The Advantages of Corporate Owned Life Insurance
Written By: John Klotz
IT Entrepreneurs and consultants need life insurance like anyone else. The question often gets asked whether or not a life insurance policy should be owned individually or by the corporation.
Let’s take the example of Jim Smith, Software Entrepreneur. Jim is self employed and is the proud owner of Zenith Consulting Inc. an operating company that has revenues of $1 million annually. Jim also has a Holdco company called Jim Smith IT Consulting Inc. (JSIT) . Jim is a happily married to Jane Smith and they have two young children, Stevie and Melissa, aged 9 and 5 respectively. Jane is stay at home mom who has given up her career in advertising. They are financially dependent on Jim’s income.
If something unforeseen happens to Jim such as a premature death or disability, it is important that coverage be in place to protect his family. So he sat down with his trusted and advisor, Davey Jones, and came up with an insurance amount that would pay off mortgages and provide an ongoing stream of income for perpetuity. Several millions of dollars of coverage were required to replace his income for the next 20 years whilst his family grows up. And he agreed to it and went through the appropriate insurance hurdles of blood work and physicians reports and got approved.
Now Davey turned to him and asked “Jim, so, who is going to own this policy, you personally, or your company?”
Jim looked like a deer in the headlights. “Davey, what the heck are you talking about? What’s the difference? Isn’t it the same? What’s the big deal? Why are you trying to confuse me?”
Davey took a deep breath and began to explain. “You see, Jim, you may want to consider holding this policy in your Holdco ( JSIT). Remember your decision to incorporate. It was based on the fact that you were being taxed in the 47% marginal tax rate. You felt you were getting hosed by Revenue Canada with the huge personal taxes you were paying. As well, you needed to be protected from lawsuits, so incorporation presented a great tax and risk reduction strategy. Your accountant set up your Opco (Zenith). He also set up your Holdco (JSIT). Lo and behold, you suddenly found yourself in the 16 % corporate tax rate. That’s a huge difference, wouldn’t you agree?
Jim sighed…”Yes – we were getting hammered before with taxes, and now my taxes are so much more reduced.”
Davey continued. “With the premium on your life insurance being owned by the corporation, the corporation only has to earn $1191 for every $1000 of insurance premium, assuming a 16 % corporate tax rate. If you own the policy personally, with your 47 % marginal tax rate, you will have to earn $1886 for the same $1000 premium. That’s a big difference!
Jim was slack jawed. “That’s is a big difference, Davey. I want to have it owned by the corporation.”
Davey looked patiently at his client. “I’m not finished, Jim. Because, there’s more. In many cases, corporate owned life insurance provides tax planning opportunities that would be unavailable if insurance were held outside of a corporation. For example, there is the existence of the Capital Dividend Account (CDA). If you die, the insurance proceeds are paid into the CDA. The monies in the CDA can be paid out generally tax free dividend to your heirs less the Adjusted Cost Base (ACB) of the policy. Generally speaking the ACB decreases over time and becomes insignificant.”
“So What does this mean to me?” asked Jim.
“Well it means that your corporation can pay for the premiums at corporate tax rates and that Jane and the kids can receive most of the proceeds tax free, if it is structured properly.”
Jim thought about it for a moment.”But you told me that life insurance was a tax free payout. Now you are talking about tax on the life insurance”
“Good listening, Jim,” said Davey. “That being said, perhaps if you are concerned about the small amount of insurance proceeds that will be subject to tax, then you can increase your coverage on the insurance policy? Considering that you are paying less as a result of your 16 % tax bracket, then it might make sense to do so.”
“OK” said Jim.” I’m sold.”
“But Jim, there’s still more. Life insurance is tax shelter. Any growth within the policy accumulates tax deferred. Remember you mentioned that you had $25,000 annually you wished to allocate from the corporation to build wealth for yourself personally. The neat thing about the policy we have set up is that you can deposit monies into the policy and not pay any tax on the growth. When you want to retire, you can use the cash values in the corporation for collateral for a loan. The monies will flow out of the line of credit into the corporation and you can use the monies to pay yourself a pension. At the same time, the interest on the corporate loan is tax deductible to the corporation. When you drop dead at age 100, the life insurance pays off the line of credit and the rest of the monies flows tax free to your family through the Capital Dividend Account.”
“So you are telling me that not only can I protect my family, but I can shelter corporate assets tax free and create a retirement plan for myself?” plied Jim.
“Yes – I think you get it,” said Davey. “But there are some drawbacks to having the life insurance policy held in corporation versus owning it individually. One of the issues is creditor protecting the assets. If creditors make a claim against your corporation, they could seize the cash value of the insurance policy. That’s why it’s important to have the policy in the Holdco (JSIT), versus the Opco, (Zenith). As well, if the policy is owned by Opco (Zenith), the cash value is considered passive income and it could jeopardize the $750,000 Capital Gains exemption that Opco (Zenith) is allowed. This would occur if the cash values of the policy made is such that Opco (Zenith) went offside on the fact that 90 % of its assets must be used principally in active business. So, again, we’ve got to use the Holdco (JSIT), to host the policy.”
“Thanks Davey,” said Jim. “I guess there’s more to this insurance than meets the eye. Let’s set up the policy under my HoldCo (JSIT) and start the retirement plan! Now let’s grab our clubs and head out to the links!”
This article was written by John Klotz. John is President of Northwood Mortgage Life. You can reach John at firstname.lastname@example.org or call 416-783-7526.
The characters in this article are fictitious. However, the ideas are not. But the concepts discussed in this article are meant to be used in conjunction with the appropriate advisors including financial consultants, accountants, and lawyers. We will not be held responsible if you act on this article without getting advice from the proper disciplines.