Tracking Shares with Jonah Mayles | E019
A little used tax planning strategy that can have a big impact on your estate.
In this episode of Financial Planning for Canadian Business Owners, Jason Pereira, award-winning financial planner, university lecturer, writer, talks with Jonah Mayles, Partner, Tax and Estate Planning at Sterling Park Financial. Jonah Mayles shares his wisdom derived in the field of tax law as well as insurance, and the often overlooked topic of insurance tracking shares in reference to estate planning.
Episode Highlights:
● 01:16 – Jonah Mayles explains what he does for a living.
● 02:14 – What is the concept of insurance tracking shares?
● 03:11 – What are the benefits of insurance tracking shares?
● 11:00 – How does the tax implication math happen upon death?
● 13:10 – Can beneficiary children buy shares directly from the estate?
● 14:07 – They discuss how taxes will be affected by COVID-19.
● 15:00 – What does the CRA speak to in reference to insurance tracking shares?
● 16:32 – Has Jonah seen financial arrangements where clients have borrowed from the policy as well?
● 19:17 – Jonah Mayles shares various use cases that solve several customer dynamics.
● 22:36 – The two types of lawyers that will always be busy: family lawyers and estate litigators.
3 Key Points
1. The cash surrender value of the policy contributes to the value of the fair market value of your shares.
2. We are headed towards the biggest wealth transfer in history with the Baby Boomer generation dying off.
3. Insurance is not only great for the client, but the government also gets to receive their money way faster.
Tweetable Quotes:
● “What I do at Sterling Park, my partners are all insurance guys, been in insurance their entire careers, whereas what I do is the tax and estate planning that goes into the insurance plans that we implement for our clients.” – Jonah Mayles
● “Insurance tracking shares is essentially a class of tracking shares that is created for a corporation that is going to acquire a whole life insurance policy.” – Jonah Mayles
● (Insurance tracking shares) “What it does is it tracks the value of either the cash surrender value of the policy or the death benefit, or both.” – Jonah Mayles
Resources Mentioned:
● Facebook – Jason Pereira’s Facebook
● LinkedIn – Jason Pereira’s LinkedIn
● FintechImpact.co – Website for Fintech Impact
● jasonpereira.ca – Website
● Linkedin – Jonah Mayles
● SterlingParkGrp.com – Website for Sterling Park Financial Group
Full Transcript:
Speaker 1: Welcome to the Financial Planning for Canadian Business Owners podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur, plan for success, and make the most of your business in life. And now, your host, Jason Pereira.
Jason Pereira: Hello, and welcome to the Financial Planning for Canadian Business Owners podcast. Just a reminder, before we get started, as always, please sign up for my newsletter at jasonpereira.ca, where you'll get notification of all my media and other goings on. Now today's show. Today in the show I have Jonah Mayles of Sterling Park. Jonah has a background in tax law as well as insurance. And I brought him on the show specifically to talk about one concept in particular that is very much overlooked in estate planning and insurance in general, and that's the concept of insurance tracking shares. So with that, here's my interview with Jonah.
Jason Pereira: Hello Jonah, how are you?
Jonah Mayles: Good.
Jason Pereira: Thanks for taking the time today.
Jonah Mayles: Thanks for inviting me, I've been looking forward to it.
Jason Pereira: Good. Well, we've got all the time in the world, we're entrapped indoors, right? So, Jonah Mayles of Sterling Park, tell us about what it is you do.
Jonah Mayles: So I am a tax lawyer by trade and somehow, because if you asked me 10 years ago, would've never believed it, somehow found my way into insurance. So what I do at Sterling Park, my partners are all insurance guys, been in insurance their entire careers. Whereas what I do, I do the tax and estate planning that goes into the insurance plans that we implement for our clients. So I essentially do the same thing that I did as a tax lawyer, just for our clients that are acquiring insurance.
Jason Pereira: So in a previous episode, I had your partner, Zak, come on to discuss business and insurance, and I've also had another expert, Trevor Parry, talking about estate freezes and whatnot, and they built off each other. And one of the topics I saved for you is the concept of tracking shares or insurance tracking shares, because you're very, very adept at this. So I wanted to open that up. Let's just start with the conversation of what is this concept of tracking shares or insurance tracking shares? And then we can start talking about why they're important use cases and whatnot.
