The Financialist • Issue 131 • October 2016
BY BRETT A. SIMPSON
BComm CFP CLU ChFC RHU
There are some risks that we take purely for the fun of it: skinny-dipping, roller coasters, even alcohol consumption. These risks range from fairly benign to potentially catastrophic. At one end of the spectrum, skinny- dipping would be fairly low risk (unless it’s someone else’s pool or near Amity Island!), surfing, scuba diving or helicopter skiing would introduce a small chance of high risk. Other thrill rides and sports like bungee jumping, ziplining, skydiving, hang gliding and motorized racing, have lottery-like odds of bad outcomes that no one expects, but regularly happen.
We all take risks in sport or recreation, and even transportation. Jaywalking at night, running red lights or stop signs, and excessive speed are all choices or mistakes that can have disastrous consequences. When we were younger, without the wisdom, perspective or experience of danger, we tended to take exploratory risks for fun. It may have been smoking, alcohol, marijuana or non-prescribed drugs, and some might have become long-term habits.
Or it may have been a passion or interest that led to higher risk activities in sport, behavior or even our avocation. Whatever path we choose, there will inevitably be some risk to our most precious resource: our health. That risk may even be a genetic shadow only showing itself in future years as our lifestyle path unfolds.
In financial planning, we can’t stop small- odds catastrophic risks from existing, but we can mitigate the negative financial effects on you, your family, and future generations through third-party insurance plans. The challenge is to anticipate the realistic possibility that an unlikely event, albeit unpleasant to think about, might in fact happen and therefore, plan adequately to avoid the financial catastrophe that it can bring!
We love our children and grandchildren and always hope for the best outcomes in their lives. Sometimes parents and grandparents may be in a position of wisdom, experience and capacity to do more than just hope. Starting financial tools, that they will ultimately need, can be a great headstart gift and inter- generational lesson on planning ahead.
Although an RESP or “In Trust For” investment account may be advanta- geous to parent and child alike in creating education or opportunity funding, neither of these tools protect the child’s human capital that the very investment in education is meant to enhance.
If you can, consider protecting a child’s future human capital value by underwriting their known health and lifestyle risks now. Most young adults realize they need to protect their dependents, pay back their debts, and cover taxes and costs arising from their premature death once they enter a relationship of inter- dependence, have children, or mortgage a home. By applying for and securing a permanent, growing life insurance policy that has an internal reserve of cash value on a child, and a guaranteed right to get more coverage in future, benefactors can ensure the child’s access to this irreplaceable financial tool when they need it later.
The policy would be owned by the parents or grandparents with the minor child as the life insured. They retain ownership, name successor or contingent owners, and beneficiaries until they choose to transfer the policy with a simple administrative form. Qualification early in life is easier and the “insurance” cost will be minuscule, so the remainder of deposits grow tax-deferred inside the chosen investment portfolio of the policy. As the policy value grows, so does the death benefit, thereby creating a valuable base to protect the child’s future dependents.
The policy can be transferred on a tax-deferred basis to the insured when desirable. This allows the parent(s) or grandparent(s) control beyond the child’s age of majority, without the concern for income attribution of the policy earnings being included in their taxable income.
If the policy was transferred to the child and then surrendered for its cash value, the income gain in excess of the contributed adjusted cost basis would be taxable income to the child. They would usually be in a low tax bracket at this time of need and could pay little or no tax on the surrender.
Although surrender for the cash value is available at any time, the smarter strategy is to transfer the policy to the child and they borrow from their policy directly or assign it as collateral to a lender. The insurer would accrue interest on the borrowed amount, but if paid, the policy would continue to earn a tax-sheltered return on its entire value as if the loan did not exist. Direct policy loan proceeds in excess of the cost base would be treated as taxable income in the year received, but are deductible from future higher rate income when they are repaid.
This can provide a unique absolute tax savings strategy for self-financed loans during low income years (student or parental leave), with tax-deductible repayments in subsequent higher income years. Maintaining the policy chassis does double duty, providing needed protection and tax-sheltered working capital for needed emergencies or opportunities.
Importantly, an option should be included at inception to guarantee the child’s future health insurability. The options to purchase any type of coverage occur every three years between ages 21 and 48, or on marriage or child birth for up to eight times the initial benefit amount. From birth through life, our health is never certain. Your knowledge and capacity can create security for generations of your heirs. Your Rogers Group Financial advisor can help deliver your vision.