IT-87R2 "Policyholders' Income from Life Insurance Policies".
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|Tax Topics - Income Tax Act - Section 12.2 - Subsection 12.2(1)||0|
|Tax Topics - Income Tax Act - Section 138 - Subsection 138(12) - Life Insurance Policy||0|
Kevin Wark, Michael O'Connor, "The Next Phase of Life Insurance Policyholder Taxation is Nigh", Canadian Tax Journal (2016) 64:4, 705 - 50
Overview/purpose of accumulating fund (p. 709)
The accumulating fund is intended to represent the savings element in the policy and has historically been the greater of (1) the cash surrender value and (2) the present value of future benefits less the present value of future premiums payable under the policy (effectively the reserve that can be claimed by the insurer in respect of the policy).
For Canadian tax purposes, the accumulating fund determines whether the policy is exempt from the annual accrual rules for life insurance policies, and, if it is not exempt, how much is included in income. There are a number of different policy designs that may provide little or no cash value but can create a significant accumulating fund. For example, in a universal life level cost of insurance (UL LCOI) policy, the mortality charges in the initial years will exceed the annual mortality costs, and such excess is not available to the policyholder as part of the cash surrender value. However, in later years, the excess is available to effectively subsidize the cost of insurance when the policy mortality charges are below the actual mortality cost.
In order for a life insurance policy to qualify as an exempt policy, the inside buildup of value in the policy, as measured by the accumulating fund of the policy, must not exceed certain limits when compared with its benchmark policy. The benchmark policy is known as the "exemption test policy" (ETP).
Alan MacNaughton, "New Income Tax Rules for Holders of Life Insurance Policies and Annuities", 1983 Canadian Tax Journal, No. 6
Comparison to MTAR
The accumulating fund can differ from the "maximum tax actuarial reserve" permitted to the issuing life insurance company under regulation 1401(1)(c) for two reasons. First, under regulation 307(5)(a), the fact that the issuing life insurance company may have reinsured part of its risk under the policy with another life insurance company will not affect the accumulating fund. Second, regulation 307(2)(b) requires that in the unlikely situation that the interest rate series used in determining the full preliminary term reserve increases over time, an interest rate series that is constant over time must be used instead.
Despite the complexity of the provisions described above, the accumulating fund usually will be equal to the cash surrender value of the policy less outstanding policy loans. The reason for this is that the cash surrender value normally exceeds the full preliminary term reserve for all years except the first few years after issue.
Accumulating fund viewed as a measure of savings accumulaion
It is helpful to consider the accumulating fund as a measure of the savings accumulation built up by the policyholder. The savings accumulation less the ACB of the policy is a natural measure of the income earned if three adjustments are made to the ACB. First, income that has already been taxed must be included as part of the ACB to avoid double taxation. This is accomplished under subparagraph 148(9)(a)(iii.1). Second, the cost of ancillary benefits that do not contribute to the savings accumulation must be removed from the ACB. Accordingly, subparagraph 148(9)(e.1)(iii) excludes from the ACB the part of premiums paid after May 31, 1985 that relates to the cost of accidental death benefits, disability benefits, and other ancillary benefits. Third, the ACB must be reduced to recognize that a part of the savings accumulation has been directed to pay for the insurance protection that has been afforded to the policyholder. Subparagraph 148(9)(a)(ix) accomplishes this by reducing the ACB on December 31 of each year by the net cost of pure insurance for the year, beginning December 31, 1986 for most holders. The net cost of pure insurance is defined by regulation 308(1) to be the probability of dying in the calendar year (qx in actuarial notation) multiplied by the difference at the end of the calendar year between the benefit on death and the accumulating fund (computed without regard to any policy loans). Alternatively, the insurer can use the cash surrender value in place of this modified accumulating fund. The benefit on death used in the calculation is defined by regulation 310 to exclude accidental death benefits. The probabilities of dying are to be taken from a standard mortality table prescribed in the regulation, but the precise table has not yet been decided upon. The reference to the CSO 1958 mortality table in regulation 308(1) is only an interim measure to allow the regulation to be made and is to be changed.