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Cross-Border Life Insurance Part 2: The Hidden Risks of U.S. Individuals Buying Permanent Life Insurance While Living in Canada

09.10.24 // Markets & Investing // Blog Article //

Written by Carson Hamill CIM®, CRPC®, Associate Portfolio Manager & Assistant Branch Manager & Dean Moro BComm, CIM®, Associate Portfolio Manager

When it comes to securing your financial future, life insurance is often a critical component of your estate planning strategy. However, if you're a U.S. citizen living in Canada, the decision to purchase a permanent life insurance policy from a Canadian insurer might seem straightforward, but it’s riddled with pitfalls that could lead to unexpected tax liabilities and regulatory complications. Here’s why buying that policy across the border might not be as simple—or as beneficial—as it seems.

The IRS Never Sleeps: Beware of the 1% Excise Tax on Insurance Premiums

One of the first hurdles you'll encounter is the Internal Revenue Service’s (IRS) 1% excise tax on insurance premiums paid to non-U.S. companies. This tax is a little-known but potentially costly burden on U.S. citizens who purchase foreign insurance policies. Imagine this scenario: You’re George Costanza from Seinfeld, trying to hide under your desk at work to sneak in a nap, thinking you can escape detection. But just as George inevitably gets caught, the IRS always finds a way to catch up with you, adding that 1% tax on your premium payments, no matter where you’ve gone. Even if you’ve moved to Canada and think you’re off the IRS’s radar, they’re still watching—and taxing.

PFIC Trap

If the excise tax wasn’t enough, there’s another IRS trap waiting for you: the Passive Foreign Investment Company (PFIC) rules. These rules are designed to prevent U.S. taxpayers from deferring tax on income earned through investments in foreign corporations. Unfortunately, your Canadian life insurance policy might be classified as a PFIC, leading to extremely punitive taxation on any gains within the policy. The tax treatment under PFIC rules is harsh, often leading to higher taxes and complicated reporting requirements, potentially costing you more than the policy is worth.

Estate Planning Nightmares: Double Trouble with U.S. and Canadian Rules

Coordinating estate planning across two different countries is no walk in the park. U.S. and Canadian laws differ in many respects, especially regarding how life insurance proceeds are treated for estate tax purposes. For example, in the U.S., life insurance proceeds are generally included in the deceased's estate if they had any ownership interest in the policy. If you’re holding a Canadian policy, this could lead to unexpected estate tax liabilities when it’s time to pass on your wealth. And then there’s the issue of portability. If you decide to move back to the U.S., continuing your Canadian policy might not be straightforward—or even possible. You could find yourself without coverage or facing the prospect of purchasing a new policy in the U.S., often at a higher cost due to age or health changes.

The Regulatory Maze: Navigating Cross-Border Insurance Rules

Lastly, navigating the regulatory maze of cross-border insurance rules can be daunting. Canadian and U.S. insurance markets are governed by different sets of regulations, and a policy purchased in one country may not be fully recognized or enforceable in the other. This could leave your beneficiaries facing legal hurdles when trying to claim benefits, adding stress and uncertainty during an already difficult time.

The Bottom Line: Double Check Before Going Cross-Border

While the idea of purchasing a permanent life insurance policy in Canada might seem appealing, especially if you’re living there, it’s crucial to consider the myriad complications that come with it. The 1% excise tax, PFIC rules, exchange rate risks, estate planning challenges, and regulatory issues all add layers of complexity that could end up costing you more than you bargained for. Before making any decisions, it’s wise to consult with a cross-border financial advisor who understands both U.S. and Canadian tax and insurance laws. They can help you navigate these tricky waters and ensure that your estate planning strategy is both tax-efficient and compliant with all applicable regulations. After all, you don’t want your carefully laid plans to turn into a financial nightmare—just like George Costanza’s ill-fated desk naps.

About Snowbirds Wealth Management

Gerry Scott is a portfolio manager and founder of Snowbirds Wealth Management, an advisory firm focussed on the cross-border market. Together with Dean Moro and Carson Hamill, associate portfolio managers with Snowbirds Wealth Management, they provide investment solutions for Americans living in Canada, and Canadians residing in the United States. Licensed in both Canada and the US, they provide tailored investment solutions to minimize the tax burden when moving assets across borders.

To schedule an introductory call, please click here.

Statistics and factual data and other information are from sources RJLU believes to be reliable but their accuracy cannot be guaranteed. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities nor is it meant to replace legal, accounting, taxation or other professional advice. We are not tax advisors and we recommend that clients seek independent advice from a professional advisor on tax-related matters. The information is furnished on the basis and understanding that RJLU is to be under no liability whatsoever in respect thereof.

Raymond James (USA) Ltd. advisors may only conduct business with residents of the states and/or jurisdictions in which they are properly registered. Investors outside the United States are subject to securities and tax regulations within their applicable jurisdictions that are not addressed on this site. Raymond James (USA) Ltd. is a member of FINRA/SIPC.

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