Corporate-owned life insurance – estate transfer

BY ANDREW STEWART

Business owners have two options when choosing how to own a life insurance policy on their lives: corporate or personal. Why choose corporate ownership? Using low-tax corporate dollars to pay the insurance costs is a significant incentive for corporate ownership, but there are other advantages with corporate-owned life insurance.

Why corporate-owned life insurance?
A significant advantage of a corporate-owned life insurance policy is the annual tax savings reached from the corporation paying insurance premiums with dollars that were taxed at a lower active business rate. Life insurance premiums are generally not tax-deductible. As a result, not as much pre-tax dollars are needed when the policy is held corporately versus personally since personal tax rates are generally higher than corporate tax rates on active business income.

For example, Marie owns a dentist practice that is incorporated and is considering purchasing a life insurance policy with an annual premium of $10,000. Marie’s personal marginal tax rate on regular income is 50% and her dentist practice tax rate is 15%. If Marie purchases the policy personally, her practice will have to pay her $20,000 so that she has $10,000 after-tax to pay the annual premium. In contrast, if Marie’s corporation owns and funds the life insurance policy, it would only have to earn $11,765 before-tax to fund the $10,000 annual premium. This results in savings of $8,235 per year.

Apart from tax savings, there are other reasons why a corporation would own a life insurance policy. For example, it may need insurance for key person coverage, funding for a shareholder buyout, or insuring a bank loan.

Structuring a corporate-owned life insurance policy
In most cases the corporate policyowner should also be the beneficiary of the policy. If a shareholder is the beneficiary of the policy, the amount of annual premium paid by the corporation would likely be considered a taxable shareholder benefit. Taxable shareholder benefits are taxed as ordinary income and not deductible by the corporation.

Corporate-owned life insurance can maximize estate values in comparison to corporate investments
An estimated $3.7 trillion in business assets is expected to change hands by the year 2020 as 550,000 owners exit their businesses. Those assets are often used to purchase investments that generate income that’s taxed at the highest corporate rate, which ranges between 50.2% and 54.7% depending on the province or territory. The fact that 80% of business owners net worth is tied up in their company creates some unique challenges for them.

The focus of the corporate owned life insurance concept is to transfer the value of shares from the corporation into the owner’s estate in the most tax-efficient way possible. With this concept, the corporation redirects some of the after-tax surplus dollars from business income into a corporate-owned permanent life insurance policy rather than passive investments.

For example, suppose Marie is age 50 and her dentist practice is doing well and profitable. She can afford to allocate $50,000 of surplus from business income each year for the next ten years. Marie wants to create an inheritance for her children. Marie wants a tax-efficient way to get the value of her shares in the company into the hands of children. Marie looks at two options, she can invest into passive investments earning a decent 6% annual rate of return making no withdrawals. Or pay annual premiums for corporately owned whole life insurance policy with an initial death benefit of $1,000,000.

Compare results:
Let’s assume Marie lives a long life and dies at age 85. The passive investment total would be around $1,050,000 while the corporate-owned life insurance policy would have a life insurance death benefit of roughly $2,690,000. Marie can create an estate 154% greater than with passive investments.