The concept of life insurance seems fairly straightforward: if an insured person dies, a death benefit is paid out. However, in addition to that basic premise, a comprehensive and versatile use for life insurance exists for business owners
As the title suggests, a corporation can own a life insurance policy on the life of a shareholder or key employee. Listing all of the concepts and strategies that you can use with corporate-owned life insurance is beyond the scope of this article; instead, I will present a brief conceptual overview and illustrate the basics in the form of a simplified case study.
Overview
John Doe is the sole shareholder of Doe Inc. The business has been operational and profitable for many years, building up a sizeable amount of retained earnings. John has a spouse and two children, all of whom rely on the income earned in Doe Inc. Similar to many owner-operator businesses, Doe Inc. would struggle to survive without John.
John is concerned about the following:
- What would happen to his family, financially-speaking, if he were no longer in the picture
- Tax liabilities arising on the deemed disposition of his corporate shares
Solution
After determining a need for life insurance and long-term tax planning, John applies and is subsequently approved for a participating whole life insurance policy. In addition to the death benefit, this policy has an investment component, called cash value.
Policy Owner – Doe Inc.
Life Insured – John Doe
Policy Beneficiary – Doe Inc.
Premium Paid By – Doe Inc.
Potential Outcomes
Outcome 1
John is alive and well by the time his retirement rolls around and the insurance policy remains in force. The policy is an asset because of the cash value, and John has multiple options as to how to proceed moving forward. For instance, one way is to use the policy’s cash value to supplement his retirement income or to fund a big-ticket purchase. Often, the recommended way of accessing the cash value will not be to withdraw it from the policy, but use the policy’s cash value as collateral to secure an outside loan.
Outcome 2
John passes away and Doe Inc. receives the tax-free death benefit. Most, if not all, of the death benefit can then flow through on a tax-free basis to John’s spouse/estate, via the Capital Dividend Account.
What Was Accomplished?
- Lifestyle protection for John’s family backed by the security of the insurance policy. John can rest assured knowing if something happens to him, his loved ones will be taken care of. This solves the first of John’s concerns.
- With Doe Inc. owning the policy and paying the premiums, corporate dollars are what’s funding the policy. This is more tax-effective than John withdrawing funds from the corporation to pay for the premiums personally. Furthermore, by allocating retained earnings into this asset (insurance policy), Doe Inc. was able to avoid the high tax on passive investment income that corporations face, as well as potentially protect against the small business deduction claw-back. Cash values in a participating whole life insurance policy grow on a tax-sheltered basis*. The death benefit is also received by the corporation on a tax-free basis.
*if the policy is tax-exempt, which is easily accomplished with proper planning*
Summary
This basic case study provides a glimpse of how Corporate-Owned Life Insurance can play a valuable role for John, his business, and his family. This is especially true when it comes to risk management and tax planning. John was able to provide peace of mind and financial protection for his loved ones while also accomplishing proactive tax planning. Ultimately, John did this by repositioning a portion of his corporate assets and diversifying his overall asset mix.
For additional information on Corporate-Owned Life Insurance, or to inquire about setting up this strategy, please contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca.
DISCLAIMER: the tax components can be expansive and complex. Above all, we recommend working with tax specialists and experienced insurance advisors. It is important to note that despite the potential tax advantages, there still must be a need for life insurance coverage.
“Corporation” refers to Canadian Controlled Private Corporations (CCPC).