Life Insurance

Life insurance can help unlock corporate reserves

January 23, 2015

So, three weeks into our trial separation, how are you feeling? I admit I’ve missed you, but must also admit that there are benefits to my new freedom.  (If you who missed it, we have switched to a once a month format for Dollars and Sense. Let us know what you think.)

Today’s column focuses on a fairly narrow niche, which is people who have a corporation, and who also have a personally-owned life insurance policy. If you are in that situation, or you are a professional advisor, lawyer or accountant, this will be of particular interest to you.

One of the benefits I have at my firm is that we have a team of professionals working with us, including an insurance specialist, tax accountant and estate planning lawyer. It’s impressive the things you can absorb hanging out with such smart people.

Last week I was reminded that a personally-owned life insurance policy may be a valuable asset that can be sold to a corporation, to take out cash. This policy has to be sold at verified fair market value, but such a transaction can allow the corporation to pay cash to the shareholder, without tax. Otherwise, this money would have to be paid out as a dividend or salary.

If the individual insured under the policy is older, has a health impairment or is uninsurable, the market value of the policy may far exceed its cash value. This market value must be certified by a qualified actuary to be satisfactory to the Canada Revenue Agency.

However, in circumstances where a person’s health prevents them from buying life insurance, or if they have to pay extra for a “rated” policy, then the actuary will generally certify that the life expectancy of that person is shorter than normal. (This situation arises more often than you might expect.)

For example, the market value of a $100,000 face amount life insurance policy on a 40-year-old with a 45-year life expectancy might only be the cash value (if any), with a very small value attributed to the present value of that future death benefit. There are a lot of premiums to pay between now and the expected payout.

On the other hand, let’s wait 20 years. Now, the life insured will be 60. If that person has any cluster of small health maladies that are treated with prescription drugs, then insurance companies might be saying they don’t want to take a risk on them, in terms of selling them a new policy. 

In a more serious situation, let’s say the person is in remission from a cancer diagnosis that was treated. They would certainly be uninsurable at that time. If the person is in their 70’s or older, “official” life expectancy is less than at younger ages.

In either of these situations, you can see that an actuarial valuation will give significant value to that death benefit, as it might be expected to pay out in, say, 10 years instead of 45 years.

That gives the policy a higher market value. Let’s make up a number of $200,000, certified by a qualified actuary. In that case, the policy can be sold to the owner’s corporation, and $200,000 withdrawn tax-free from the Corporation.

There are some other qualifications and complications, so please don’t do this without consulting your tax and insurance professionals.

Once the policy is owned by the corporation and the person dies, the corporation then receives the death benefit. This creates a balance in something called the Capital Dividend Account (CDA).  This value will depend on the price transfer.

The CDA can be paid out as a tax-free dividend to the shareholders. Likely, the new shareholders will be the estate of the deceased, or the spouse or children, depending on the wording in the Will.

Purchasing life insurance in a corporation, and using corporate dollars to pay the premium, is very common in the first instance. However, I have seen quite a few examples where people who own corporations also own personally owned life insurance.  This tip may prove beneficial.

Our next column will focus on helping you save on taxes when you file your return. For my part, I’m very excited that I’ve already started my tax return. I know that makes me a nerd, but I’m willing to share my discoveries with you.

All the best!

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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.

Please consult legal, tax, investment and insurance experts for advice on your unique situation.

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David Christianson, BA, CFP, R.F.P., TEP, CIMis a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.