Back End Leveraging

Now that you are an expert in the world of insurance and permanent life policies, I’m going to throw a couple advanced concepts at you. I’m going to first discuss the problem that this concept addresses and then you will see how insurance can be effectively used to solve it.

Most successful business owners retain cash within their corporation since once the owner is at a certain marginal tax rate it doesn’t make sense to take any more profits out personally as the taxes are so high.

This leads to business owners putting their profits into different investment vehicles such as mutual funds or stocks within their corporation. The problem with passive investments within a corporation is that the taxes on any gains are quite high. In Alberta the passive investment tax rate is 50.67% combined Federally and Provincially. (2019)

Not only are the returns taxed quite highly, the business owner still has the difficulty of getting the cash out of the corporation upon retirement. He/she will still most likely have a high marginal tax rate and the cost of paying out profits via dividend or salary will likely cut it in half with taxes.

Okay, so how does insurance fix this problem?! You’re about to learn!

One thing that we didn’t talk about in the last two emails is cash surrender value (CSV). Both universal life and whole life policies have something known as CSV and you can think of it like the equity within your life insurance policy.

There’re two major things that you can do with CSV:

  1. If you cancel your policy the insurance company is obligated to pay you whatever the amount of CSV you have. (May be taxed)
  2. You can use the CSV to take a loan either internally or with a third-party lending institution.

Again think of it like the equity within your home, if you sell your home you would receive it, but you can also use it to get a home equity line of credit (HELOC).

Now here’s the thing.

A permanent life insurance policy classified under section 148 of the Income Tax Act (ITA) is tax exempt from any growth it receives in this policy within certain limits and depending what type of insurance it is. That means that the CSV can grow within the policy tax free which can be quite substantial growth when other investments in your corporation are taxed at more than 50%.

Now you can use this for a concept known as back end leveraging.

Upon retirement the business owner can use the CSV to obtain a secured line of credit. He/she then uses this year over year to supplement their retirement income. You can pay it personally in a couple different ways which all have very specific tax consequences.

  1. The corporation receives the loan and pays out a dividend to the shareholder. (Dividend tax rates)
  2. The corporation receives the loan and pays out a salary to the shareholder. (Salary tax rates)
  3. The shareholder pledges the corporate asset and takes the loan personally. (Tax-free)

Upon death the loan will be repaid with the insurance and the remaining amount will be paid to the beneficiary of their choice.

Now you’ll remember from the last email we talked about Paid Up Additions. Because your face amount is constantly growing there can be no need for you to pay the interest on this loan. You can enjoy the supplemental income from this loan over your retirement and it’s completely repaid upon death.

This can be an effective way to grow a larger retirement income, as well as provide options for more efficient taxation when taking income from your corporation.

There are a million things I couldn’t include in this post, there is quite obviously a bit more complications than laid out here.

I will encourage you to schedule a free 30-minute strategy session with me.

What this session will highlight is:

  1. If you have unforeseen liabilities threatening your future
  2. How you can be more efficient with your finances and save on taxes
  3. How you can receive maximum after-tax value from your company if/when you sell
  4. How you can pass down your business to your family without sacrificing your goals
  5. If your planning has something missing from it

So please schedule a session and I look forward to exploring how we can help you.

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