Tax season is upon us! This time of year there is a flurry of T slips, RRSP contributions, Income summaries with all the paperwork it is easy to get lost in the details. I firmly believe in an encompassing approach to wealth management, which includes proper tax planning. Recently one of my co-workers reminded me of one of the ways life insurance can provide significant tax relief for business owners. As tax season heats up, I thought I would share the tax tip.
If a business owner has incorporated their business it is quite common to purchase life insurance within the corporation and use corporate money to pay the premiums. However I have personally seen many cases where folks have a corporation yet personally own their life insurance. My co-worker reminded me that in this specific case the personally held life insurance policy can be sold to the corporation. Paying corporate dollars to a shareholder is typically done as a salary or dividend, both of which are taxable. However the corporate money used to buy the life insurance policy would flow to the owner tax free.
There are a few wrinkles to this strategy. For one the Canada Revenue Agency mandates that the value of the policy be certified by a qualified actuary. The age and health condition of the life insured will have a big impact on the value of the policy. If the life insured is young and healthy the value of the policy will be smaller. However, for example, if the life insured is nearing retirement and has one or two minor health concerns the value of the policy will be higher.
To help clarify let’s use a few numbers. A life insurance policy with a $200,000 death benefit on a healthy 40 year old business owner likely won’t have a value much more than the cash value of the policy. Selling that policy to a corporation will provide minimal tax relief. However fast forward 25 years that business owner is now 65 with one or two minor health concerns, the likelihood of collecting that $200,000 death benefit has jumped, which means the value of the policy has increased. Pretend an actuary values the policy of the 65 year old business owner at $175,000. That personally held policy can be sold to the corporation allowing the owner to pull $175,000 out of their corporation tax free.
Once the life insurance is held by the corporation if the individual dies the death benefit will be paid to the corporation. This payment creates the Capital Dividend Account, that is a fancy accounting term, but the key is that the Capital Dividend Account can be paid out as a tax free dividend to share holders. The details of the business owner’s will determines who will get their shares when they die, however often it is a family member. If that is the case, through the Capital Dividend Account, the death benefit of the corporately owned life insurance can still flow tax free to the owner’s family.
This article provides a high level overview of selling a personally owned life insurance policy to a corporation. There are additional details and qualifications, it is best to consult your tax and insurance professionals before implementing this strategy.
This information transmitted is intended to provide general guidance on matters of interest for the personal use of the reader who accepts full responsibility for its use, and is not to be considered a definitive analysis of the law and factual situation of any particular individual or entity. As such, it should not be used as a substitute for consultation with a professional accounting, tax, legal or other professional advisor. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group.