The Tax Benefits of Corporately-Owned Life Insurance: An In-Depth Analysis from a Certified Financial Planner’s(CFP) Perspective

Corporately held life insurance can provide significant tax advantages for businesses and their owners, making it an attractive option for many. However, to fully leverage these benefits, it is crucial to understand the planning implications and potential pitfalls associated with such policies. We will delve deeper into corporately-owned life insurance's tax advantages and downsides from a CFP's perspective, highlighting the importance of proper structuring and financial planning.

Tax Advantages of Corporate-Owned Life Insurance

1) Premium Funding: Funding policy premiums through the corporation can be more cost-effective than doing so personally, given the difference in corporate and individual tax rates. This advantage can result in significant savings for business owners.

For example, let's look at Tom, a Canadian Controlled Private Corporation(CCPC) owner considering life insurance with a $1000 monthly premium. Tom’s personal marginal tax rate is 48%, while his corporate tax rate is 11%. If he were to fund the policy premiums personally, Tom would need to earn $1923 in the corporation, and after he pays himself personally, he would be left with $1000 after tax for premium payments. However, if his corporation owns and pays for the life insurance, only $1123 in pre-tax earnings are required for the $1000 premium, resulting in a $800 monthly savings.

2) Tax-Deferred Cash Value Growth: The tax-deferred growth of the policy's cash value can help business owners shelter their corporations from passive investment income, making corporate-owned life insurance an effective tax-planning tool.

This advantage is vital because passive investment income earned inside CCPCs has very punitive taxes associated with them, often taxed at the highest marginal tax rate. In addition, the new passive income rules introduced in 2018 could affect the tax rate on active business income in the CCPC if too much investment income is earned. The tax-deferred cash value growth within a corporate permanent life policy benefits business owners by helping them shelter the CCPC from passive income to reduce the impact of the two above tax integration rules.

While the tax deferral advantage of permanent life insurance also applies to personally held policies, investing within the company saves the tax cost of paying the owner through salary or dividends for personal investment. Permanent life insurance products appeal to business owners with surplus long-term investment funds for wealth accumulation inside the corporation.

3) Tax-Efficient Estate Planning: The creation of Capital Dividend Account (CDA) room upon receiving life insurance proceeds exceeding the policy's cost basis allows for tax-free capital dividends to be paid from the corporation to beneficiaries upon death. This feature can be beneficial for the tax-efficient transfer of assets to the next generation.

It’s worth mentioning that all the benefits mentioned above of corporate insurance are only tax efficient if the policy is structured correctly by a knowledgeable financial planner; otherwise, it could cause the CCPC owner significant future tax liabilities.

Potential Downsides of Corporate-Owned Life Insurance

1) Liquidity: Permanent life insurance policy investments are generally long-term and may lack the liquidity of marketable securities. Before purchasing a permanent life insurance policy, assess your cash flow needs and how the policy aligns with your overall investment strategy.

2) Sale of Business: Owning permanent insurance may pose issues if selling the corporation owning the insurance is anticipated. If not set up correctly, transferring the policy from the corporation before the sale could result in taxable gains and a potential shareholder benefit assessment if no consideration is exchanged for the policy. Again, avoiding this issue requires a financial planner or accountant specializing in corporate planning.

3) Access to the capital gains exemption: For business owners, holding permanent life insurance within a corporation may affect their ability to claim the lifetime capital gains exemption (LCGE) on their corporation's shares. The investment portion of a life insurance policy is treated similarly to marketable securities and other passive investments, not as an active business asset. When the shareholder is the life insured, the policy is typically valued at its cash surrender value to determine if the company shares qualify for the LCGE. With the 2023 LCGE on qualifying share dispositions at $971,190, your shares' qualification can significantly impact your future tax liabilities.

To conclude, corporate-owned life insurance can provide significant tax advantages to business owners. However, proper policy structuring and consultation with an accountant and corporate financial planner are essential to maximizing these benefits and reducing the impact of the drawbacks. A CFP can offer invaluable guidance on aligning life insurance policies with overall business and personal financial objectives while minimizing potential pitfalls and tax liabilities. By seeking the expertise of a CFP, CCPC owners can make informed decisions about corporate-owned life insurance and its role in their long-term financial planning. #financialplanning #financialliteracy #lifeinsurance