Using Corporately Owned Life Insurance for Corporate Investing

One of the advantages of life insurance is using it for corporate investing! For business owners including those who own a professional corporation, once they have decided on paying themselves with salary and/or dividends, they should evaluate where to invest their corporate retained earnings either by leaving those funds inside the corporation or taking them out to invest personally.

In this article:

• What is Corporate-owned Insurance
• Who is Corporate-owned Insurance Right For?
• Tax Benefits of Corporate-owned Insurance
• Ways of Using Corporate Owned Insurance
• Why Should Small Business Owners Have Life Insurance?
• Corporate-owned Insurance: An Example
• How Should a Corporate-owned Insurance Policy be Set Up?
• How Can Corporate-owned Insurance Proceeds be Tax-free?
• Maximizing the Value of Corporate-owned Insurance
• Advantages and Disadvantages of Corporate Investing
• How to Use Life Insurance for Corporate Investing
• Frequently Asked Questions (FAQs) about Investing

What is Corporate-owned Insurance

When deciding whether to own a life insurance policy personally or corporately, business owners have two options. Why do you want to own a corporation? Although there are other factors to take into account with corporate-owned life insurance, using low-tax corporate dollars to pay the insurance costs is a benefit for corporate ownership.

When a corporation owns a life insurance policy they do so with corporately owned dollars. Corporately owned dollars are taxed much lower than personal tax rates (could be as low as 10.5% compared to as high as 53.53% personal). Hence the advantage of using corporately owned money to buy a policy is there is much more buying power. Secondly, a huge advantage is corporately owned permanent policies (such as Whole Life and Universal Life) accumulate cash value tax sheltered with no implications to the corporation.

Who Is Corporate-owned Insurance Right For?

First and foremost Corporate-owned Insurance is right for those who are small business owners and medium-sized business owners, also those who are owners of businesses with retained earnings can definitely benefit from corporate-owned insurance. Corporate-owned insurance is a great option for doctors, dentists,  who have their own practices, and for those who are small business owners, whether you are a contractor, own a clothing store, a coffee shop or any small business.

We have personally helped many business owners in the medical field such as doctors, dentists, optometrists and others get whole life insurance policies and universal life insurance policies which has benefited them and saved them plenty of money in taxes which is extremely important for all business owners.

Corporate-owned Insurance is also right for those who are business owners and are in the 53.53% tax rate bracket or even lower, this is the tax rate brackets in Ontario:

If you are in any of these tax brackets and are an owner of a business you are someone who would want to definitely look into getting a corporate-owned insurance, if you aren’t sure where to start and want to know how this can benefit you, please talk to an advisor to learn more about the specificities of corporate-owned insurance.

Tax Benefits of Corporate-owned Insurance

Corporate-owned insurance can offer several tax benefits to businesses, depending on the type of policy and the circumstances in which it is used. Here are a few potential tax benefits of corporate-owned insurance:

• Tax-Free Death Benefit: One of the primary benefits of corporate-owned insurance is that the death benefit paid out to the company is generally tax-free. This means that the company can receive a lump-sum payment from the insurance policy without having to pay income tax on the proceeds.
• Tax-Deferred Growth: Certain types of life insurance policies, such as whole life insurance and universal life insurance, offer the potential for tax-deferred growth. This means that the cash value of the policy can grow over time without being subject to income tax, as long as the funds remain inside the policy.
• Deductibility of Premiums: In some cases, the premiums paid for corporate-owned insurance policies may be tax-deductible as a business expense. This is true for policies that are taken out to protect against the loss of a key employee or to fund a buy-sell agreement.
• Estate Planning Benefits: Corporate-owned insurance policies can also offer estate planning benefits for business owners. For example, the death benefit paid out by the policy can be used to provide liquidity for estate taxes or to equalize inheritances among heirs. Additionally, if the policy is owned by an irrevocable trust, the death benefit may be excluded from the insured’s taxable estate.

