Corporate Owned Life Insurance
Personally owned, or corporately owned, that is the question, especially if you're a business owner considering the purchase of life insurance. Life insurance is an important piece of any business and can be a tremendous asset to your business in the following ways:
- Key Person Insurance - In the event that the loss of a key person would mean a monetary loss for the company. In this situation, the corporation is the owner and beneficiary.
- Buy/Sell Insurance - Can be used to help settle a buy/sell agreement between two or more partners. In this instance, the corporation owns the policy on the shareholders and on the death of a partner, the corporation can redeem his or her shares. There are at least five ways to set up buy/sell insurance, which I will discuss in a later article.
- Estate or Succession Planning - This will help fund the transfer of shares to charity, family, or other business partners. In this situation, you need to be aware of the rules regarding taxable benefits when the insured is a shareholder vs. an employee or when the beneficiary is a spouse, rather than the corporation.
- Taxes Payable - Life insurance can be used to offset tax liabilities on death, which negates the need to sell your assets at an inopportune moment. The proceeds will then be typically deposited into the Capital Dividend Account (CDA) for further disposition to shareholders tax free.
- Charitable Bequests - Finally, life insurance can insure that a charity will receive a designated amount of money.
All of these life insurance options can be personally owned or corporately owned and which one is right for you will depend on the following factors:
- What is the purpose of the insurance?
- Who will receive the proceeds of the insurance?
How quickly will the funds be required?
A common misconception is that life insurance is an expense that can be deducted as an expense by a corporation. The CRA Document addressing this issue indicates that the only real opportunities to deduct premiums is when the policy is collaterally assigned to a lending institution, is a charitable gift, an employee benefit, or part of a Retirement Compensation Agreement (RCA).
Disposition of proceeds - Keep in mind that on death, the designation of the beneficiary will determine whether there will be tax issues or not, assuming the life insurance policy is owned and paid for by the corporation.
But to really break it down and determine whether corporately owned life insurance is right for your circumstances, you may want to weigh the following attributes:
- Premiums are paid by the company - While deducting the premium isn't typically possible, you can have your company pay the premium of a corporately owned policy. The benefit of this is the typical difference in tax rates that comes with small businesses.
In Ontario, the highest individual marginal tax rate is 46.41% vs. 16.50% for small businesses. An annual $10,000 premium would require the individual to earn $18,660.20 ($10,000/(1-.4641) before tax to pay the $10,000 premium vs. only $11,976.05, if the small business pays the premium. *NOTE* The later assumes the taxable income of the small business is under the $500,000 limit for the preferred rate.
- Capital Dividend Accounts (CDA)'s are an option - It can be used to funnel the proceeds of the life insurance policy tax free at the death of a shareholder. As an added bonus, Capital Dividends do not reduce the Adjusted Cost Basis (ACB) of the shares.
- Multiple Insured Parties Under One Umbrella - Often with a multiple ownership corporation, and buy/sell insurance in particular, there may be a considerable age or various underwriting premium differences in rates for the parties insured, which causes unequal premium rates between the people involved. A corporate owned policy can close the gap and solve the various inequalities in premium rates that come with each individual paying their own policy.
- Available for Universal and Whole Life Policies - These policies have cash values that build up over time and are considered an asset to a corporation. However, a split dollar strategy is also an option where the cash value belongs to the employee, but the death benefit goes to the corporation.
- Peace of Mind - When asked, many business owners just prefer to pay out as much as they can from their corporate account, rather than their personal account. This is mainly because of the tax benefit outlined above.
Things to Keep in Mind
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- There is no creditor protection - While individual life policies are creditor protected, corporate policies are not.
- The Share Value Increases - When the insured shareholder dies, the cash surrender value of the corporate owned policy can potentially increase the value of the shares, raising the cost for family members who may wish to buy them.
- Issues regarding the "Net Family Property" Designation - In Ontario, under the new Family Law Act, a surviving shareholder who uses the life insurance proceeds to purchase shares from the deceased's estate, would not be able to claim those shares they bought as "net family property." However, in cases where the shareholder uses a Tax-Free Capital Dividend from the corporation, it has yet to be established whether this would be considered using the life insurance proceeds to avoid the "net family property" calculation.
- Certain Policies Could Jeopardize the Preferred Tax Rate Benefit - CRA requires that 90% of a corporation's assets be used in an active business. It's possible that the cash value that comes with universal life and whole life policies may be considered passive and not an active business asset, which could jeopardize your ability to qualify for the preferred tax rate benefit.
Bear in mind that entire books have been written on the subject, so clearly, this only scratches the surface. Still, we hope you have enough information to at least start the conversation with your insurance advisor. We would be happy to help, so call us at 1.866.899.4849.