Insured Retirement Plan

Are you a business owner interested in protection for your business and family, while also wanting access to tax-free funds in retirement?

The Corporate Insured Retirement Plan (“I.R.P.”) is a strategy involving two steps:

1. Allocating a portion of the corporation’s liquid assets into a tax-exempt permanent insurance policy.

2. Upon retirement, or as needed, you can access funds from the policy on a tax-free basis to provide retirement income or fund large ticket items.

Step 1

The I.R.P. can be executed with either a participating whole life insurance policy or a universal life policy – this article will illustrate the participating whole life option.

Participating whole life is a type of life insurance policy that never expires, regardless of how long the insured lives for. These policies have two components:

1. Death Benefit – paid out tax-free when the insured dies
2. Cash Value – this is the investment or savings component of a participating whole life insurance policy. The cash value and death benefit will grow by way of dividends from the insurance company (more on this below) and exempt policies require no annual tax reporting – much like a RRSP.

So, Step 1 involves applying for a participating whole life insurance policy with the following structure:

• Policy Owner: Corporation
• Payor: Corporation
• Beneficiary: Corporation
• Insured: Business Owner

Allocating corporate assets into the policy can be done over a period of 5, 10, 15, or 20 years – the business owner has customization over the payment length, deposits and amount of insurance applied for. However, the insurance amount needs to be justified and necessary. For the I.R.P., it is recommended that the corporation (in the above structure) be a holding company, NOT an operating company.

Step 2

Cash value can be viewed as the investment component of a participating whole life policy. Deposits from participating whole life payors gets pooled into the insurer’s “participating account” – this account covers expenses, taxes, insurance claims, among other items. The participating account funds are invested by the insurance company’s professional asset management team. Dividend distributions to policyholders will reflect the participating account’s investment performance, as well as the items mentioned above – notably claims experience. While dividends are not guaranteed, Equitable Life (for example) has issued a dividend every year since 1936 – the same year they introduced their participating whole life product.

The policyholder has multiple options in terms of what to do with their dividend distributions (the specifics are beyond the scope of this article), but the most common and tax-effective method is to allow the dividends to be reinvested in the policy accumulate within the cash value (called “paid-up additions”).

Cash value can be accessed three ways:

1. Policy Loan
2. Policy Withdrawal or Surrender
3. Using the policy as collateral to secure a 3^rd party loan

Option #3, using the policy as collateral to secure a 3rd party loan, is the method used to implement the I.R.P. strategy. Here is how it works:

1. Working with one of the Canadian lenders who specialize in cash value lending, a tax-free loan is secured by collateralizing the policy’s cash value. Lenders typically will loan up to 90% (sometimes higher) of the cash value for participating whole life policies. Depending on individual circumstances, additional collateral might be required and interest may be capitalized.
2. The loan can either be taken out corporately or personally. If a corporate insurance policy is leveraged for a personal loan, a guarantee fee should be paid to the corporation to avoid it being deemed a shareholder benefit.
3. If the purpose of the loan is to earn business or investment income, the interest might be deductible.
4. On death, the insurance proceeds are used to pay off the outstanding loan to the 3rd party lender. The remainder of the death benefit is received tax-free by the corporation. Once in the corporation, it can then be paid out to the estate or beneficiary, potentially on another tax-free basis depending on the balance in the corporation’s capital dividend account (CDA). Note: if the policy was leveraged to secure a personal loan, there are some additional steps to the payout of the death benefit and repayment of the loan to ensure the capital dividend account gets handled properly.

Benefits of the I.R.P.

1. Provides an immediate and permanent death benefit for covering business debts/taxes, income replacement for loved ones, and/or legacy planning purposes
2. Protects the small business deduction tax rate, which is affected by excess passive income in a corporation
3. Avoid the high tax rates that accompany passive income earned within a corporation
4. Provides a secure, guaranteed, diversified asset to the business owner’s overall investment portfolio
5. The cash value grows on a tax-deferred basis
6. Provides the business owner(s) access to a flexible, tax-effective cash-flow stream during their retirement
7. All or a portion of the death benefit will result in a credit to the Capital Dividend Account
8. By leveraging the policy instead of withdrawing from it, the entirety of the cash value remains invested
9. When a collateral assignment is required as part of the loan, a portion of the insurance premiums may be deductible against the corporation’s income

Case study: Michael

Relevant facts

Patrick is 55 years old and the owner/operator of ABC Ltd., a successful Canadian Controlled Private Corporation (CCPC) in business for 20 years. ABC Ltd. has amassed a sizeable investment portfolio, as Patrick only withdraws a moderate amount from the corporation each year to meet his personal income needs, leaving the remainder of the ABC Ltd. profits inside the corporation. Patrick plans to retire in 10 years.