It’s important to note that the tax treatment of corporate-owned insurance can be complex and depends on the specific facts and circumstances of each case

Ways of Using Corporate Owned Insurance

There are several ways that businesses can use corporate-owned insurance to help protect themselves and their key employees. Here are some common uses of corporate-owned insurance:

• Key Person Insurance: Key person insurance is a life insurance policy that a business takes out on a key employee to protect against financial loss that could occur if that employee were to die or become disabled. The company pays the premiums and is the beneficiary of the policy. If the key employee dies, the company receives the death benefit tax-free.
• Buy-Sell Agreements: A buy-sell agreement is a legal agreement between co-owners of a business that specifies what happens if one of the owners dies or becomes disabled. Life insurance is often used to fund the agreement, with the proceeds going to the surviving owner(s) tax-free. The company pays the premiums, and the policy is owned by the business.
• Executive Bonus Plans: An executive bonus plan is a way for a company to provide key employees with life insurance as a fringe benefit. The company pays the premiums, and the employee is the owner and beneficiary of the policy. The premiums paid by the company are deductible as a business expense, and the death benefit is received by the employee tax-free.
• Supplemental Retirement Benefits: A company can use corporate-owned life insurance to fund a supplemental retirement benefit plan for key employees. The company pays the premiums, and the policy is owned by the company. When the employee retires, the policy’s cash value is used to fund the retirement benefit, which is received by the employee tax-free.
• Estate Planning: Corporate-owned insurance can be used as part of an estate planning strategy for business owners. For example, the death benefit can be used to provide liquidity for estate taxes or to equalize inheritances among heirs. Additionally, if the policy is owned by an irrevocable trust, the death benefit may be excluded from the insured’s taxable estate.

Why Should Small Business Owners Have Life Insurance?

Business owners definitely need life insurance because unlike traditional jobs, they are not usually going to receive a pension plan and they are truly on their own when it comes to protecting their financial future and their assets. Being a business owner is one of the toughest jobs in Canada solely based on the fact that there are just so many unpredictable situations in life, and being a business owner just adds to the unpredictability. If you are a small business owner and don’t have life insurance, consider some of these reasons as to why you should have life insurance:

There are so many specificities that exist for business owners when it comes to taxations, insurance and financial preparedness and planning. This being said at Protect Your Wealth we are happy to discuss the specifics of corporate-owned insurance. Please feel free to contact us and find out what can be a good plan of action that will protect your business, but more importantly, protect you and your family.

Corporate-owned Insurance: An Example

The annual savings from the corporation paying insurance costs with money that was taxed at a lower active business rate is a significant benefit of a corporate-owned life insurance policy. Costs of life insurance are typically not tax deductible. Since personal tax rates are typically higher than corporate tax rates on active business income, less pre-tax money is required when the policy is owned by a corporation as opposed to an individual.

There are additional justifications for a corporation to own a life insurance policy in addition to tax benefits. For instance, it might need funding for a shareholder buyout, insurance for a bank loan, or key person coverage (key owners or employees).

How Should a Corporate-owned Insurance Policy be Set Up?

The corporate policy-owner should typically be the policy’s beneficiary as well. The amount of the yearly premium paid by the corporation would probably be regarded as a taxable shareholder benefit if a shareholder is the policy’s beneficiary. Taxable shareholder benefits are not deductible by the corporation and are instead taxed to the shareholder as ordinary income.

How Can Corporate-owned Insurance Proceeds be Tax-free?

When compared to a personally owned policy, the net estate value from a corporately owned life insurance policy is the same. The corporation’s capital dividend account (CDA) has produced this . The life insurance proceeds can be paid as a tax-free capital dividend to shareholders who are Canadian residents thanks to the CDA credit. A private corporation’s CDA may typically be increased by an amount equal to the life insurance proceeds it has received, less the policy’s adjusted cost basis (ACB). Typically, the collected premiums paid less the net cost of pure insurance equals the ACB of a life insurance policy . The Income Tax Act defines as an assumed mortality cost, and over time, it may lower the ACB of the policy.

