The 10/8 Arrangement and the Leveraged Insured Annuity, and Why They Ended

Two leveraged life insurance arrangements lost their tax advantages under rules announced in the federal budget of 21 March 2013 and enacted that December. They are the 10/8 arrangement and the leveraged insured annuity, and today the Income Tax Act calls the contracts it catches a "10/8 policy" and an "LIA policy". Borrowing against a life insurance policy was not banned. What changed is that a policy meeting either definition loses specific tax results, and each definition carries its own list of consequences.

If you have been shown a leveraged proposal, or you hold an older contract and wonder whether the label fits, the useful questions are narrow. Does anything credited inside the policy, or any limit on an account in it, depend on a loan? Is a loan repayable at the death of the person insured, with a life annuity on that same person assigned to the lender? And, as a separate matter, is the interest deductible at all? The current immediate financing arrangement has its own page, and so does which part of the premium is deductible.

What follows is general information written by a licensed insurance professional. It explains mechanisms and the wording of the law; it is not a tax opinion on your contract. Canadian Wealth Creation Centre Inc. is not authorized to give legal, tax or notarial advice and gives none here. Reading is free, and the firm is paid by insurer commission if a policy is bought through it. Whether a particular policy, loan or corporate structure is caught is a question for a Chartered Professional Accountant or a tax lawyer reading the actual documents.

What do the 2013 rules do to each arrangement?

The two sets of rules overlap less than their shared history suggests. The interest denial applies only to a 10/8 policy. The loss of exempt status applies only to an LIA policy. Here is the map, with the provision behind each line. Each line is explained further down.

These are federal rules, and they apply in every province. Quebec announced that it would harmonise its own tax law with them, as set out in the Quebec section below.

What was a 10/8 arrangement?

The 2013 budget describes a typical structure in three steps. The taxpayer puts money into a life insurance policy. The taxpayer then borrows an equal amount, secured by the policy or by an investment account in respect of it. Then the taxpayer invests the borrowed amount in income-producing assets. Meanwhile, the account inside the policy is credited with a return linked to the rate charged on the loan.

The lender could be the insurer itself, through a policy loan made under the contract, or another lender that took an assignment of the policy or of the account. The definition the Act adopted later covers both. The contract had an account inside it, which the Act calls an investment account, as some universal life designs do.

Illustrative example. Assume you borrow 100 at 10 percent and the linked account is credited at 8 percent, the pair of rates the name evokes. These figures are chosen for the arithmetic and come from no contract. Each year you owe 10 of interest to the lender, and 8 is credited inside the policy. Before tax, before insurance charges and before whatever the borrowed 100 earned elsewhere, the gap is a cost of 2. Now assume a combined tax rate of 50 percent, also chosen for round numbers. If the interest was deductible, its after-tax cost was 5, against 8 credited inside a policy that was not taxed each year. For a 10/8 policy after 2013, the deduction is denied, so the after-tax interest cost is the full 10, against the same 8.

The budget named the concern plainly. The taxpayer took the position that the interest on the borrowing was deductible, while the interest income earned on the amount invested in the policy was not included in income. The borrowed money itself went into income-producing assets, which is why a deduction was claimed at all. The objection was to the pairing: a deduction on one side, and on the other a sheltered return that existed only because the loan did.

A corporation could gain one more result at death. When a private corporation receives life insurance proceeds because of a death, its capital dividend account is credited with those proceeds less the policy's adjusted cost basis immediately before the death. Paying a capital dividend out of that account then needs a separate election under subsection 83(2). The loan could be repaid out of the same death benefit. How the account works in the ordinary case is on the capital dividend account glossary page.

What was a leveraged insured annuity?

The budget describes it as the use of borrowed funds in connection with a lifetime annuity and a life insurance policy, both issued on the life of the same individual. A holder, which could be a corporation, bought both contracts. A lender advanced funds and took an assignment of both as security. The loan was repayable when that individual died, out of the death benefit, and the annuity payments helped carry the interest and the premiums until then.

The budget and the CRA name the tax results that made it worth assembling. The interest on the borrowing was generally deductible. A deduction was claimed for part of the premium, as the cost of a policy assigned as collateral. Part of the income earned on the capital invested was sheltered, because the insurance policy was an exempt policy. And where a private corporation received the death benefit, its capital dividend account could grow.

Valuation at death added a further result. A life annuity whose payments stop at death can have little market value at that moment. For the deemed disposition that happens at death, a low value kept much of the capital that had gone into the arrangement out of the calculation. Subsection 70(5.31), explained below, now fixes that value.

