Wednesday, February 18, 2009
ost people consider permanent life insurance a tax-free investment vehicle with a death benefit. In many cases that is true; however, there are instances where a taxpayer receives, or is deemed to have received, proceeds of disposition (POD). The result is a capital gain if the proceeds exceeds the adjusted cost base (ACB) and any selling expenses.
The ACB of a life insurance policy is defined in subsection 148(9) of the Income Tax Act.
While there are a number of factors that go into determining the ACB of a life insurance policy, the two main factors are: premiums paid and something known as the Net Cost of Pure Insurance (NCPI).
The premiums paid under the policy increase the ACB and over the life of the policy this amount grows. Where the policyholder receives a dividend from the policy and apply it as a premium, that premium is not added to the ACB.
The NCPI is the amount at risk for the insurer times a mortality factor. The calculated amount reduces the ACB. As the insured person ages, the mortality factor increases and so does the NCPI.
Early in the life of the policy, the ACB is usually positive since the premiums exceeds the NCPI. As the insured person ages, the NCPI grows faster than the premiums and the ACB approaches zero.
The ACB cannot become negative.
The good news is the insurance company will provide with the ACB amount.
The bad news is that depending on what that amount is, proceeds on the policy may give rise to income taxes.
Posted 2009/02/18 at 18h01ET in Estate Planning.