The total return on an investment is the sum of the income it pays, and the change in its price —hopefully upward — while it is owned. The more familiar term for a price increase is a capital gain. From a tax perspective, only half of a capital gain is taxed, and that tax is not levied while the price is rising, but rather when the investment is sold. That’s why long-term investors usually prefer less distributed income, so that they have more exposure to a price rise, and eventual capital gain.
This untaxed buildup is known as an unrealized capital gain, further rewarding an investor by deferring tax for years and possibly decades. If it’s all sold in one year, the income inclusion will push into higher tax rates on the higher income, so instead the investor may plan to sell in stages, triggering only a portion of the gains each year. But even that can’t go on forever. When the investor dies, the remaining investment is deemed to be sold, with a potentially hefty tax bill to follow.
For married spouses and common law partners, there is some tax relief. Investments are capital property that can pass from one to the other at its adjusted cost base. This applies to transfers both during lifetime and at death, the latter sidestepping that deemed disposition on a first death. Still, this does not eliminate the tax, though it does extend the time when it can be expected to land. A cost-effective way to neutralize the tax is for the couple to obtain joint-last-to-die (JLTD) insurance.
JLTD insurance premiums are based on the two (or more) people whose lives are insured on the policy. Statistically the insurer expects to pay out later than if there had been distinct coverage on each person, which then leads to a lower premium. The face value / death benefit will be based on the estimated tax arising on the second death, aligning the insurance receipt with when it will be needed. This concept is based on capital gains generated in a non-registered account, but it applies similarly to RRSP/RRIF rollovers taxed at a second death.