Jonah Mayles: So insurance tracking shares is essentially a class of shares that's created for a corporation that's going to acquire a whole life insurance policy. And what it does is it tracks the value of either the cash surrender value of policy or the death benefit or both. So if you have a company worth $10 million, you have an insurance policy that's maybe worth two, these shares just track that $2 million value. It doesn't entitle you to dividends or proceeds on the sale of a business or votes. Absolutely nothing but the tracking of the value of the policy.
Jason Pereira: Yeah, so corresponds to one specific asset of the policy. I mean, this is a trick that's been known in the investment circles, for anyone familiar with corporate class mutual funds, that's exactly the same mechanism, track a certain underlying asset portfolio where it might be. So what's the benefit of tracking in general? And we can get into the difference between the cash value versus the death benefit.
Jonah Mayles: The benefit is under section 75 of the tax act, there's a deemed disposition of capital assets on death. So if you own shares of a corporation or private corporation with a value of $10 million, on death, if you can't roll those shares over to your spouse, tax-free, it triggers a tax bill. And that tax bill is going to be $2.6 million.
Jason Pereira: As an example.
Jonah Mayles: As an example. And this is-
Jason Pereira: It's not $2.6 million flat, thank God no. And this is something we covered in Post Mortem Planning with Trevor Parry, so greater detail there.
Jonah Mayles: Right, you did minimize it, but what's crazy, and I always say this is, how often people are unaware that you can minimize that tax bill and how to do it, even people in our business. So the insurance track ensures that comes into play because what a lot of people, even in the insurance business don't understand is, is that the cash surrender value of the policy attributes to the fair market value of your shares. So you can acquire a policy inside your company to fund that tax bill I just talked about, but without the right structuring, you could actually contribute to that tax bill with the mechanism that you acquired to pay it.
Jason Pereira: So I mean, let's imagine I, as an example, I set up a, and we'll use your tax bill of 2.5 million. Say I do an estate freeze, I've frozen that at current tax rates, the tax bill at $2.5 million. I buy a $2.5 million insurance policy, that policy, if it's term 100 there's no cash value to it, it's straight money in, money out. But I look at tax sheltering opportunities and corporate surplus opportunities. I say, "Okay, you know what? A whole life policy is a good fit here. I like the additional tax benefits." The problem being that, as you said, as that cash value grows, now that value of the company increases also, which creates an eventual liability, maybe not for me, but for the next generation as well. But if there's no freeze, then it definitely creates liability for me on death.
Jonah Mayles: Correct. And to me, this was the best kept secret in insurance. So when I started in insurance, I did not know the difference. I mean, you just talked about the difference between a term 100 and whole life, I didn't know that. I left Bay Street and went to go work at Canada Life, and had no idea what the difference between term and whole life insurance was. So when I started at Canada Life, I go to my boss's office and I go, "Okay, who's going to train me?" He's like, "No one's going to train you. I hired a lawyer. If you can figure out tax law, you can figure out insurance." So I'm like, "I don't even know where to start."
Jonah Mayles: So I asked someone to bring me everything that Canada Life has ever written or published on insurance. And I had no meetings for the first two weeks of my career there. So I sat in my office and read everything. And it was mostly junk, salesy stuff, then I come across insurance shares, and I open up my tax act and I go through all the provisions of the act. I'm like, "Oh my God, this is necessary for everyone to want to talk to in my life now." And then I went out to these meetings and no one was bringing it up. No one was talking about it. And to me it is essential to have this conversation with a client. Every time-
Jason Pereira: I mean honestly, I was in a similar boat. Even with all the insurance training I had, I had zero exposure to it until I came across it in Joel Cuperfain's book. And it was just one small sleeve of a handful of pages and reading this I'm like, "This is interesting," right? So it really is this best kept secret of this sort of stuff. And I often wonder if it's just because the insurance guys rely too much on the lawyers for the freezes and the lawyers don't understand the concept of insurance, so therefore it's sitting in this vacuum of basically mutual blind spots for both of them.
