David, a 55-year-old high-net-worth individual in Québec, is considering a Universal Life policy. He wants maximum flexibility in premium payments and investment choices. His advisor, Sophie, explains that the policy's tax-exempt status is crucial. What is the primary characteristic that allows a Universal Life policy to maintain its tax-exempt status under Canadian tax law?

Question: David, a 55-year-old high-net-worth individual in Québec, is considering a Universal Life policy. He wants maximum flexibility in premium payments and investment choices. His advisor, Sophie, explains that the policy's tax-exempt status is crucial. What is the primary characteristic that allows a Universal Life policy to maintain its tax-exempt status under Canadian tax law?

Answer options:

• The accumulated cash value must exceed the Adjusted Cost Basis (ACB) by a specific amount. ✅ The policy must satisfy the '100% rule' or the 'accumulated fund test' to ensure it remains primarily an insurance product.
• The cost of insurance charges must be deducted from the investment account annually.
• The policy must be designated as an 'exempt policy' by the insurer at the time of issue.

Correct answer: The policy must satisfy the '100% rule' or the 'accumulated fund test' to ensure it remains primarily an insurance product.

Explanation: For a policy to be tax-exempt, it must pass the 'exempt test' (e.g., the 100% rule or accumulated fund test outlined in the Income Tax Act) which limits the amount of savings relative to the insurance coverage to prevent it from being primarily an investment vehicle.