Estate Freeze with Life Insurance: Unlocking Tax-Efficient Business Succession Planning

Planning for the future is essential for business owners, especially when it comes to transferring ownership to the next generation. An estate freeze combined with life insurance is a highly effective strategy that provides tax efficiency, income security, and peace of mind. In this comprehensive guide, we’ll explore how this strategy can help business owners achieve their financial and legacy goals.

In this article:

• What is an Estate Freeze?
• Why Use Life Insurance for an Estate Freeze
• When Would You Consider an Estate Freeze? 
• Estate Freeze Case Study
• Why Choose This Life Insurance Strategy
• Frequently Asked Questions (FAQs) About Estate Freezing for Business Planning

What is an Estate Freeze?

An estate freeze is a financial strategy designed to “freeze” the value of appreciating assets, such as a business, at its current fair market value (FMV). This prevents the owner from incurring immediate capital gains taxes while deferring the future growth of the business to a successor.

The intent of an estate freeze is to transfer the future growth of the assets and their associated tax liability to other taxpayers, usually family members. An estate freeze is implemented by exchanging property that is likely to grow in value (e.g. common shares of your business) for property with no growth potential (e.g. fixed-value preferred shares of your business).

Estate freezes generally make sense only when there is an expectation that the corporation will grow in value, resulting in capital gains, and where there is a clear successor or next generation of owners.

Why Use Life Insurance in an Estate Freeze?

Life insurance is the backbone of an effective estate freeze strategy. Here’s why:

• Liquidity for Share Repurchase: The proceeds from a life insurance policy provide the necessary funds to repurchase shares after the owner’s death
• Tax Efficiency: Life insurance proceeds are generally tax-free, ensuring the business can cover the repurchase without depleting its cash flow.
• Flexibility: If the life insurance payout exceeds the required amount, the surplus can be used for business reinvestment, acquisitions, debt reduction, or shareholder dividends.

When Would You Consider an Estate Freeze? 

Before you consider an estate freeze, be sure that you do not require the future growth to fund your legacy and lifestyle needs. An estate freeze works best when you want to achieve one or more of the following objectives: 

• You want to minimize and defer tax. 
• You operate a business and have family members take over the business after you retire or after your death. 
• You wish to split your income with family members who are in a lower marginal income tax bracket than yourself. 
• You own an operating company that has grown to a size where you would use all of your lifetime capital gains exemption (LCGE) on the disposition of the shares of the corporation. You may also have a spouse and/or children who have not used their LCGEs and you expect your business to grow significantly in the future. 
• You reside in a jurisdiction with high probate fees (e.g. Ontario or British Columbia) and want to minimize such fees. 

Case Study: Charles’ Estate Freeze with Life Insurance

Charles is a 50-year-old successful business owner in Ontario. He has retirement savings but relies on his company for additional income. He wishes to transfer ownership of the business to his daughter Chloe in a tax-efficient manner while maintaining financial security. 

His Key Challenges:

• Transferring ownership without burdening Chloe with high upfront costs.
• Maintaining a steady income stream during retirement.
• Ensuring the business has funds to repurchase shares upon his passing.

Solution: An estate freeze combined with a layered life insurance strategy.

 This estate freeze allows him to:

• Freeze the value of his shares, with all future growth deferred to Chloe
• Maintain control of the company until Chloe is ready to take it over
• Maintained an income of $250,000 in retirement
• No immediate capital gains tax incurred

Charles’ Life Insurance Plan

Charles’ advisor recommended a structured insurance approach that included both term and permanent life insurance policies. This plan addresses his needs effectively and ensures financial security for the business.

Breakdown of the Layered Coverage:

1. Term Life Insurance: 
   • Solution 10: Covers the initial 10 years for short-term liquidity.
   • Solution 20: Extends coverage to 20 years to handle mid-term financial needs.
2. Permanent Life Insurance: 
   • Term to 100 20 Pay: Provides lifetime coverage after 20 years with no additional premiums.

Life Insurance Plan Details

• Premiums: 
  • Years 1–10: $222,250 annually.
  • Years 11–20: $219,100 annually.
• Ownership: Policy owned by Charles’ company.
• Beneficiary: Charles’ company.
• Coverage Timeline: 
  • Year 1: $15 million total.
  • Year 10: $12.5 million (Solution 10 ends).
  • Year 20: $10 million permanent coverage remains (Solution 20 ends).

Using life insurance as part of the Estate Freeze provided the following: 

• Cost-effective life insurance by layering term life insurance and limited pay permanent life insurance to meet Charles’ objectives 
• The life insurance ensures the money is readily available to repurchase all of Charles’ remaining shares when he passes away 
• If Charles were to pass away after year 20 when the value of his shares is less than the life insurance amount of $10,000,000 that is already paid up, Charles’ company could use the additional funds however the business determines, such as: 

1. Invest back into the business 
2. Make a business acquisition 
3. Pay down debt 
4. Declare a dividend

Financial Benefits for Charles

1. Income in Retirement: 
   • Structured share repurchases provide Charles with $250,000 annually.
2. Tax Efficiency: 
   • Avoids immediate capital gains tax and ensures the company can repurchase shares tax-free.
3. Business Security: 
   • Guarantees liquidity to manage outstanding shares upon Charles’ passing.
4. Flexibility in Use of Surplus Funds: 
   • Surplus insurance proceeds can be used for reinvestment, acquisitions, debt repayment, or dividends.

Why Choose This Life Insurance Strategy?

This estate freeze strategy highlights the versatility of life insurance as a tool for wealth preservation and business continuity. For business owners like Charles, the combination of tax planning, retirement income security, and succession planning creates a comprehensive solution that benefits both the owner and the successor.

Frequently Asked Questions (FAQs) About Getting Life Insurance for An Estate Freeze

Get Expert Guidance for Your Estate Freeze

Understanding how to utilize an estate freeze for your business may seem daunting, but armed with the right knowledge and support, you can find a policy that not only fits your needs but also offers reassurance for your loved ones’ and your business’ futures. At Protect Your Wealth, we specialize in designing customized financial solutions that align with your unique goals. Whether you’re looking to secure your retirement, transfer your business, or protect your family’s future, our expert team is here to help.

Plan your business succession with confidence –  for more insights and expert advice on life insurance, estate planning, and financial security, contact us 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, Manitoba, Alberta, and British Columbia, including areas such as Kingston, Coquitlam, Red Deer, and Springfield.