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.
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.
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:
|Reason to have life insurance:||How life insurance can help:|
|Estate protection, family’s financial stability||If you passed away, and your business the company couldn’t support their family.|
|Decreasing capital gains taxes||If you owns investments, real estate with accumulated capital gains, and/or shares of a private company, life insurance policies can help you with decreasing capital gains taxes|
|Other taxes||Own your registered assets and make a probated will.|
|Retiring debts||If you are a small business owner, there is a high chance that you have some business debts or personal debts. Life insurance can help you and your family pay off outstanding debts. This will be especially beneficial when you retire|
|Business owner passes||Family owned small businesses can have a tough time if the key business owner passes, life insurance can help in these cases to allow for your family to take time to grieve and have some finances to take care of any expenses.|
|Obligations to spouses or dependents||Life insurance is helpful for any matrimonial obligation and for any obligations to your dependents|
|In the case of corporate buy out||In the case of a buy out, insurance can be there to just give you peace of mind that there can be many ways to cope with a buy out.|
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 has produced this (CDA). 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 (NCPI). The Income Tax Act (Canada) (ITA) defines NCPI as an assumed mortality cost, and over time, it may lower the ACB of the policy to 0.
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 LifeTM 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
The financial status of each person is one of a kind and is determined by a combination of their specific goals and their current financial circumstances. A financial planner will be able to provide a strategy for you to maximize the benefits of these significant tax advantaged plans once they have a thorough understanding of your current financial situation as well as your short-term and long-term goals. This understanding is gained through discussion of these topics with you.
Critical illness insurance is an excellent way to protect yourself against the financial burden that could result from a future injury or illness. If you are the main earner for your family and are in good health, critical illness insurance is a good strategy to avoid future tragedies.
The Canada Education Savings Grant (CESG) is a government-funded grant. This is the 20% contribution made by the government to the RESP beneficiary. Having said that, the government’s maximum CESG contribution will be $2,500 each year. This means that the account’s sponsor will have to contribute $12,500 to the RESP in order to obtain the maximum CESG contribution amount for the year.
An RRSP is a retirement savings plan that you create, and you or your spouse or common-law partner contribute to. Contributions to deductible RRSPs can be utilized to lower your tax liability. Any income earned in an RRSP is usually tax-free as long as the funds remain in the plan; however, you must usually pay tax when you receive payments from the plan.
Life insurance is particularly beneficial for those who have to provide for their spouse, children, and other family members in the event of their death. Depending on the value of the policy, life insurance death payments might assist beneficiaries to pay down a mortgage, support education expenses, or fund retirement. Permanent life insurance has a cash value component that accumulates over time.
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.