Are you looking for a tax-effective way to transfer funds to your child or grandchild to help them pay for their education or their fist home? Consider using an exempt life insurance policy that allows for cash accumulation. You'll be providing insurance protection on your child's or grandchild's life, while maintaining control of the policy as it builds up a tax-advantaged cash accumulation that they can use to fund their education or home purchase - once you are ready to transfer the ownership of the policy.

While using a trust to transfer wealth to a younger generation can be costly and time consuming to establish, using an exempt life insurance plan can be very effective, both in terms of cost and the time it takes to set up. And a cash value, exempt life insurance plan offers yet another advantage over a trust - it allows you to maintain control of it until you decide the time is right to transfer the policy, along with it's cash value, to your child or grandchild. On the other hand, trusts typically allow you to maintain control only until the child reaches age 18 or 19.

Usually, when a life insurance policy is transferred from one party to another, a disposition is deemed to occur, and a taxable policy gain may occur. Fortunately, when a life insurance policy is transferred to the child of a policy holder, special provisions in subsection 148(8) of the Income Tax Act apply to the transaction, thus avoiding any taxable policy gain. Under these provisions, the policy is transferred to the child at the original Adjusted cost Basis (ACB), which affords the parent or grandparent the opportunity to create a significant cash accumulation in the exempt policy, while avoiding a taxable gain at the time of transfer to the child.

The tax-advantaged roll over of a life insurance policy applies as long as:

• An interest in a life insurance policy is transferred to the child of a policy holder
• No consideration is exchanged for the transfer of the policy
• The life insured under the policy is the child of the policyholder or transferee

(See Tax Tip #4 for the definition of "child" as it pertains to this roll over).

Let's consider an application of a cash-value life insurance policy to transfer wealth to a younger generation ....

Grandpa deposits $5,000 a year for 10 years into an exempt life insurance policy. In 10 years, when granddaughter is 18 and eager to continue her education at university, Grandpa transfers the policy to her. Granddaughter can then withdraw the cash value Grandpa built up in the policy to fund her education. Granddaughter is in a low tax bracket at this point in her life, so the net withdrawals are maximized.

As the Income Tax Act restricts the amount of tax advantaged cash accumulation permitted within an exempt life insurance policy, there may be limited opportunity to create the desired cash value if the life insured is a young person. As a result, the amount of money you desire to tax-shelter within an exempt life insurance policy on a young child's life may exceed the amount of life insurance actually available on that child's life, due to financial underwriting limitations. To overcome this obstacle, Grandpa could have made his adult daughter the life insured under the policy as she is likely eligible to be underwritten for a greater face amount of life insurance. Grandpa could still roll the policy over to Granddaughter at age 18 on a tax-exempt basis, because the conditions listed above are still satisfied.

It's important to note that the policy holder must be alive at the time of the transfer. If you attempt to have the transfer executed under the terms of your will, the policy will not directly roll over to the child, but to your estate, instead. To prevent this situation from arising upon your death, you could name the child as the successor owner of the policy. This way, upon your death (the death of the policyholder), the policy will not be considered part of the deceased's estate, according to the Insurance Act.

The Canada Customs and Revenue Agency has stated that the roll over provision described in subsection 148(8) will indeed apply in such a situation.

As we've seen above, an exempt life insurance plan can do more than simply provide a means for you to leave a legacy to your heirs; a tax-advantaged cash accumulation life insurance plan can also be used to transfer wealth between generations in a very tax efficient manner!