The two arrangements differed in kind. The 10/8 created a credited return that depended on the loan. The leveraged insured annuity did not need one: it combined ordinary rules on interest, collateral premiums and annuity valuation so that they offset one another. That is why the Act answers them with two definitions and two sets of consequences.

Why did the government act, and when?

The 2013 budget said the government was acting to eliminate "multiple and unintended tax benefits" relating to two leveraged life insurance arrangements, to improve the integrity and fairness of the tax system. It added that the government would monitor developments and consider further action if structures emerged that undermined the measures. In 2020 the CRA described the 2013 rules as enacted to deny those unintended benefits.

Neither measure was a prohibition. The rules remove results. A person who assembles either arrangement today carries all of the interest, all of the lender's terms and all of the policy's own costs, without the offsets the arrangement was built to produce.

What does the Act do today to a 10/8 policy?

Everything starts with the definition. A 10/8 policy under subsection 248(1) is a life insurance policy, other than an annuity, that meets two conditions. First, an amount is or may become payable under a borrowing to a person who holds an assignment of an interest in the policy or in an investment account in respect of it, or under a policy loan made under the policy's terms. Second, one of two things is true. Either the return credited to an investment account is set by reference to the interest rate on that borrowing or loan and would not be credited without it, or the maximum amount of an investment account is set by reference to the amount of the borrowing or loan. Both branches describe an account whose return or size depends on the loan.

The interest goes first. Subsection 20(2.01) says that, for the interest deductions in paragraphs 20(1)(c) and (d), interest does not include an amount paid after March 20, 2013, in respect of a period after 2013, on a policy that is a 10/8 policy when the payment is made. The same applies to an amount payable for a period after 2013 during which the policy is a 10/8 policy. In both cases the amount must be the one the definition describes. The deduction is not reduced or capped. The amount is simply not interest for that purpose.

The premium goes next. Paragraph 20(1)(e.2) allows a deduction for part of the premium on a policy assigned as collateral, limited to the least of three amounts. One of the three, the net cost of pure insurance, leaves out any period after 2013 during which the policy is a 10/8 policy. With that amount gone, the premium deduction goes with it for those periods.

The third consequence arrives at death. Take a death after 2013 where the policy is a 10/8 policy immediately before the death. Subparagraph (d)(iv) of the definition of capital dividend account in subsection 89(1) then subtracts the amount still owing, immediately before the death, on the borrowing from a lender holding an assignment. The death benefit still arrives and still repays that lender. The part of it that only ever matched the loan does not add to the account.

A transitional door existed, and it is closed. Subsection 148(5) let a policyholder who disposed of an interest in a 10/8 policy by a partial or complete surrender, after March 20, 2013 and before April 2014, deduct an amount. The deduction was capped by the least of three measures tied to the investment account and to repayments of the loan. That window ended in March 2014. Any relief for a surrender today would have to come from another provision, which your accountant can check.

What does the Act do today to an LIA policy?

Again the definition comes first, and it is shorter because it describes a structure rather than a calculation. An LIA policy under subsection 248(1) is a life insurance policy, other than an annuity, where a person or partnership becomes obligated after March 20, 2013 to repay an amount to a lender at a time determined by reference to the death of an individual whose life is insured under the policy. The lender must also be assigned an interest in both the policy and an annuity contract whose payments continue until at least that individual's death. So there are two hallmarks: repayment timed to a death, and a lender holding both contracts.

The premium deduction goes at the door. Paragraph 20(1)(e.2) applies to a life insurance policy "other than an annuity contract or LIA policy". A caught policy does not reach the three amounts, whoever the lender is and whatever the money was used for.

Exempt status goes next. Subsection 306(1) of the Income Tax Regulations defines an exempt policy as a life insurance policy that meets the test's conditions, other than an annuity contract, an LIA policy or a deposit administration fund policy. An LIA policy therefore cannot be exempt. The budget described the result: income accruing in the policy is taxed each year on an accrual basis.

There is a second effect at the moment of change. Under paragraph 148(2)(d), when a policy last acquired after December 1, 1982 ceases to be an exempt policy, the policyholder is deemed to dispose of the interest for proceeds equal to its accumulating fund, and to reacquire it at that amount. The rule does not apply where the change results from the death of the person insured, or happens while that person is totally and permanently disabled. Income arises to the extent those proceeds exceed the adjusted cost basis. Ask for a calculation on your own policy, and do not assume that only future growth is affected.

