Corporate-Owned Life Insurance
According to the Government of Canada, life insurance can help individuals cope with the financial impact of a person’s death. The life insurance death benefit may be paid out through a tax-free, lump-sum dividend.
Corporate-owned life insurance is a type of life insurance policy that pays a kind of benefit to a business when an insured employee passes away. Many companies opt for this type of life insurance to lower their tax burden, raise their after-tax net income, boost employee benefits, and cover expenses resulting from a worker’s death. Often, not all employees are covered under this policy. Only the most critical, or typically top 35% of employees based on their compensation, are protected and notified before a policy is purchased.
Corporate-Owned Life Insurance Tax Benefits
There are various ways corporate-owned life insurance can reduce and even eliminate taxes. For instance, consider the following:
- Companies can purchase more insurance with corporate dollars: The cost to fund life insurance policy premiums are often lower if a corporation pays versus an individual since a corporation’s tax rate is usually lower than a personal tax rate. For instance, a business that is a Canadian Controlled Private Corporation can claim a small business deduction, where the net tax rate is at 9%, effective since January 1, 2019. This small business deduction lowers the Part I tax that an enterprise would otherwise be required to pay.
- Companies can gain a tax-free transfer of insurance: For a business to receive tax-free proceeds, they need to be both the beneficiary and the owner. Many times, shareholders purchase a corporate policy to cover their personal needs simultaneously. Nonetheless, a portion or nearly all of the insurance proceeds can go to the shareholder’s estate tax-free. When an insurance payout goes to the enterprise, a credit is added to the Capital Dividend Account (CDA).
The CDA is a separate, notional account giving shareholders tax-free capital dividends that are not recorded in a business’ taxable financial statements or accounting entries. A notional account means that this isn’t actually a real account with funds that are deposited into it – it is purely used for tax calculations to determine the amount of funds that can be designated as a capital dividend and paid out tax-free. All private corporations in Canada qualify for a Capital Dividend Account. The CDA is determined by subtracting the adjusted costs basis from the death benefit. It can be paid out tax-free immediately or for a future time.
Premium deposits are able to grow tax sheltered: A tax shelter in Canada aims to lower or eliminate tax liabilities and allow investors to pay reduced taxes. Various insurance policies fund extra deposits for the accumulation of business assets. These corporate assets are recorded on corporate balance sheets and can be beneficial for companies and their shareholders. For instance, tax-free savings accounts allow Canadian investors to earn investment income, such as dividends, interest, and capital gains tax-free. Furthermore, these corporate assets can strengthen a company’s banking relationship and the ability to receive additional lending.
- Key-person life insurance can give companies quick access to funds: As previously mentioned, critical employees such as owners or managers are often covered under life insurance. If a key employee suddenly passes away, the life insurance policy can serve as a business interruption insurance to provide extra time for the remaining owners to create a succession strategy. Many times, investors require companies to have key-person life insurance. If it is a requirement for financing, a portion of the premiums can be deductible based on factors such as the net cost of pure insurance, the total amount of life insurance purchased, and the average loan balance amount from the year.
- Life insurance can be used to fund capital gains taxes due to death: If an owner of a company owns shares at their death, their taxes will have to be paid. However, life insurance can help provide liquidity to fund such taxes. For instance, many Canadian controlled private corporations are made up of a group of shareholders who can be related or unrelated business partners. Having one shareholder pass away can put a strain on the other shareholders, so it is commonplace for them to enter into a shareholders’ agreement. This agreement goes beyond corporate law and sets regulations on how the business will be governed and what will result in case a shareholder dies. For example, the contract may state that shareholders will hold insurance on each shareholder’s life, so that they can purchase the shares owned by the deceased. Otherwise, the agreement may indicate how a business will have life insurance on all shareholders’ lives to use the life insurance proceeds to redeem the shares from a deceased shareholder.
- Corporate wealth transfer allows for passive wealth to accumulate: Passive wealth accumulates and grows without needing to manage funds actively. Investing in an initial sum of money can get reinvested and grow exponentially. With a corporate-owned life insurance policy, a business can decide to add an investment aspect to reinvest money back to the insurance benefit amount. This total can grow tax-free and increase the sum of the insurance benefit payout upon death.
- Purchase a corporate insured annuity for surplus capital: A corporate insured annuity contract can be bought from a corporation liquidating their interest-earning investments. The cash flow produced from the allowance can pay for life insurance premiums and tax payables on the annuity income. Any remaining funds can be used to supplement a business’ income on a higher after-tax basis. When a death occurs, an enterprise can receive a tax-free benefit from the corporate-owned life insurance policy.
Overall, life insurance can serve as an effective way to manage corporate operations and tax costs in case a death occurs.
FINAL THOUGHTS
Corporate-owned life insurance can serve as an investment alternative for companies to accumulate tax-deferred assets. Businesses can pay non-deductible premiums, gain tax-deferred cash values, raise liquidity, and receive tax-free death benefit proceeds.
To learn more about the tax-free benefits that come with corporate-owned life insurance, contact the experts at Hometown Life Insurance. Our licensed professionals will be happy to answer any questions you have.
