April 7, 2023

The Need for Corporate Owned Life Insurance

Chris Lubell

In a private corporation, life insurance is generally utilised for two things: risk management and opportunity creation. As a result of life insurance, which provides the organisation with a tax-free reimbursement in the event that an owner or another person who is essential to the company's success passes away, the risk management role is accomplished. Additional planning options are available since life insurance permits the tax-sheltered accumulation of monetary value.

The following are the main requirements for corporate-owned life insurance to fulfil the risk management objective:

Key Individual Life Insurance

Any shrewd corporation would insure its buildings and machinery that generates income. Therefore, the company should also provide life insurance for the employees who manage the business and take the decisions that affect its profitability. Any owner, management, or worker whose demise might impede the company's ability to expand and succeed in the future is a vital individual and ought to be covered by life insurance as such.

Through consultation with the company's management, life insurance advisor, and accounting specialists, the appropriate amount of key person life insurance should be established. In this conversation, the potential damage to the organisation from the loss of a key employee will be analysed and estimated.

Funding the Partnership or Shareholders Agreement

It is customary in business for there to be a Shareholder's or Partnership Agreement when two or more persons join forces to own a business or partnership. The terms and conditions of the parties' cooperation in the business venture are outlined in these documents.
The protection of the shareholder's heirs should be a top priority in these agreements. The employment of corporate-owned life insurance for this reason ensures that, in the event of death, there will be sufficient monies available to purchase the dead partner's interest from his or her estate.

To Pay Off Debt

A business owner should think about life insurance for the commitments of the corporation. This would guarantee that the company's net value is maximised when it is transferred to the owner's heirs and beneficiaries or to a successor owner (who might be a relative).
The Capital Dividend Account is one benefit of using corporate-owned life insurance to pay down debt. The company receives the life insurance proceeds tax-free in the event that the insured business owner passes away. A hypothetical account called the Capital Dividend Account (CDA) is credited with the death benefit less the policy's adjusted cost basis. The credit left in the CDA can still be given tax-free to the surviving or succeeding shareholders even if the firm pays all the life insurance proceeds to the creditors to discharge the outstanding debt obligations.

This enables the heirs to collect any surplus or potential earnings as tax-free capital dividends up to the CDA's remaining balance after the insured's passing.

To facilitate financing for investments or businesses

The bank frequently demands that the corporation's principal(s) have life insurance when a firm borrows money for operations or investments. If the life insurance is obtained in this situation as a prerequisite for receiving the bank loan, then a portion of the life insurance premiums will be tax deductible to the corporation.

The justifications for purchasing life insurance for the bank loans are in line with those given in the section on paying off debt, but thanks to the bank's formal request for life insurance, a tax deduction is also now possible.

Additionally, there may be circumstances in which a potential investor would prefer that the company's owner obtain insurance before making an investment. Even though there would be no deduction for collateral insurance in this scenario, it might give an investor comfort.

Helping the family business succeed

It's common in family businesses to want to pass control of the enterprise on to the following generation. Making ensuring the business is still in good financial shape for the next generation to take over is one of the shared goals of this transition. This can be achieved by having life insurance on the first-generation owner to ensure that, should the succession take place as a result of the death of the firm founder, the company is left financially sustainable and debt-free.

Additional advantages of corporate life insurance

The examples listed above are all instances where a firm would use life insurance to mitigate risk. Holding life insurance through a corporation might also lead to appealing planning opportunities. The following are some of these possibilities:

Planning Your Estate as a Business Owner

The first $500,000 of yearly corporate income is taxed at a very lenient rate for owners of private corporations that qualify as small businesses in Canada. Each province has a different rate. For instance, it is 11% in B.C. and Alberta for 2021 and 12.2% in Ontario. Due to the low small business tax rate and the Capital Dividend Account described above, the business owner has the chance to purchase life insurance in the corporation that is earmarked for estate planning purposes (such as paying taxes due at death on capital gains).

Corporate Investment Income Protection

While there is a relatively low income tax rate on income from active businesses, there is a very high tax rate on corporate investment income. This tax is higher than 50% in some provinces. It may be possible to significantly delay paying taxes by using tax-exempt life insurance policies to conceal this investment income.

Preserving the rate of the small business income tax

Utilising whole life or universal life insurance to maintain the small company income cap is another benefit to the firm. A corporation's $500,000 small company tax ceiling begins to be reduced whenever it earns passive investment income of more than $50,000. The small company restriction for that tax year is completely eliminated once the passive investment income hits $150,000. Purchasing tax-exempt life insurance is one option to prevent this. The investment increases tax-sheltered and has no effect on the small business income threshold.

These are the main justifications for why company life insurance is crucial. It not only aids in risk management and corporate tax reduction, but it also offers the business owner important planning alternatives.

As always, feel free to spread this information to anyone you believe would be interested in it.

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