The capital dividend account is closed to it. Subparagraph (d)(ii) of the definition in subsection 89(1) adds life insurance proceeds received because of a death only for a policy "other than an LIA policy". The death benefit still repays the lender, but none of it goes into the account, so no capital dividend can be elected on the strength of it.

Finally, the valuation. Subsection 70(5.31) applies for the deemed disposition at death in subsection 70(5) and for the trust rule in subsection 104(4). It covers the annuity assigned under the LIA definition, on the death of the individual that definition refers to. The value of property deemed disposed of because of that death is then worked out as though the annuity were worth the total premiums paid under it. Whether that produces tax, and for whom, depends on who owns the annuity or the corporation holding it, whose death triggers a disposition, and the other rules that apply. It is a valuation rule, not a tax on every annuity.

Can you deduct interest on money borrowed against a policy?

Sometimes, and the policy is part of the answer. Paragraph 20(1)(c) allows interest on borrowed money used to earn income from a business or property. Its subparagraph (i) excludes borrowed money used to acquire a life insurance policy. On our reading, money borrowed to pay premiums falls under that exclusion, whatever the structure is called.

A policy loan from the insurer faces a second rule. Under subsection 20(2.1), interest on a policy loan counts for the deduction only to the extent the insurer verifies it in prescribed form and within the prescribed time. The form is CRA Form T2210, Verification of Policy Loan Interest by the Insurer. Interest that was added to the policy's adjusted cost basis is left out of what can be verified. The insurer sets the policy loan rate and may change it as the contract allows, and the interest is owed to and paid to the insurer.

The 2013 rules then add their own layer. For a 10/8 policy, subsection 20(2.01) removes the deduction for the periods it covers, whatever the money was used for. For an LIA policy, the 2013 rules added no interest denial; the ordinary tests of paragraph 20(1)(c) apply, including its own rule for money borrowed to acquire an annuity contract. Interest on money used for personal spending is not deductible under any of them.

Illustrative example. Assume you take a 50,000 policy loan from the insurer, which lends it and receives the interest. You use 30,000 to buy equipment for a business you run yourself and 20,000 for a family holiday. The figures are chosen for the arithmetic. On our reading, interest on the 30,000 traced to the equipment may qualify, if the insurer verifies it on Form T2210 and the policy is not a 10/8 policy. Interest on the 20,000 does not. The tracing, and the claim, belong to your accountant.

What if you already hold an older arrangement?

The two definitions treat older contracts differently. The LIA definition requires a borrower who becomes obligated after March 20, 2013, and the budget said the measure would not apply where all borrowings were entered into before Budget Day, 21 March 2013. Our reading of the wording, not a CRA ruling: a new borrowing after that date, such as a refinancing with a new lender or an added advance, can be a new obligation that brings an older arrangement inside the definition. Whether a change to the rate or term of an existing loan does so depends on the loan documents. A Chartered Professional Accountant or a tax lawyer should confirm it before you change anything.

The 10/8 definition carries no such date. Our reading is that the interest and premium denials apply to periods after 2013 during which the policy is a 10/8 policy, whenever the contract was issued. The surrender window under subsection 148(5) closed in March 2014.

Ending an old policy has its own tax rules. A surrender, or a lapse with a loan outstanding, is a disposition. For tax, the proceeds are the cash surrender value less the policy loans owing, so a small cheque is not the figure that decides the result. Income arises only to the extent the proceeds exceed the adjusted cost basis (subsections 148(1) and 148(9)). Before you act, ask the insurer in writing for the disposition proceeds, the loan settlement, the adjusted cost basis and the tax slip it expects to issue.

These documents let a professional answer the question for your file:

• The policy contract, including its investment account and policy loan provisions.
• The original illustration and the most recent annual statement.
• The loan agreement, and every amendment or refinancing since 20 March 2013.
• The assignment of the policy, and of any annuity, to the lender.
• The annuity contract, if there is one.
• The corporation's capital dividend account records, if a corporation owns the policy or is its beneficiary.
• Any Form T2210 the insurer issued, if interest on a policy loan was claimed.

How do you test an arrangement against the definitions today?

What follows is our reading of the wording of subsection 248(1), not a CRA ruling and not a clearance for any contract. The people to confirm it for a given file are a Chartered Professional Accountant or a tax lawyer, reading the policy, the loan agreement and the assignment together.

Start by setting aside who the lender is, because that is not the test. The 10/8 definition reaches a borrowing from anyone who holds an assignment, and it also reaches a policy loan made by the insurer under the contract. What it asks is whether a return credited to an investment account depends on the loan's interest rate and would not be credited without the loan, or whether an account's maximum is set by the amount of the loan.