Jonah Mayles: And right. And that's a very important point. I wrote an article about this, it was published in a newsletter that went out to a bunch of professionals in the city. And I was getting calls, "Oh my God, all my clients, they're all ..." I messed them up. I'm like, "Hold on, have they done a freeze when they acquired the insurance?" Because often they go hand in hand. And if you do a freeze, sometimes you don't need the insurance tracking shares. The reason being is, as we were talking about that tax bill on death is based on that frozen amount. So if you froze it, that tax bill at 2.5 million, that growth in the insurance policy is going to the next generation share. So you've already accomplished that goal. But a lot of times clients can't do freezes for whatever reasons. There's a shareholders' agreement in place, which says you can't, it's a type of business that you can't freeze.
Jonah Mayles: The best illustration I can provide as to why this is so important and how often it's not looked at, is Zak and I were meeting with an individual. He already acquired an insurance policy. We were just meeting to talk about industry-related things. And me and Zach were like, "Okay, we're here, let's see the policy you got." And he did financed life insurance. And he financed 100% of it. And he did it to fund a tax bill on death. And the policy was enormous. And we're going through everything that the insurance guys had done, and I'm like, "So what are you doing about the $10 million tax bill? And he started swearing at me. I'm like, "Don't swear at the guy, I'm just the guy who's bringing the news, don't kill me."
Jason Pereira: Only the messenger, my God.
Jonah Mayles: And his policy, the cash surrender value, grew to $40 million at life expectancy. And there was no freeze, because he couldn't do the freeze based on the business he was in. So that CSV attributed would attribute $40 million of value to his shares on death, which means that triggers an additional $10 million of tax. And he had no idea, and this was rushed, the whole thing was rushed by his advisors.
Jonah Mayles: And I then met with his accountant. And if you don't do, and this is an important thing with insurance tracking shares, is we put them in place right before the policy is done. So we will get approval of the policy, and when that happens, before we actually finalize the policy, we get a policy number. And we have our own draft of the insurance shares. I drafted them, so I just give them to the lawyers and they file them, and now they're part of the company. I actually put in the insurance policy number in my shares. So to track the actual policy in case there's multiple policies. Again, we don't want confusion, we don't know what's going to happen on the course of 30-
Jason Pereira: [inaudible 00:09:35] challenge and [inaudible 00:09:36] dates don't line up exactly, yeah, [inaudible 00:09:41].
Jonah Mayles: And so we put the shares in place and we subscribe for those shares for a dollar each, or a dollar in total, most likely. We do that because insurance tracking shares track the insurance policy, but the policy isn't in the company yet, which means there's no value to the shares, right? However, this guy, that sees the cash surrender value of the policy by the time we came in was already at $420,000.
Jason Pereira: So it's a hundred and some odd thousand dollar tax bill right there.
Jonah Mayles: But we did with the accountant, because again, we couldn't do a freeze, he had to dip into his pocket, $420,000, and subscribe for the insurance tracking shares.
Jason Pereira: So yeah, so essentially he passed that on to someone else by buying shares at fair market value. Fair enough. So it can't be done that later. So can it be done for just growth from that point on or does it have to be an all or none proposition?
Jonah Mayles: It's from that point on. You acquire them at the fair market value of the tracking, which is the underlying-
Jason Pereira: So let me rephrase that. So there's no way for him to subscribe to just future growth for a dollar, because the value's already X, right? Let's go through the mechanism of what happens. So let's say I've got these tracking shares in place. I pass away, the tracking shares are owned by my next of kin, so my children. How does the math of all this flow through? Okay, so death benefit gets paid to the company. Let's just call it $5 million. Let's say there was a cash surrender value of $2 million, make numbers nice and clean. What does this look like when we start talking about tax implications?
Jonah Mayles: So, I mean, if the CSV is $2 million, it means we've saved the, I'll call the principal of the business, half a million dollars in tax, because-
Jason Pereira: Because that 2 million was not attributable to me, it's attributable to my kids, and therefore it never got added to my terminal tax bill, okay?
