The last few weeks I’ve talked about a bunch of high-level stuff for Canadians that emigrate to another country. I touched on your Canadian investment accounts, how CPP and US Social Security integrate and what is a PFIC. Today let’s start a series that digs a bit deeper on planning stuff for those of you that are moving to the US.
First up, Life Insurance.
If you own Life Insurance in Canada, you likely understand that the payout to your estate or beneficiaries is not subject to income taxes. Life Insurance is a great way to transfer the risk of death to a 3rd party and provide a payout to your beneficiaries. But you might have a tax problem on your hands with the US for this life insurance policy. Before you move you MUST check with your insurance provider to confirm your policy meets the Exemption Test. The US tests life insurance in two different ways.
The Cash Value Accumulation Test and the Guideline Premium Test.
Simply put, under the Cash Value test, there are limits on the amount of cash value your policy can have in relation to the death benefit. The Guideline Premium test provides limits on how much you can contribute in relation to the death benefit.
To confirm if your existing policy in Canada is good or not under US law requires the help of your insurance carrier. Without doing this you run this risk of getting a nasty surprise from the IRS. The issue? If your Canadian policy does NOT meet the exemption test, the income from the policy would be taxed annually as ordinary income under US tax law. This normally includes looking at both the Cash Surrender Value of the policy but also the Death Benefit. It leads to the potential of you paying tax on something you don’t actually receive. So again, please get a determination on your Canadian Life Insurance long before you move.
If you have a Term insurance policy, you’re probably safe because term doesn’t typically have a Cash Surrender Value but Universal Life and Whole Life policies have a higher risk of not meeting the Exemption Test. Regardless, please do NOT take my word for it. ALWAYS check with your insurer to be sure. What can you do if you are now in a situation where getting a new insurance policy is more expensive or not possible? Well then you should speak with your advisors about an Irrevocable Life Insurance Trust.
Those are a topic for another time, just understand that there are some options that allow you to keep a Canadian policy if it doesn’t pass the Exemption Test. There is one other complication to consider and it’s US Excise Tax.
The US charges a tax equal to 1% of the annual premium on any foreign life insurance issued on a US resident or citizen. That’s an extra $100 per $10,000 of premiums for your policy and this might also make you consider US-based life insurance as a more cost-effective option. Note that using the Irrevocable Life Insurance Trust might help with the bigger issue of the non-exempt policy tax but it does nothing to help with this Excise Tax. If you’re now a US resident or citizen and keep your Canadian policy you will pay the 1% extra.
The TL/DR- if you have Life Insurance here in Canada, before you move, check with the insurance company of make sure it meets the US’ Exemption Test. From there you can determine whether an ILIT makes sense even after paying the Excise Tax or if you can find a similar option when you have moved.
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