How to Accumulate Wealth Through Corporate-owned Life Insurance

You work hard as an entrepreneur. After years of development, your company’s earnings have been growing and debt has been reduced. At this point, you may be thinking about how to use the company’s funds to invest and pass on the assets effectively.

Now we have an excellent strategy to help you solve the above problems. It is to use the company’s retained earnings to purchase permanent life insurance to accumulate wealth.

Buying corporate-owned life insurance has the following advantages:

1. Corporate-owned life insurance can achieve higher returns
2. Using “cheaper” corporate dollars to pay insurance premiums
3. Insurance investment income will not affect CCPC Small Business Deduction (SBD)

1. Corporate-owned life insurance can achieve higher returns

Compared to investing in GICs or other investment products with corporate funds, investing in life insurance can achieve greater and more stable returns. It can also be used as a tax-effective savings vehicle. First of all, shareholders can immediately get the protection that worth several or even dozens of times of the initial premium. Second, the investment returns of the policy can be qualified for the preferential tax treatments. In some cases, the returns can even be completely tax-free.

To better explain this strategy, please see the following example:

Mr. Smith is the sole owner or key shareholder of a private company. He is in good health. His company is very profitable, and he has no plans to use these retained earnings for any specific purpose. Further down the road, he hopes to transfer this wealth more effectively to his children or other beneficiaries.

Let’s assume Mr. Smith is:

1. 35 years old
2. Plan to invest $18,755 annually
3. Has a corporate investment tax rate of 50%
4. Has a shareholder dividend tax rate of 40%

Now, he has two investment options:

1. Purchase 1 million permanent life participating insurance
2. Purchase a GIC with a 2% annual interest rate

Which option is better? Let’s compare

As can be seen from the above figures, the returns from insurance are much greater than the GICs. Moreover, as investment continues to grow, the gap between insurance and GIC widens. At first, there was a gap of about one million dollars between the two. When Mr. Smith turns 85 years old, the gap can be as high as three million dollars. Therefore, insurance not only protects the insured but also can grow its value quickly. It maximizes shareholder value.

2. Using “cheaper” corporate dollars to pay insurance premiums

There are many factors to consider when choosing between an individual and corporate ownership. Where the funds to pay insurance premiums are insides a corporation, income tax savings will normally result. If the corporation pays dividends or salary directly to the shareholders then to pay the premium, shareholders may need to pay income taxes on the received amount. For example, in Ontario, the highest personal marginal tax rate for 2019 is 53.53%. Assuming that money is taken out of the corporate account in the form of salary to buy insurance, that person’s ability to purchase insurance will be significantly reduced.

Let’s make the simplest comparison by using Mr. Smith’s example. His company has $18,755 to invest every year. If he chooses to invest in corporate-owned life insurance, he can get a $1,000,000 insurance policy. If he chooses to take money out as a form of salary then invest in insurance, he may only afford a $455,000 insurance policy, assuming Mr. Smith is taxed at the highest marginal rate 53.53%. $18,755 is only $8,175 after tax. As you can see, his purchasing power has been greatly reduced.

3. Insurance investment income will not affect CCPC Small Business Deduction (SBD)

In 2018, the federal government of Canada revised some rules that had a significant impact on Canadian-controlled Private Corporations (CCPCs). For companies with passive investment income of more than $50,000, they may be required to pay more taxes under the new regulations. Passive investment income may include interest, capital gains, rents, royalties or dividends received by the company. When it exceeds the threshold of $50,000, every extra dollar earned on the passive investment income will reduce SBD limit by $5. When the passive investment income exceeds $150,000, the SBD limit will be reduced to $0. A CCPC can no longer enjoy the preferential tax rate.
Under the current tax law, the investment returns from life insurance will not be counted as passive investment income; therefore, will not affect the SBD limit. Companies can continue to enjoy the preferential tax rate up to $500,0000 in their active business income.

If you want to know more about the new rules, you can visit: How to avoid paying more taxes for passive investment income?

Of course, everything has two sides, corporate-owned life insurance has the following disadvantages:

1. No creditor protection
2. Additional accounting and legal fees may be incurred

1. No creditor protection

The biggest drawback of life insurance owned by the corporation is the loss of creditor protection. A personally held policy usually receive enhanced creditor protection because the policy can designate certain family members as beneficiaries under the policy. This protection applies to the cash value and death benefit payable under the policy. On the other hand, this might not be the case for a corporate-owned policy. A corporation cannot normally designate family members as beneficiaries without raising shareholder concerns. Therefore, a creditor can claim the insurance policy like any other investments held by the company. Having said that, in some cases, the corporation can use a holding company to buy life insurance to mitigate the risk.

2. Additional accounting and legal fees may be incurred

Investing in corporate-owned life insurance often requires tax and legal advice, which may incur additional costs. If the policy amount is too small, using professional services might not be worthwhile. It might be more cost-effective to purchase an individually owned life insurance policy instead.

Conclusion

There are advantages and disadvantages to buying corporate-owned insurance. The biggest advantage is the tax benefits. The biggest drawback is the loss of creditor protection. But with careful planning, the advantages of owning a corporate-owned policy usually far exceed the disadvantages. Your financial advisors can help you assess whether corporate-owned life insurance can play a beneficial role in your company’s operations.

Disclaimer

All content on this site is information of a general nature and does not address the circumstances of any particular individual or entity. Nothing in the site constitutes professional, legal, tax, investment, financial, insurance or other advice, nor does any information on the site constitute a comprehensive or complete statement of the matters discussed or the law relating thereto. For more information, please visit ApexLife.ca.