Jonah Mayles: So that's the first math that's done there. Then when the $5 million gets paid to the company, it depends how we drafted the tracking shares. If they track the death benefit and the CSV, so the entirety of the $5 million, what would likely happen next is the company would redeem the insurance tracking shares owned by generation two. So that would trigger the cash to flow out of the company tax-free because of the capital dividend account. So then the $5 million flows out tax-free and the shares don't exist anymore. And this is a big thing, is that an estate freeze, which should be done when it fits, which is often, is tax deferral, not tax elimination, right? You're deferring the tax of generation. Here we've actually eliminated the tax. We didn't defer the half a million dollars of taxable from gen one to gen two. Gen two doesn't have that. Because those shares are redeemed, they no longer exist. So when they pass away, there's no-
Jason Pereira: Yeah. And again, the capital dividend account is necessary, you have to use that to redeem tax-free.
Jonah Mayles: Correct. And all of this needs to be drafted properly, not only in the shares themselves, but in the shareholders' agreement.
Jason Pereira: Okay. So then let's talk about the implications to the remaining shares that [inaudible 00:12:46] would have on my estate owns. So basically there's still capital dividend account amounts left, typically. So that can be used to redeem additional shares from me up to the stop-loss rule, so basically about 50% there. But then the interesting permutation of this is that the estate still own shares. And typically, we've talked about pipeline planning in the past, I mean, because this money lands in my kids' hands free and clear, in theory, they don't need a pipeline do they? They could just buy the shares from the estate directly.
Jonah Mayles: Yes. That comes to that not one box fits for everyone. And it really depends on [inaudible 00:13:20] the business is, and if it's going to be carried on by the kids or not. And right now, and I don't know if this will always be the case, but right now the majority of our clients are real estate. It just seems that there has been so much wealth created in the city through real estate in the last 10 to 20 years. And that's where the tax bills come into place so much, because they don't want to sell the assets upon death. The kids will-
Jason Pereira: I have a case just like that right now.
Jonah Mayles: Right. No one wants to sell real estate, you want to hold it for as many generations as you can. So in that case you may not do a pipeline, you may not do a loss carryback, and not to get off topic, I mean, this is my own view, I don't think the pipeline is going to be around for much longer.
Jason Pereira: Well, they tried to take a run at it once already with the small business tax changes, and the pipeline is not the problem. The problem is that same strategy is being used while you're alive to recharacterize income. And that is a glaring, let's call it loophole, the size of a Mack truck you can drive through right now, and they're going to target that at some point.
Jonah Mayles: I mean, we are in an environment right now where our governments are in so much debt, there's only a few ways to get out. They're either going to cut all of our services, which they're not going to do, or they increase taxes, and they're going to start looking at things like that.
Jason Pereira: Well, especially when it comes to taxes triggered around in estate, right? We don't have estate taxes. We have income tax at the time of death and deem dispositions. But given the fact we're about to hit the largest intergenerational wealth transfer in history with the boomers dying off, anything that reduces that tax bill probably is not going to do very well in Ottawa going forward.
Jonah Mayles: If it's aggressive, and some things are more aggressive than the next. And that's actually a good point, is that insurance tracking shares have been blessed by the CRA. There's new technical interpretations, and really what the CRA speaks to is not whether they're valid shares, because they are valid shares, it's that point I just made about that client we met, it's when you subscribe for them. The CRA is concerned that people approve to subscribe for them after the fact and not pay the fair market value for that shares.
Jason Pereira: Yeah, and when you think about it, it makes ... I mean, where would the problem be? I mean, there are any number of use cases or situations whereby just a simple standard corporate structure does not fairly reward the share owners for when they came in, what they did, whatever it is, right? So being able to say, "No, no, no, this is my money and therefore it basically tracks to that." Tracking shares is a concept, something that is just elsewhere, just using them in the case of insurance, why would there be a problem? If you're okay with freezes, this should not be an issue either.
Jonah Mayles: Right. And it's one of the great things about insurances, it's not only great for the client, but the government gets their money way faster.
Jason Pereira: Yeah, and this is, again, when people say, "Well, how long is the government going to allow this to happen with CDAs and everything else?" It's like, well, do they want to get paid on time or not, right? You basically don't. All you're going to do is force more mass liquidations, more stress sales and not make your constituents happy, that's for sure. This guarantees that the money comes out as fast as possible, that they get paid, because they have insatiable appetite for taxation.