Objective

Patrick is hoping to accomplish four things:

1. Reduce the high taxes the company pays each year on the passive income earned within his corporate investments
2. Provide lump-sum cash to his wife to cover financial liabilities arising in the event of his death
3. Supplement his retirement income on a tax-effective basis
4. Pay less tax when eventually disposing of his corporate shares

Executing the I.R.P. – Step 1

Patrick is in good health so has no problem being approved for a participating whole life policy. Based on his insurance needs and other financials, Patrick will allocate $75,000 per year from his corporation into the policy, for a period of 10 years (known as a 10-pay policy). This provides an initial death benefit of $1,010,000.

Prior to commencing the I.R.P. and at the advice of his accountant, Patrick created a holding company (“HoldCo”). HoldCo owns the shares of ABC Ltd., so dividends can flow tax-free from ABC Ltd. to HoldCo.

So, HoldCo will be the policy owner, payor, and beneficiary of the insurance policy. Patrick is the life insured.

Executing the I.R.P. – Step 2

Fast forward 10 years, Patrick is now 65 and has concluded the last of his 10 deposits into his participating whole life policy. Based on current projections, the policy’s cash value will look like this:

Year 10: $434,000

Year 15: $985,000

Year 20: $1,313,000

Note: there are policies that accumulate more cash value in the early years, but Patrick wanted a policy with a higher death benefit in the early years.

Upon retirement, Patrick decides he would like $300,000 to pursue an investment opportunity, so we set up a personal loan by leveraging the policy’s cash value. To avoid any risks of the loan being deemed a shareholder benefit, Patrick will pay HoldCo a guarantee fee of 1.5%. The $300,000 is received tax-free by Patrick and the lender has allowed the interest on the loan to be capitalized. The entirety of the cash value remains invested, so the projected numbers above will not be impacted by this outstanding loan.

Fast forward another 8 years and Patrick, now age 74, wants to withdraw another $300,000 from the cash value. Following the same method as done 8 years earlier, Patrick receives a tax-free loan by leveraging the policy. Patrick pays a 1.5% guarantee fee and is able to capitalize the interest.

At age 85, Patrick passes away and the outstanding loan is paid off using the death benefit. The HoldCo receives a tax-free death benefit of $1,219,000 and can disburse nearly all of it to Patrick’s estate on a tax-free basis by using the corporation’s capital dividend account balance (CDA). The amount not eligible for the capital dividend account will be paid to the estate by way of taxable dividend.

Comparison of the I.R.P. vs Alternative Investment – Values to the Estate

At Age 65

I.R.P. – $1,013,000

Alternate Investment – $568,700

At Age 75

I.R.P. – $901,000

Alternate Investment – $219,350

At Age 85

I.R.P. – $1,219,000

Alternate Investment – $377,300

*Assumptions used for alternate investment: balanced portfolio earning 5% per year. Numbers courtesy of Equitable Life.

Summary

By executing the I.R.P. strategy, Patrick accomplished the following:

1. Lifelong protection for his loved ones if something were to happen to him
2. Tax-sheltering passive corporate assets that otherwise would be subject to high tax rates on income earned
3. Protecting the eligibility for the lifetime capital gains exemption by using a tax-exempt insurance policy
4. The cash value is providing a fully-accessible pool of money for retirement uses, investment opportunities, or large-ticket items
5. Maximizing the value received by his estate (or loved ones) on death by utilizing the tax-free capital dividend account

For more information or to get started with this concept, contact Jeff Graham at (604) 363-7549 or jeff@firstoakfinancial.ca, or schedule a complimentary consultation using the link below: