Before we can even begin to dive into any strategies involving permanent life insurance, I need to explain the basics of permanent life insurance as well as how corporate life insurance works.
Okay, let’s break into it.
There are two major types of permanent life insurance:
- Universal Life Insurance
- Whole Life Insurance
Both have MANY misconceptions around them and have had decades of bad salesman misinforming clients in the pursuit of commissions.
Marketing gimmicks and fads come around quite often and exploit insurance when it’s popular or at a particular “hot” point in its cycle.
It’s the same with all financial vehicles, if you will remember when mortgage rates were as high as 15% and corresponding GIC rates were 13% they were the hottest item to sell.
Now GIC rates don’t even keep up with inflation and the vast majority of Canadians understand they’re a terrible long-term investment to the avail of most banks.
Life insurance can be quite complicated but I’m going to try and simplify it as much as possible.
In this post, I’m going to go over how insurance works within a corporation.
Life insurance in a corporation:
When a corporation wants to hold a life insurance policy on one of the shareholders this is generally how you would have it structured.
- The corporation is the owner of the policy
- The corporation is the payor of the policy
- The corporation is the beneficiary of the policy
- The shareholder is the life insured
Upon death of the shareholder the following events happen:
- The face amount is paid into the corporation
- A capital dividend account (CDA) credit will be created
- Face amount (-) ACB of insurance (=) CDA
- Proceeds can flow through CDA tax-free to the deceased estate or other shareholders as outlined in the shareholders agreement (USA).
Few definitions and explanations:
Capital Dividend Account:
The CDA is a notional account within your corporation that allows for tax-free capital dividends to be paid out to shareholders.
Just like when you sell off property and 50% of the sale is tax-free, that 50% flows out through the CDA.
Adjusted Cost Basis (ACB) of life insurance:
With permanent life insurance there is an ACB attached to it.
The discussion of ACB of a life insurance policy is beyond the scope of this email, however, what you need to know is that in the early years of your policy you may have a high ACB.
In the later years of your policy, your ACB is usually ground down to zero hence creating a 100% CDA credit from the face amount.
- Steve Co. owns a $1,000,000 whole life policy on Steve
- Upon death $1MM is paid into the corporation
- There is no ACB on this policy
- Face amount (-) ACB (=) CDA
- $1,000,000 (-) $0 (=) $1,000,000
- Available CDA increases by $1,000,000
- Entire face amount can flow out to Steve’s wife who is also a shareholder of Steve Co. tax-free through the CDA.
There are infinitely more complications than this but I hope this begins to give you a basic explanation of how corporate life insurance works.
I will encourage you to schedule a free 30-minute strategy session with me.
What this session will highlight is:
- If you have unforeseen liabilities threatening your future
- How you can be more efficient with your finances and save on taxes
- How you can receive maximum after-tax value from your company if/when you sell
- How you can pass down your business to your family without sacrificing your goals
- If your planning has something missing from it
So please schedule a session and I look forward to exploring how we can help you.