Jason Pereira: So basically we've talked about that specifically in the case of real estate. I think that's a very valid one. I actually have a case like that. Have you seen this paired up with immediate financing arrangements, where they basically then also borrow from that policy as well or is that kept separate?
Jonah Mayles: No, no. It can be done in terms of the same implementation, because the financing to me is a way to fund the cost of insurance, right? So the people that call an IFA free insurance, it's not.
Jason Pereira: It's not.
Jonah Mayles: You're deferring the cost to a later time. So that's-
Jason Pereira: With an interest rate attached to it, so.
Jonah Mayles: Right. Right now it's a great time to finance your life insurance, because rates of the bank are unbelievable, right? We're working with a client right now, after their deduction, the cost of financing the insurance is going to be 1.4% a year. It's amazing. But that is separate from the tracking shares, because the financing to me is on the front end, how am I going to fund the policy to keep my business going and not take capital out of my business? And the insurance shares deal with, what happens when I die?
Jason Pereira: I bring it up specifically around the use case of real estate we used, because typically real estate bugs only want to buy real estate in every capacity. I have a friend of mine, where we get in this argument every year at RRSP time, and I always argue with him, "Do you hate taxes more or do you hate the RRSP more?" And he grudgingly cuts me a check, but if he could cash that all out and buy more real estate, he would, although he might, let's see where the values are in a couple of years based on what just happened.
Jonah Mayles: Okay, but you did bring up a good point with the financing and the tracking shares, which is [inaudible 00:18:05] at the end. And because, if the financing hasn't been wound up prior to death, so that is still outstanding, when the money flows into the corp tax-free, that debt has to be repaid before you extract, before you do the redemption of the shares. And I know that sounds like it makes sense, it's common sense, but when certain individuals are managing the estate and they're not aware of these things and the steps that they have to do, and they haven't read the shareholders' agreement or the shares, which a lot of people don't, you don't know that. That impacts the timing and the steps of first you do one, two, three, four, and you've got to do things in order and do them right. That's a good point, yeah.
Jason Pereira: Yeah, and frankly, it's ... So it's entirely feasible that money flows in because death benefit, especially if it was for death benefit for cash probably not for death benefit, that benefit flows in, it could be sufficient to pay out both, right? But again, that's assuming you don't wind up that long.
Jason Pereira: So tell me about some interesting use cases where this becomes particularly useful when we start looking at some of the more esoteric stuff we encounter in the real world. I mean, you mentioned in the pre-interviews issues surrounding breakdown, dissolution of marriage, certain shareholder agreements, tell me where this can solve for problems with certain customer dynamics.
Jonah Mayles: So far we've been talking about how the insurance tracking shares can be used to mitigate your tax bill arising on death because of the CSV of the policy. That's one use for them. And we've also talked about how sometimes that won't be necessary if you've done a freeze, because that value already isn't in those shares of the deceased. But there are times even when it freezes done that we will use insurance tracking shares. And it's not for that reason, it's actually just to ensure that the insurance proceeds go where they're supposed to go. And sometimes that's not an easy thing to figure out on a corporate owned policy. If it's a personally owned policy, you can designate a beneficiary, that's who the insurance company is going to write a check to. But if it's a company, they're the owner and the beneficiary, that means that the money goes into the corporation, but then the principal of the corporation is no longer there.
Jonah Mayles: So what happens with that insurance? And it really depends on who the shareholders are and how the shareholders' agreement has been drafted. But we just did the insurance tracking shares in a case, second marriage, so there's two spouses, five kids, three from the first marriage and two from the second. And the insurance was being used to, I'll say, I don't like the word equalize, because nothing is equal, but to balance the value of the estate amongst all the beneficiaries. Everyone has entitlement into a certain part. The ex-spouse is entitled to X, the kids, the new spouse-
Jason Pereira: Okay. Everybody got a claim.
Jonah Mayles: Right. And there are assets in that company that have a value, and it's an active business. And some of the kids are going to run with that business, so they're going to acquire the shares of the company. There's a value, not only the value of the shares, but the value to getting a business, and running it, and income every year. There were two kids that were not part of the business, that were going to get a cottage or a house. What we did is we acquired a whole life insurance policy inside the corp, funded by the corp. But to ensure that that money went to the right place when there are seven shareholders from different arms of the family, perhaps they don't all love each other.