The entire amount of the life insurance proceeds would be covered by the CDA credit. The corporation may distribute a capital dividend to its shareholders who are residents of Canada tax-free as long as it has a CDA balance. The shareholders may be the estate, the surviving spouse, or the heirs, depending on the estate plan of the deceased shareholder. A company may distribute capital dividends in the form of a cash dividend or as payment for the redemption of shares. To assist a tax expert in determining the corporation’s CDA balance, Canada Life can provide specifics regarding the policy’s ACB. The Canada Revenue Agency must receive an election before the capital dividend is paid. The general rule is that any portion of the insurance proceeds not covered by the CDA balance would be paid from the corporation as a taxable dividend.

Maximizing the Value of Corporate-owned Insurance

Since money is kept at the corporate level and not distributed to the business owner as a taxable distribution, it results in a sizable tax deferral (dividend or salary). The operating company’s small business limit may be lowered if these corporate assets are used to buy investments that produce income subject to the highest corporate rate, which can range from 48.7% to 54.7% depending on the province or territory. In contrast, a tax-exempt life insurance policy’s cash value growth is tax-advantaged, which means it isn’t taxable. Unlike other forms of passive corporate income, the growth of the policy is not slowed by taxes, and it does not lower the corporation’s small business limit. Life insurance has two distinct advantages over corporate investments: tax-advantaged growth in a policy and the CDA. As a result, it is a way of transferring corporate wealth to a spouse or beneficiary.

Advantages and Disadvantages of Corporate Investing

The main advantage of leaving funds inside a corporation is the favourable tax rate, when compared to personal income tax rates. This allows a much larger after tax investment available when left within the corporation.

However corporate investments have pitfalls that should be considered. First off, passive investment income inside a corporation is taxed at the least favourable tax rate. This means any investment income earned inside a corporation may be subject to a nearly 50% tax rate.

Secondly, due to Canadian tax regulations, the previous year’s investment income now reduces the federal small business deduction by $5 for every $1 the investment income exceeds $50,000. In practical terms, for a corporation earning 5% on 1M of retained earnings or $50,000 of investment income, every dollar that corporation earns beyond this reduces the federal small business deduction by $5. Furthermore, once $150,000 is earned the deduction is eliminated entirely.

How to Use Life Insurance for Corporate Investing

This is where life insurance can play a crucial role. Cash value, permanent policies such as universal life and whole life grow tax free. The corporation must be both the owner and beneficiary of the policy. This allows corporate retained earnings to efficiently be invested without being subject to much higher passive income tax rates and having no impact on reducing the small business deduction.

Corporately owned life insurance is an investment vehicle which is tax sheltered. Effectively, the policy is almost like having a corporate tax free savings account with tremendous additional benefits. Corporately owned insurance policies can be used to borrow against for investment purposes, create an extremely efficient way of transferring corporate retained earnings and may allow for additional assets to flow out of the corporation tax free through a notional capital dividends account.

Frequently Asked Questions (FAQs) about Investing

Thinking of investing with life insurance?

Using corporate investing for life insurance is a must for business owners. We would be happy to provide further analysis for your specific circumstances and your financial goals. Contact Protect Your Wealth today to learn more! 

At Protect Your Wealth, we work with and compare policies and quotes from the best life insurance companies in Canada to ensure the best solution for you and your needs. We provide expert life insurance solutions, including no medical life insurance, critical illness insurance, term life insurance, and permanent life insurance to build the best package to give you the protection you need. 

Contact Protect Your Wealth or call us at 1-877-654-6119 to talk to an advisor today! We’re proudly based out of Hamilton, and service clients anywhere in Ontario, Alberta, and British Columbia, including areas such as Waterdown, Calgary, and Kelowna.