Side Account (Universal Life Insurance)

A Side Account is a separate, taxable account associated with a Universal Life Insurance policy. It is used to hold excess premium payments that exceed the maximum allowable contribution under Canadian tax rules for tax-exempt life insurance policies. The side account is not part of the policy itself, and its value is kept distinct from the policy’s investment accounts.

Why Side Accounts Exist
Universal life insurance allows for investment growth within the policy on a tax-deferred basis, but only up to a limit defined by the Income Tax Act. When premium contributions or cash value accumulation exceed these government-imposed limits, the policy risks losing its tax-exempt status.

To avoid this, any excess funds are diverted into a side account.

Key Features of a Side Account

• Separate from the policy: It is not included in the policy’s tax-sheltered investment accounts.
• Taxable annually: Interest or growth within the side account is taxed every year
• Pays out separately: On death, the value of the side account is paid to the policyowner or their estate, not to the named beneficiary under the policy.
• Can be withdrawn: Clients may be able to withdraw funds from the side account at any time, subject to minimum withdrawal rules or fees.

When Funds Are Directed to a Side Account‍

1. The policyholder contributes more than the maximum premium allowed to maintain tax-exempt status.
2. The investment accounts inside the policy accumulate more value than the limits allow.
3. The insurer automatically transfers the excess to the side account to preserve the policy’s exempt status.
4. These transfers typically occur at the policy anniversary, when the insurer performs the annual exempt test calculation.

Tax Implications of Side Accounts
Unlike the tax-deferred investment growth inside the universal life policy, any growth in the side account is taxable in the year it is earned. This can reduce the overall tax efficiency of the strategy if the side account accumulates significant value.

Access and Withdrawals
Policyowners may:

• Withdraw all or part of the side account value
• Transfer funds back into the policy (as new premium payments), if room becomes available
• Be subject to market value adjustments or administration fees, depending on the insurer

Side Account vs. Policy Investment Accounts

Bottom Line:
The side account acts as a safety valve in universal life insurance, protecting the policy's tax-exempt status when funding exceeds allowable limits. However, it loses the tax advantages of the main policy and should be managed carefully. A knowledgeable insurance advisor can help determine when contributions may trigger side account deposits and whether alternative funding strategies are more appropriate.