How to Use Corporately-Owned Life Insurance to Build Wealth
Dymond Scruton Advisory Group - Jul 26, 2018
Corporately owned Life Insurance can provide a number of benefits to business owners, their families and the operating companies. Many people understandably grimace when approached with a suggestion of buying anything with the word "insurance" in
Corporately owned Life Insurance can provide a number of benefits to business owners, their families and the operating companies.
Many people understandably grimace when approached with a suggestion of buying anything with the word "insurance" in it. This is because of the feeling that it is likely to pay for something that may not ever be necessary. However, in this post we are going to focus specifically on how life insurance can be used as a very efficient way to build and accumulate wealth in a corporate structure and significantly enhance the value of estates. This focuses on the investment aspect and tax treatment of Permanent Life Insurance and how it can grow over time, versus the insurance aspect.
Moreover, as the government has introduced measures, beginning January 1st, 2019, to limit the tax benefits of retaining money and investing within corps, this strategy will become even more beneficial. See our previous post for full info on the changes.
Here are the basics of how it works:
Business owners and incorporated professionals retain money inside their corp structure to avoid paying out and incurring taxes on money that is not currently needed for lifestyle expenses.
In order for this money to grow over time, it can be invested in a number of different vehicles, such as stocks, bonds, real estate, etc. However, these vehicles are all subject to tax along the way, or when realized.
Permanent Life Insurance contains and investment component that grows over time, mostly on a tax-free basis. The annual premiums are paid for with pre-personal-tax dollars. Once the death benefit is eventually paid out in the corp, it is paid out into a "capital dividend account", which can essentially be paid out to shareholders tax-free.
The bottom line is that for money that will not be needed for liquidity, the rates of return on equivalent dollars invested in corporately owned permanent life insurance have been significantly better than investments in a diversified portfolio of other securities, such as stocks and bonds.
This is largely due to the favorable tax treatment of this product and the use of pre-tax money and the capital dividend account. It can also be quite useful for tax and retirement planning purposes on a persoanlly-owned basis. But it does lose some of the tax benefits versus being corporately-owned.
We always urge people to evaluate the merits of these strategies in context of their financial plan, so that prudent decisions can be made around amounts, liquidity needs, estate objectives, etc. Please contact us if this type of consultation is of interest - we are happy to help, with no obligations.
Here's a more detailed breakdown of the strategy further, sourced from our partners at BDO Canada:
What are the tax benefits of owning life insurance inside a corporation?
There are several tax advantages of owning life insurance inside a corporation. First, the cost to fund policy premiums will be lower if paid by the corporation rather than personally—assuming the corporation’s tax rate is lower than the personal tax rate (which is usually the case).
For example, Kate owns a CCPC and is considering buying life insurance with a monthly premium of $500. Kate’s personal marginal tax rate is 48% and her corporate tax rate is 12%. To fund the policy premiums personally, Kate will need to earn $962 each month in order to have $500 after tax to pay the premiums. If Kate’s corporation owns and pays for her life insurance policy, her corporation will need to earn only $568 before tax to fund the $500 premium. This equals savings of $394 each month if her corporation owns the life insurance policy and pays the premiums. It’s important when the corporation pays the premium on the life insurance, that the corporation is also the beneficiary.
Second, business owners benefit from tax-deferred growth in the value of investments in an exempt permanent life policy held within the company until disposition. This benefit is comparable to the tax-deferred investment growth in a registered retirement savings plan by potentially allowing for greater asset growth because the earnings can accumulate free from tax.
The tax deferral benefit of permanent life insurance also applies to such insurance held personally. However, where the funds to invest are already in the company, investing the funds within the company will save the tax cost of paying the owner funds by way of salary or dividend to allow them to invest personally. Permanent life insurance products can be an attractive option where the business owner has excess funds in the company to invest on a long-term basis to accumulate wealth and ultimately transfer to the estate. As mentioned, this option may become increasingly popular due to the new rules that will restrict access to the small business limit based on a private corporation’s level of passive investment income.
Finally, as discussed in our related article, the life insurance proceeds over the cost basis of the policy can be paid as a tax-free capital dividend upon death.
Keep in mind that even if you already own life insurance personally, you may be able to transfer such a policy to your corporation. However, the costs and benefits of such a transfer are beyond the scope of this article. Your BDO tax advisor can assist you in making a determination of whether this would be beneficial to you.
What are the potential disadvantages of owning life insurance inside a corporation?
There are several potential disadvantages of owning life insurance in a corporation to bear in mind. Three of these risks are discussed in our companion article, and won’t be discussed here. However, there are two additional risks to mention when investing in a permanent life insurance policy in a corporation: liquidity and access to the capital gains exemption.
Investments in a permanent life insurance policy are typically for the long term and therefore don’t have the liquidity of marketable securities. Before buying a permanent life insurance policy, you should consider your cash flow needs and how the policy will fit into your entire investment plan.
Access to the capital gains exemption
As a business owner, holding permanent life insurance within a corporation may affect your ability to claim the lifetime capital gains exemption (LCGE) on the shares of your corporation. In this way, the investment portion of a life insurance policy is treated in a similar manner to marketable securities and other passive investments. It’s not an active business asset. Where the shareholder is the life insured, the life insurance policy will generally be valued at its cash surrender value for purposes of determining whether the share of the company will qualify for the LCGE. Since the LCGE applicable on the disposition of qualifying shares is $848,252 in 2018, the tax impact of whether your shares qualify may have a material impact on your taxes in the future.
Again, please contact us if you are interested in any consultation regarding the tax-efficiency of your corporate structure, investment strategies within or your financial and estate plan, overall. We are open to being a sounding-board for our contacts, any time. We urge you to pass this on to anyone who may benefit.
Have a great weekend!
Jeff, Robert, Mike, Ini & Donna