What is Business Life Insurance?

A business owner has the option to either purchase a personal life insurance policy or buy one in the name of the business. Business, or business-owned, life insurance operates similarly to personal life insurance in that it pays a death benefit and may include an investment component. However, company-owned life insurance offers additional benefits tailored to support business needs. For example, it can be used as loan collateral to provide immediate cash for the business. This type of insurance can be bought as a term policy (for 10, 20, or 30 years) or as a permanent policy (lasting the entire life of the owner), depending on the financial requirements of the business.

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articipating life insurance for corporations in Canada offers several advantages, making it an attractive option for business owners. Here are some key benefits:

• Tax-Saving: The cash value within a participating life insurance policy grows tax free. This means the corporation does not pay taxes on the investment gains as long as they remain within the policy. Unlike mutual funds, where investment growth is taxed annually, the growth within a life insurance policy is tax-free. This provides a significant tax saving benefit, making participating life insurance a more efficient investment vehicle for the corporation

• Tax-Exempt Dividends: Business owners don't need to worry about passive income rules as dividends from participating life insurance policies are generally tax-exempt. This allows the corporation to receive dividends without increasing its taxable passive income, which can be a significant advantage under Canadian tax laws.

• Dividend Payments: Participating policies can pay dividends, which can be used in various ways, such as reducing premiums, increasing the death benefit, or being taken as cash. Dividends received are generally tax-exempt, providing a source of income or additional growth without adding to the corporation's taxable passive income.

• Enhanced Death Benefit: The death benefit from a participating life insurance policy can provide a significant tax-free payout to the corporation. This can be used to fund buy-sell agreements, key person insurance, or to provide liquidity for the estate.

• Access to Cash Value: Corporations can access the cash value of the policy through policy loans or withdrawals. This can provide a source of funds for business opportunities, emergencies, or other financial needs.

• Creditor Protection: In some cases, the cash value and death benefit of a life insurance policy may be protected from creditors, which can be particularly beneficial for business owners concerned about protecting their assets.

• Estate Planning: Participating life insurance can be an essential tool in estate planning, helping to ensure that the business can continue smoothly after the death of an owner or key person. It can provide liquidity to pay estate taxes, fund succession plans, or provide for family members.

• Employee Benefits: Corporations can use participating life insurance policies as part of an executive compensation package. This can help attract and retain key employees by providing them with valuable life insurance coverage and potential access to the policy’s cash value.

• Premium Financing: Some corporations may leverage the cash value of the policy to finance the premiums. This can help manage cash flow while maintaining valuable life insurance coverage.

• Dividend Flexibility: Dividends from participating policies can be used to purchase additional insurance, enhancing the policy's value and increasing the eventual payout to the corporation.

• Strategic Investment: The conservative and stable nature of participating life insurance policies makes them a strategic long-term investment for corporations, balancing the company’s portfolio and providing a stable asset.

• Corporate-Owned Life Insurance (COLI) Policies: When structured properly, COLI policies can provide significant tax and financial benefits, including funding deferred compensation plans or other employee benefit programs.

 

These advantages can make participating life insurance a valuable component of a corporation's financial strategy, offering both protection and growth opportunities. However, it's important for corporations to work with financial and legal advisors to ensure that these policies are structured correctly and aligned with the company's overall financial goals.

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How Can Life Insurance Be Used for Your Business?

As a business owner, you may be concerned about how your business will continue after your death. Life insurance can be a vital part of a business continuation strategy, ensuring the business thrives even during ownership transitions.

• Key Person Insurance: This type of life insurance is owned and paid for by the business, covering the life of a key employee critical to the company’s operations. If the key person passes away, the business receives a tax-free death benefit, which can be used to cover expenses, repay debts, or hire a replacement. Key person insurance is a cost-effective way to maintain the business's viability and profitability by buffering against potential reductions in sales or growth during the transition.

• Buy/Sell Agreement: This contract outlines how shareholders or business owners can purchase shares from a deceased owner or partner. A life insurance policy can fund a buy-sell agreement, with the death benefit used to buy out the deceased partner’s shares from their heirs. This arrangement prevents partners from using personal funds or business assets to complete the buyout. While partners can individually own policies on each other, it is more efficient for the business to own the policies and manage the process.

• Estate Equalization: This strategy ensures fair asset distribution among a shareholder’s beneficiaries. Whole life insurance is an effective tool for estate equalization, especially when some beneficiaries are involved in the business, and others are not. Family members with a stake in the business inherit the business or assets, while others receive an equivalent cash value from the tax-free proceeds of the life insurance policy.

• Life Insurance Collateral Assignment: Business-owned insurance can also provide living benefits. A whole life policy accumulates cash value, which can be used for a policy loan or as collateral for secured funding from a bank. Restrictions may apply regarding how much cash value must accumulate before borrowing. If loan payments are not made, the collateral (cash value) can be used, reducing the policy’s death benefit.

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What Are the Risks of Corporate-Owned Life Insurance?

While corporate-owned life insurance (COLI) offers several advantages, there are potential risks:

• Tax Implications on Death: When a corporation's shareholder dies, and there's no spouse to roll over the shares, the shares are deemed disposed of at Fair Market Value (FMV) immediately before death. The cash surrender value (CSV) of the life insurance policy is included in the FMV calculation, potentially resulting in a high FMV and a substantial capital gain, leading to significant tax liability.

• Insurance-Tracking Shares: To mitigate this tax liability, insurance-tracking shares can be issued to the heirs (typically the business owner's child). These shares track the cash value of the COLI policy but do not entitle the shareholder to dividends, proceeds from a business sale, or voting rights.

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Contact Financial Solutions for free and professional advice:

While there are many benefits and flexible planning opportunities when purchasing and using life insurance through a private corporation, there are a number of additional complexities to consider. Corporate tax issues, shareholder agreements, accounting for permanent insurance balances and additional compliance for capital dividends are just a few. You should always consult the appropriate financial advisors to ensure the planning is done correctly and that compliance/administrative issues have been addressed. You’ll sleep better if you do.

At Financial Solutions, we work with a team of expert insurance and financial advisors, along with experienced business accountants, to serve you better.

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