Jonah Mayles: So we put in insurance tracking shares that not only did we draft the shares, but then we amended the shareholders' agreement to take into account that money is to go to those two kids. And the money flows into the corp, it flows out through the capital dividend account to those kids. And that's another important thing, is that we had to specify that the capital dividend account that grew, based on the insurance policy, was going to be used for those funds.
Jonah Mayles: And this is one of those things where sometimes insurance is not just a numbers game. Often it is. Often it's client is doing a freeze, they have a tax bill, we're going to fund that tax bill, this is the cheapest way to do it, and this is what the insurance is going to grow to to fund that tax bill. Math, it's easy, it's simple, it works. Sometimes it's the messy stuff and it's the family stuff. And my years of advising on Bay Street with these types of families help, and then Zak has his FEA, which helps a lot, but has a finance background. So we're aware of these issues that happen and we try to think of ways to mitigate a fight at the end, mess at the end.
Jonah Mayles: One of the best things to me about insurance is how clean it is at the end of the day. Because I don't care what's going on in the economy, there's two types of lawyers that will always be busy, family lawyers and estate litigators, because there's always going to be a fight. I don't care how big the estate is, I've seen fights over $400 million, because what's enough, right? It's all ... So insurance tracking shares is a good way for us, it's only do insurance planning, but work into the family planning and succession planning for business and make sure that when the matriarch or patriarch dies, these things can happen seamlessly, as seamlessly as it can. And it's funny that something like insurance tracking shares can be such an important cog in that wheel, but it can be, it really can be. It can prevent [inaudible 00:23:27].
Jason Pereira: I mean, litigation on estates, especially because when it comes to estate plans, any form of ambiguity is ripe for contention. And something as definitive as no, no, no, no, no, I hold shares, tracking that, here's the contract, here's the partnership agreement saying that I'm entitled to the CDA. There is no confusion. There is no ambiguity. Whether the other people like it or not, short of attacking the capacity of the person who was deceased to make that decision, really there's nothing to be done, right? It's cut and dry, right? It doesn't mean you can't sue over it, but just means that you're not going to get anywhere over it.
Jonah Mayles: And another thing that I really like about it, the insurance is going to pay out in let's call it two to three weeks. So the insurance flows into the corp. Obviously they're not going to do the redemption right away, because someone just passed away and there's a lot going on. But in this particular case, we're going to take two people out of the company within 60 days after the passing of principal. That takes two wildcards out of the game. They have their money and they're gone. And the brothers the sister that are going to run the business, now they don't have to think about, "Well, I'm going to be working in the business, it's really hard and we working 16 hour days. They got to cut a check to my two brothers over there that aren't working in a second because they weren't left a cent, so I have to take care of them because I was left the business." It gets rid of all that messiness. So insurance tracking shares are really good for family planning as well.
Jason Pereira: Absolutely. So messy subject, estate planning always can be, especially when there's money, even when there's not. But this is a helpful starter for a lot of people on how basically just ... You kill two birds, one stone, right? We discussed this previously. Specifically we can attribute everything, death benefit, cash surrender value to one individual, or we can separate the two and reduce that tax burden with a whole life policy. You still have the money coming into the estate, [inaudible 00:25:25] the corp to deal with the estate planning bill. I mean, it's a highly versatile dynamic solution that frankly we don't see a lot of in the marketplace. And again, like I said, it's the Venn diagram with the blind spots for the insurance guys and the type of lawyers, and just you need a ... No surprise you know this, because you were exposed to both, but you people do.
Jason Pereira: So, Jonah, thank you very much for this, I very much appreciate it. Hopefully everybody will learn from this and seek out proper advice and know that it is possible to utilize insurance, especially in creative ways like this, to minimize family dynamic issues on death.
Jonah Mayles: Thank you for having me, it was fun.
Jason Pereira: My pleasure.
Jason Pereira: So I hope you enjoyed that interview with Jonah Mayles of Sterling Park. And if you're involved in the estate planning world, I hope you take the time to look into the strategy as it can be very, very valuable and reduce the overall tax bill on death. As always, if you enjoyed this podcast, please leave a review on iTunes, Stitcher, or whatever is your podcast. Until next time, take care.
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