A year ago, the projected deficit for 2020 was estimated to be $20 billion. Shockingly, as a result of Covid-19, this projection has risen to over $380 billion by the end of the year. So, what does that mean for tax rates and how will this affect your estate plan?
Even as they continue to unfold, the Covid-19 pandemic and its effects are influencing the way we plan for our future. During the period of lockdown and self-isolation, many people put a great deal of thought as to how to keep themselves and their families safe – not only physically but financially as well. For some, this meant finally looking at the recommendations they had been considering about their life, critical illness and disability coverage. For others, it became a time to reassess their investment, retirement and savings plans, as we all know the results uncertainty can have on the equity markets.
Then, there are the potential long-term effects that this pandemic may have on estate planning and its primary objective of reducing the impact of taxes during life and at death.
As the national deficit continues to balloon, the logical question remains: where is the money going to come from to help cover this? While the government may be loath to raise taxes, and politically that is something it might wish to avoid, there is no question that increased tax revenues are probably necessary.
For the past year or so, financial pundits have predicted that there may be an increase in the inclusion rate for taxation on capital gains. However, there is speculation on the actual amount of inclusion because this percentage has fluctuated historically. For example, when the tax on capital gains was first introduced in 1972, the inclusion rate was 50 per cent, meaning this amount of the capital gain would be taxed. Over the years since, the inclusion rate fluctuated between 50 per cent to 75 per cent. It was lowered again in 2000 to the current inclusion rate of 50 per cent.
In Canada, the top personal marginal rate in most provinces exceeds 50 per cent. This means that the tax payable on a capital gain, realized or deemed at death, could be over 25 per cent. It is highly possible that the inclusion rate will soon be increased to help augment tax revenues to combat the huge deficit. If it increases to 75 per cent, as it was from 1990 to 2000, the effective rate of tax on a capital gain will increase to almost 40 per cent. This assumes that the top marginal income tax rate also does not increase. This will have a significant impact on the future cost of settling an estate due to the deemed disposition of all assets upon death.
One beneficial strategy to avoid leaving family members with an insurmountable tax bill, is to provide sufficient estate liquidity to pay taxes due at death from the proceeds of a life insurance policy. In Canada, we are fortunate to have permanent life insurance policies that insure an individual for their entire life with a premium that is guaranteed not to increase.
In its handling of its $380 billion deficit, the Canadian government could borrow money, and if they do, it is a real incentive to keep long-term interest rates as low as possible. The current yield for 10-year Canadian Bonds is less than 1 per cent, and it is clear that a low interest rate environment will persist for a considerable period of time. This is significant because the life insurance company actuaries pay particular attention to the prevailing long-term interest rates when pricing a product. This current era of low-interest rates indicate that the price of permanent life insurance will increase in the near future.
While Covid-19 is not expected to have a general impact on the cost of life insurance, it is unclear whether possible changes in underwriting guidelines could also result in higher costs for certain individuals. Another factor that could increase life insurance premiums are changes to industry accounting practices in the near future, which would require life insurance companies to modify the disclosures about long-duration contracts, such as permanent life insurance.
The bottom line is this: With higher taxes and increased life insurance premiums on the horizon, now is the time to review your estate planning needs and implement or increase your life insurance. Putting off this important task will increase costs for you – or your family – down the line.