Then look at the policy itself. Dividends on a participating whole life policy are declared under the insurer's dividend policy and are not guaranteed. Some contracts change the dividend credited on the part of the value that secures a loan. On our reading, a dividend that the insurer's policy would pay whether or not the owner has borrowed is not, on the face of the definition, a return that would not be credited without the borrowing. Ask the insurer in writing whether anything credited under your contract, or any limit on an account in it, is set by reference to a loan. Then read the answer against both branches.

Passing the exempt test is a separate question. The test in Regulation 306 limits what can accumulate against the policy's own test values. It says nothing about how a particular investment account's maximum was set, so it cannot answer the second branch of the 10/8 definition.

The LIA branch has plainer facts. An ordinary loan secured by a policy, repayable on demand or at a term, with no annuity assigned, has neither hallmark on our reading. Add a life annuity on the same individual, assigned to the same lender, with repayment tied to that individual's death, and the question changes. Take it to a tax professional before anything is signed.

Falling outside the two definitions is not the same as being safe. In its 2020 warning, the CRA said leveraged insured annuities are still promoted and that it has identified some where it will use the general anti-avoidance rule to deny the tax benefit sought. It said that similar concerns can arise with domestic arrangements that have the same or similar characteristics, and that it reviews leveraged insurance products to decide whether they are valid insurance or vehicles for a tax advantage. Staying outside also earns nothing by itself. The interest deduction still depends on paragraph 20(1)(c) and, for a policy loan, on subsection 20(2.1). The premium deduction still depends on the conditions of paragraph 20(1)(e.2): an assignment to a lender of the kind the Act calls a restricted financial institution, required by it as collateral, for a borrowing whose interest is deductible. How those conditions apply to a current arrangement is on the arrangement's own page.

The state this practice calls Infinite Financial Sovereignty®, holding the highest practical level of control over the capital-flow function in one's own affairs, is a matter of who decides when capital moves. Every borrowing arrangement divides those decisions between the owner, the insurer and any lender. Read each document for who holds which decision: who can change the rate, who can call the loan, and what happens to the security if values fall.

What should you ask for before you sign?

Start by writing down who owes whom. A leveraged arrangement can involve five or six parties, and each one's rights are in a different document.

Then put the right question to the right person, and ask for the answers in writing:

• The insurer: does anything credited under the contract, or any account limit, depend on a loan? What is the policy loan rate, and how can it change? What is the adjusted cost basis today?
• The lender: who exactly is lending, how is the rate set, when can the loan be called or the security revalued, and is repayment tied to a death?
• The Chartered Professional Accountant or tax lawyer: on these documents, is the policy a 10/8 policy or an LIA policy? Is the interest deductible, on what tracing? Does the premium deduction apply? Is there general anti-avoidance exposure? What does Quebec law add?
• The advisor: what is the insurance need apart from any tax result, how is the advisor paid, and what happens if the premiums or the interest can no longer be carried?

A proposal whose authors cannot answer those questions in writing is not ready to sign.

How does Quebec treat these arrangements?

The federal rules apply to Quebec residents like everyone else. For Quebec income tax, the Ministère des Finances du Québec announced in Information Bulletin 2013-7, dated 11 July 2013, that Quebec's tax legislation would incorporate the federal measure eliminating unintended tax benefits relating to leveraged life insurance arrangements. The bulletin says the harmonised measures apply on the same dates as the federal ones. The enacted sections of Quebec's Taxation Act were not verified for this explanation. A Quebec resident files a separate return with Revenu Québec, so ask the accountant to confirm the Quebec treatment for the year in question. Questions about the contracts, the assignments and the security under Quebec law go to a lawyer or a notary.

Who this suits, and who it does not

It suits a business owner shown a leveraged proposal who wants to know, before signing, which provisions it has to be tested against. It suits a person with an older contract who wonders whether 10/8 or LIA describes what they own. And it suits anyone told that a current arrangement is the old one renamed, who wants the test rather than the label.

It does not suit a person looking for a structure in which the tax result pays for the borrowing, because the 2013 rules exist to remove exactly that. It does not suit a person who could not carry the interest from their own cash flow if every deduction were denied, because the lender is paid in cash. And it does not suit anyone who wants an opinion on their own contract, loan or corporation. That opinion belongs to a Chartered Professional Accountant and a lawyer or, in Quebec, a lawyer or notary, working from your documents.