Life insurance is often associated with a negative connotation. To name a few of them, we might assume insurance is a vehicle for bigger organizations to sell us something that is a bad investment or we fear that our loved ones won’t inherit its true value. Although these are common misconceptions, this shouldn’t be the case. If thoughtfully planned, life insurance has significant tax benefits that you should consider.
The purpose of this article is to discuss the tax benefits of corporate-owned life insurance and what it means to you as a business owner.
Many are aware of the basic life insurance needs, i.e. paying for funeral costs and covering debts assumed by loved ones on death. However, to understand life insurance, you must first understand the different types available to you. The two types of life insurance are as follows:
1) Term Insurance - think of this insurance like car insurance; if you don’t use it, you lose it. This type of insurance is the least expensive and limits your tax planning opportunities.
2) Permanent Insurance - this type of insurance is an asset/investment. Once your premiums are fully paid, it is forever available as an investment.
A significant consideration is where the life insurance policy is owned (personally or through a corporation). Holding life insurance in a corporation, with the corporation being the beneficiary of that policy, allows business owners to pay for premiums with corporate dollars (which is more advantageous than using personal dollars). Although these premiums may not be deductible to the corporation, when the proceeds are received by the corporation, the majority (if not all) of the funds can be paid to the shareholders on a tax-free basis, through the capital dividend account.
So, what are the tax planning opportunities with respect to life insurance?
Estate Tax: Many business owners are not mindful of the estate tax on death. Those that own private corporations and sizable real estate portfolios are likely to owe a significant amount of tax on death, without cash available to pay for that tax. This leaves beneficiaries in a position where they need to sell off assets to pay for this estate tax. Life insurance helps ensure that your families will not be faced with this tax burden while maintaining your family wealth and assets. It allows the business to carry on and for your loved ones to keep those prized real estate investments for generations to come!
Protection of the Small Business Deduction: As you are likely aware, Canadian Controlled Private Corporations have a beneficial tax rate on the first $500,000 of active business net income (currently 12.2% in Ontario). As a result, a common tax strategy has always been to leave funds in a corporation, pay low tax and invest the capital in a passive portfolio, including securities and real estate.
Unfortunately, the 2018 Federal Budget interfered with the above planning. At certain passive income thresholds (starting at $50,000), it may be punitive to earn passive income in a corporation as it grinds the corporation’s ability to access the small business deduction. As a result, business owners may jeopardize the 12.2% tax rate on their active income.
What many are not aware of is that the “grind” in the tax rate does not apply to income earned inside of a life insurance policy, as the income is tax-sheltered. Therefore – no tax and no grind…seems like a positive result.
Using your Policy as a Financing Tool: If properly structured, there is also the potential to access the cash value of a permanent life insurance policy during your lifetime. Individuals can take a policy loan, use a collateral assignment or surrender the policy to access the cash as needed. If either a policy loan or collateral assignment is used for business or reinvestment purposes this may provide for tax deductions Please note that this planning requires careful consideration and should not be executed without advice from a tax professional.
In summary, corporate-owned life insurance yields many tax benefits with the key ones being addressed in this article. To understand more about these tax benefits we encourage you speak to an advisor or contact our office.
VC Partners LLP is a boutique accounting, tax, audit, and consulting firm, located in the GTA.
For any questions, please reach out to one of our team members.
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Disclaimer: Please note that VC Partners LLP is not in the business of selling life insurance policies. We are here to support you when speaking with your advisors with respect to life insurance and the potential tax benefits. This type of planning is not for everyone.