Life Insurance Strategies for Business Owners

Posted on May 7, 2018 and updated May 16, 2018 in Life Insurance Canada News
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Philip-Setter

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Bio

Philip Setter is an insurance and investment professional based out of Calgary, Alberta. He is also the founder and managing partner of Business Critical – a multi-discipline advisory firm focused on corporate tax strategies.

Working with Philip as your business advisor and tax strategist will give you a clear overview and direction for your business. His focus is on education, transparency, and providing quality service customized to your unique corporate needs. He aims to build a long lasting and trusting relationship with each of his clients.

You have only been in the insurance industry for 2 years, how have you been able to tap into the business market at such an early stage in your career?

The thing that most attracted me to financial services is how complex it can get and how many different areas you could specialize in. Like most advisors, I started in the family market with basic insurance and investing needs. Coming from a business background, however, my natural demographic was business owners and entrepreneurs. I started in the corporate market quite early on and positioned myself from a corporate tax strategy point of view. I quickly found that business owners had many questions that I could not answer from strictly an insurance perspective. That gap in the market prompted me to start Business Critical and I brought on qualified and experienced partners to work with me on the legal, accounting, and actuarial side.

What are some misconceptions when it comes to life insurance for business owners?

There are many misconceptions when it comes to corporately owned insurance in general. There are so many different types of insurance in a corporation and the biggest issue I find is that business owners have no idea how they are being taxed. Moreover, their accountant usually does not understand or specialize in the taxation of insurance within a corporation either.

Explaining how all of these different types of insurance are taxed within their corporation is usually the biggest challenge I run into as an advisor.

How does life insurance compare to other investments as a means of creating and preserving wealth?

When you start to accumulate corporate investments, you will very quickly realize that the taxation on passive investments is quite high. One thing that business owners are always looking for in their corporation is tax efficient investments that they can utilize to retain more profit at the end of the day.

One of the ways this can be achieved is by using a tax-exempt life insurance policy. In the simplest terms, a permanent life insurance policy will have an investment component that can be accessed many different ways. The real benefit to this type of policy is that the investment component can grow tax-free, as long as returns are within certain thresholds.

With passive investment tax rates as high as 50.67%, your 10% mutual fund return is very quickly reduced to less than half. You would still have your RDTOH notional account to capture some of those taxes back, but depending on your personal marginal tax rate, it could be little.

This means that when your investments within your tax-exempt life insurance policy are seeing a return of 6-7%, you would need a return of 12-14% within your mutual fund to match it.

The tax-exempt life insurance policy can be a very attractive addition to your portfolio for business owners that are looking for different ways to reduce their tax liabilities.

How can tax exempt life insurance be used as a way to expand on passive investments without decreasing your small business deduction?

Before we can discuss how tax-exempt life insurance can increase your investments within your corporation without decreasing your small business deduction (SBD), we need to summarize how the 2018 federal budget changes affect us.

Canadian business owners are lucky to be able to utilize the SBD, which is essentially being able to pay a lowered rate of tax on active business income. The lower rate is meant to entice business owners to invest back into the company, which strengthens our economy and encourages growth in small businesses. Corporations are able to take advantage of this lower tax rate for the first $500,000 of active business income.

As part of the 2018 budget changes, the federal government changed how passive investments in your corporation would be taxed. Following the proposals, there was an outcry from business owners and multiple different professions that fought back in protest of the proposed changes. They finally settled on leaving the RDTOH calculations as is and having your passive investments affect your access to the SBD. Now, if your corporation and any interconnected corporations are collectively making more than $50,000 in passive investment income, your access to the SBD will start to decrease by $5 for every $1 of passive investments.

It continues to decrease your SBD until your passive investments reach $150,000 per year, at which point your access to the SBD is completely gone. Business owners with multiple interconnected companies and collections of passively invested assets can quickly reach this amount and lose access to the valuable SBD.

Tax-exempt life insurance held corporately does not add to the calculations of passively held assets in regard to the deduction of the SBD. A business owner that is approaching the limit of $50,000 per year in passive investments can allocate some of his assets into a corporately held tax-exempt life insurance policy. This can be extremely attractive for business owners as it combines the benefit of a tax-exempt investment within your corporation, as well as maintaining access to the SBD to ensure business owners have the greatest amount of after-tax dollars to invest back into their business.

What are some other strategies that can be used to maximize the tax efficiency of life insurance for business owners?

Life insurance within a corporation can be used for a variety of different purposes. Another area that it excels in is estate planning and estate transfer. When a business owner has a surplus of cash within a corporation that he or she does not need within their lifetime, there is a concern of major tax consequences when transferring it to their loved ones.

Life insurance is one way to alleviate that tax consequence for a business owner. The business owner can purchase a policy for themselves using surplus cash within the corporation and once she passes away, that amount can flow through the corporation to other shareholders, such as her children for example, tax free. This allows business owners to create a larger legacy to leave behind for their loved ones.

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