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Life insurance is an essential tool in traditional estate planning. It provides liquidity at the time of an individual’s death and offers peace of mind knowing their family is taken care of in case something should happen to them.
But did you know life insurance isn’t just for emergencies? Structured properly, life insurance can also be an essential tax planning tool and provide significant benefits today – not just after your death.
Life insurance generally falls into two categories – term and permanent.
Term insurance is just that: insurance for a fixed period; typically 5, 10 or 20 years. Every year of the term has a set premium, with a fixed amount of insurance available during that time. When the term ends, the policy and insurance coverage expire. Due to its time-bound and fixed nature, term insurance tends to be inexpensive.
Permanent insurance provides guaranteed coverage for life. The policy pays out the death benefit, regardless of your age or changes to your health, assuming you pay your premiums. In addition to the underlying insurance, permanent insurance policies include an investment component.
Although permanent insurance policies require premium payments for life, they are generally structured so the investment component of the policy funds the premium payments after a fixed term. This means that you might only need to make premium payments for 10, 15, or 20 years which is similar to a term insurance policy, however, the coverage continues for life. The self-funding nature of these policies makes them a solid method of creating wealth in the long term.
Using a corporation to purchase insurance allows for faster accumulation of wealth. By using corporate dollars instead of personal funds to pay for the policy, the same level of income can purchase significantly more insurance. If you were to buy insurance personally, you would need to pay personal tax on the money you’re taking out of the corporation and would therefore have less cash available to put towards the insurance policy.
Structured properly, most permanent life insurance policies in Canada are known as “Exempt Policies”. Any investment income earned inside these policies grows tax-free.
Also, investments within an insurance policy tend to outperform those within a standard investment account on an after-tax basis because of the personal and corporate tax rates on investment income.
When the insured individual dies, the corporation receives the tax-free death benefit – including both the base amount and any accumulated growth in the policy’s investment component.
The amount by which the death benefit exceeds the adjusted cost basis of the policy is added to the corporation’s capital dividend account. The corporation can pay this out to the remaining shareholders or estate tax free, creating an extremely tax-efficient outcome.
If you were to cancel an insurance policy at any time, the insurer returns an amount of cash to you. This is known as the Cash Surrender Value (CSV). Most policies include a guaranteed CSV and a variable component based on the growth in the investment part of the policy.
Since the CSV is a liquid and secure asset, financial institutions are typically happy to use the CSV as security for a loan. Some financial institutions will lend up to 100 percent of CSV. As the policy may be more than you intend to leave to your estate, you could access the value of the policy while you are alive by borrowing and using the policy as collateral.
With leveraging you can access the wealth accumulated within an insurance policy during your lifetime, not just after your death.
There are several ways to structure the borrowings. The corporation can borrow against the policy to either reinvest the funds, or make shareholder distributions. In some situations, and subject to addressing possible shareholder benefit issues arising from the use of a corporate asset to secure a personal loan, the individual shareholder may be able to borrow against the corporate-owned policy to either finance their lifestyle or investment needs. Depending on the use of the funds, interest on the borrowed money and a portion of the annual premium payments might even be tax deductible.
Corporate-owned life insurance is an incredibly effective estate, tax and liquidity planning tool if used properly. The type, amount and structure of insurance needed vary significantly depending on personal needs and circumstances. Contact an MNP tax advisor today to learn whether corporate-owned life insurance could help you reach your personal and professional goals.
Kerry Smith, CPA, CA, is a Partner within MNP’s Professional Services team. For more information, contact Kerry at 604.685.8408 or [email protected]
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