The concept of life insurance seems fairly straightforward: if an insured person dies, a death benefit is paid out. However, a comprehensive and versatile use for life insurance exists, and that comes in the form of corporate tax planning.
Hence the title of this article, a corporation can own a life insurance policy on the life of a shareholder or key employee, which comes as a surprise to many. To list all of the concepts and strategies that can be used with corporate-owned life insurance would result in something resembling a novel, so this article will present a brief conceptual overview and avoid delving into specifics. Let’s illustrate the basics in the form of a simplistic 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 in the corporation. John has a spouse and two children, all of whom rely on the income earned in Doe Inc. Like many owner-operator businesses, Doe Inc. would struggle to survive without John.
John is concerned about the following:
- What would happen to his family if he were no longer in the picture
- Future tax liabilities
Solution
John is 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 Payer – Doe Inc.
Potential Outcomes
- Fortunately, John is alive and well by the time his retirement rolls around and the insurance policy remains in force. The policy is an asset, and John has multiple options as to how to proceed moving forward, such as accessing the policy’s cash value for retirement usage or maintain the coverage for estate planning purposes.
- Unfortunately, John passes away. The death benefit is received by Doe Inc. and then paid to John’s spouse via the Capital Dividend Account. With proper planning, this can be done on a tax-free basis.
What Was Accomplished?
- Lifestyle protection/guarantees 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, the policy is funded with corporate dollars. 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 alternative asset (insurance policy), Doe Inc. was able to avoid the high taxation on passive investment income that corporations face; cash values in a participating whole life insurance policy grow on a tax-sheltered basis*. This also potentially protects Doe Inc.’s small business deduction from a claw-back. This proactive planning assists with John’s tax concern.
*if the policy is tax-exempt, which is easily accomplished with adequate planning*
Summary
The above case study provides a glimpse of how corporate-owned life insurance can play a valuable role with risk management and tax planning. By John repositioning some corporate assets, he was able to provide invaluable peace of mind and financial protection for his loved ones, while accomplishing proactive tax planning and efficiency.
For additional information on the tax treatment of life insurance policies, or to inquire about setting up a corporate-owned life insurance strategy, please contact Jeff Graham at 604-761-7543 or jeff@firstoakfinancial.ca.
Disclaimer
The tax components can be expansive and complex, so we recommend working with tax specialists and experienced insurance advisors before implementing these strategies. Also, it is important to note that despite the potential tax advantages, there still must be a demonstrated need for life insurance.
For the purposes of this article, “corporation” refers to Canadian Controlled Private Corporations (CCPC).