Before delving into how this strategy works, below is a brief summary of what Critical Illness Insurance is:

Critical Illness Insurance pays a tax-free, lump-sum benefit if you are diagnosed with one of the covered conditions, such as heart attack, stroke, cancer and multiple other illnesses and conditions (26+).  You must survive for a period of at least 30 days.  Critical Illness Insurance was created to provide a “living benefit” to those who survived a major illness to help offset lost income and cover additional living expenses.

Taking it one step further, many Critical Illness insurers offer an optional feature (at an additional cost) called Return of Premium (“R.O.P.”), which can encompass R.O.P. on death, expiry, or policy surrender.  Essentially, this R.O.P. rider entitles the policy owner to a full refund of the premiums paid into the policy at a certain juncture of time.

How Split-Dollar Critical Illness Insurance works

Split-Dollar Critical Illness (“C.I.”) involves a corporation owning a C.I. policy on the life of a shareholder (or key employee).  The corporation pays the premium (excluding added Return of Premium (“R.O.P.”) costs), and the shareholder personally pays for the R.O.P. cost.  For the purposes of this case study, we will just exhibit an R.O.P on expiry.  A functional example is below:

1. The corporation is the primary policy owner and beneficiary for a $250k Term-20 C.I. policy on the life of a male shareholder, 45-years old, non-smoker.  This comes at a cost of $1,825 annually**, which the corporation pays for. This is not a tax-deductible expense nor a shareholder/employee benefit.
2. When applying for the policy mentioned above, there is an R.O.P. on expiry added.  After 20 years, if there is no claim and the policy remains in force, the shareholder is entitled to receive the entirety of the premiums that were paid.  The R.O.P. rider comes at a cost of $865 annually and the shareholder owns this portion of the policy and personally pays for this.

Outcomes

A. The insured (shareholder) remains healthy over the 20-year policy term and fortunately does not require a claim.  At conclusion of the term, the shareholder receives a cheque for $53,800.00 ($2,690 annual premium for 20 years, comprised of $1,825 for the CI cost and $865 for the R.O.P. cost).

Or;

B. The insured (shareholder) is diagnosed with a critical illness and is entitled to a claim under the terms of the policy.  The corporation receives a tax-free cheque for $250,000, which it can distribute to the shareholder via taxable dividend, or keep the funds in the corporation to help with business operations and funding shortfalls.

End Result & Analysis

The shareholder has covered himself, his family, and his business in the event he becomes critically ill.  If he remains healthy, he receives all of his money back.  If he requires a policy claim, the corporation receives a lump-sum cheque, tax-free.

What are the tax implications, if any, for the shareholder/employee when they receive the Return of Premium cheque?

There is no concrete answer from the Canada Revenue Agency but this article from Sun Life offers a deep dive into how CRA might look at this. It is ultimately up to the policy owner’s tax advisor as to how the R.O.P. portion originating from the C.I. coverage gets treated. One vitally important point:

• The purpose and intent of the insurance and R.O.P. must be well document in a Shared Ownership Agreement, drafted by a lawyer. This needs to be done when the policy is initially approved.

To learn more about this, contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.

DISCLAIMER: it is imperative to consult with your legal and tax advisors prior to executing this strategy. Shared Ownership Agreements are crucial. This commentary is provided for general informational purposes only and does not constitute financial, insurance, investment, tax, legal or accounting advice.

** numbers via SSQ illustration software.