The concept of life insurance seems is fairly straightforward. If an insured person dies, a death benefit is paid out. In addition to that, a comprehensive and versatile use for life insurance exists, and that comes in the form of corporate tax planning.
Let’s talk about Corporate-Owned Life Insurance. Like the title says, a corporation can own a life insurance policy on the life of a shareholder or key employee, which comes as a surprise to many.Honestly, to list all of the concepts and strategies that you can use with corporate-owned life insurance would end up like a novel. Instead, 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. 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 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. For instance, one way is by accessing the policy’s cash value for retirement usage. Another is to maintain the coverage for estate planning purposes.
- Unfortunately, John passes away and Doe Inc. receives the death benefit. After that, it’s 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, 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. 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 proper planning*
Summary
In conclusion, this case study provides a glimpse of how corporate-owned life insurance can play a valuable role. This is especially true with risk management and tax planning. John was able to provide invaluable peace of mind and financial protection for his loved ones. He also accomplished proactive tax planning and efficiency. Ultimately, John did this by repositioning some corporate assets.
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. Above all, we recommend working with tax specialists and experienced insurance advisors. Ultimately, it should be before implementing these strategies. It is important to note that despite the potential tax advantages, there still must be a need for life insurance.
“Corporation” refers to Canadian Controlled Private Corporations (CCPC).