortality tables and to provide standardization across insurance companies and products. The new
rules come into effect on January 1, 2017. The new rules will diminish some of the tax benefits these products have enjoyed.
However, grandfathering rules have been introduced for life insurance policies and prescribed annuity contracts issued before 2017,
and this creates a planning opportunity for clients if they act early this year.
The changes and their implications
A full discussion of the technical changes is beyond the scope of this article. The most important changes can be summarized as
follows:

Changes to the life insurance exemption test. This includes a revised definition of the benchmark “exempt test policy” and the
introduction of prescribed assumptions when calculating the exempt status of a life insurance policy. This change could limit the
amount of overfunding permitted and reduce the amount of policy values that can accumulate in the policy in the future while
maintaining the exempt status of the policy.

Changes to the calculation of the tax cost (adjusted cost basis) of a life insurance policy and the use of updated mortality tables
when calculating the mortality cost of a life insurance policy for tax purposes. While this change could decrease the taxable policy
gain realized on a disposition of the policy (surrender, policy loan, transfer of ownership, etc.), which is good, it could also reduce
the credit to the notional capital dividend account of a private corporation in the event life insurance proceeds are received by the
corporation as a consequence of death. This is discussed in more detail below.

Changes to the calculation of the taxable portion of prescribed annuity payments. This change may result in a smaller portion of
each annuity payment considered to be a tax-free return of capital while increasing the taxable portion.
The actual impact of the new tax rules on life insurance and annuity planning is dependent on a number of factors, including the type of
product, age, funding, and ownership. The changes could impact planning in some cases, while other cases may experience very little
impact at all.
Corporate-owned life insurance
Life insurance proceeds received by a private corporation as a consequence of death credit the corporation’s notional capital dividend
account to the extent the proceeds exceed the adjusted cost basis of the policy at that time. A private corporation can elect to pay taxfree capital dividends to its Canadian-resident shareholders up to the balance in its capital dividend account. From an estate planning
perspective, corporate-owned life insurance effectively converts what would normally be taxable retained earnings into tax-free capital
dividends, a significant advantage. The changes under the new tax rules result in a higher adjusted cost basis for a longer period of
time compared to the current tax rules. This may reduce the amount of the proceeds received on death which credit the notional capital
dividend account and can be paid out as tax-free capital dividends, depending on when death occurs. We believe the impact of this
change could diminish the preferential tax benefits associated with corporate-owned life insurance under the current tax rules but not to
such an extent as to change the decision to make a policy corporate owned.
Scotia Wealth Management™ consists of a range of financial services provided by The Bank of Nova Scotia (Scotiabank®); The Bank of Nova Scotia Trust Company (Scotiatrust®);
Private Investment Counsel, a service of 1832 Asset Management L.P.; 1832 Asset Management U.S. Inc.; Scotia Wealth Insurance Services Inc.; and ScotiaMcLeod®, a division of Scotia
Capital Inc. Insurance services are provided by Scotia Wealth Insurance Services Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment
Industry Regulatory Organization of Canada.
All insurance products are sold through Scotia Wealth Insurance Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank group of companies. When
discussing life insurance products, ScotiaMcLeod advisors are acting as Life Insurance Agents (Financial Security Advisors in Quebec) representing Scotia Wealth Insurance Services Inc.
® Registered trademark of The Bank of Nova Scotia, used under licence.
™ Trademark of The Bank of Nova Scotia, used under licence.
Grandfathering rules for policies issue before 2017
The new rules come into effect on January 1, 2017. However, grandfathering rules have been introduced for life insurance policies and
prescribed annuity contracts issued before 2017. Policies and contracts issued before 2017 will continue to enjoy the tax benefits
under the current tax rules as long as they continue to qualify for grandfathered status.
A life insurance policy issued before 2017 can lose its grandfathered status after 2016 if the policy is converted from one type of
insurance to another after 2016 (such as converting a term insurance policy to permanent insurance), or a change is made to the policy
requiring medical underwriting (increasing coverage, adding a term life insurance benefit, or substituting a life) but does include making
a change in smoker status, reducing a rating, or transferring the ownership of a policy. Any such changes contemplated should be
completed before 2017 to help ensure the policy retains its grandfathered status. This is especially important for owners of term life
insurance policies that have a conversion option and who would benefit from a change to permanent insurance, as this change can be
completed without medical evidence. If the conversion is deferred until 2017, the new tax rules will apply to the new policy.
Implications for clients (and their advisors)
The new tax rules come into effect on January 1, 2017 for life insurance policies and prescribed annuity contracts issued after 2016.
The new rules will diminish some of the tax benefits these products have enjoyed. Clients who are contemplating or should be
contemplating life insurance or annuity planning are encouraged to take action now to ensure they can benefit from the current tax rules
on policies and contracts issued before 2017. This is especially true for life insurance planning given the amount of time that can
elapse between the start of the planning process and when a policy is actually issued, which can be several months.
Scotia Wealth can help
Life insurance and annuity planning is a specialized area of wealth planning that requires an in-depth understanding of planning
concepts and planning tools in addition to knowledge and experience of insurance and annuity products, which insurance companies to
work with and how best to structure the planning to maximize the benefits and minimize the costs. That is what our Insurance
Consultants do. Clients should meet with one of our Insurance Consultants as soon as possible to help ensure their life insurance and
annuity plans can be implemented this year to take advantage of the beneficial current tax rules for these products.
Scotia Wealth Management™ consists of a range of financial services provided by The Bank of Nova Scotia (Scotiabank®); The Bank of Nova Scotia Trust Company (Scotiatrust®);
Private Investment Counsel, a service of 1832 Asset Management L.P.; 1832 Asset Management U.S. Inc.; Scotia Wealth Insurance Services Inc.; and ScotiaMcLeod®, a division of Scotia
Capital Inc. Insurance services are provided by Scotia Wealth Insurance Services Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment
Industry Regulatory Organization of Canada.
All insurance products are sold through Scotia Wealth Insurance Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank group of companies. When
discussing life insurance products, ScotiaMcLeod advisors are acting as Life Insurance Agents (Financial Security Advisors in Quebec) representing Scotia Wealth Insurance Services Inc.
® Registered trademark of The Bank of Nova Scotia, used under licence.
™ Trademark of The Bank of Nova Scotia, used under licence.