Corporate Insurance Opportunities in the Growth/Mature Phase of the Business Cycle



In the previous article (published Sept 15, 2022), we explored the most common insurance opportunities we find in the development/growth stage of the typical business cycle: Business Loan Protection, Key Person funding, and Buy-Sell funding. In this article, we’ll move up the business cycle and look at the opportunities in the growth/mature stage. Here, I’ll focus on strategies that generate some of the largest premium sales in our industry: (1) Estate Preservation (Capital gains funding), (2) Estate Maximization (Corporate Estate Bond), Retirement funding (Corporate Insured Retirement Program) and (3) Immediate Financing Arrangement (IFA). It’s here that we find the transition from “needing” to “wanting” insurance begins to take hold.


Estate Preservation: (Capital Gains Tax Planning):


One of the main purposes, why people purchase life insurance, plays out here. The need/want for “estate preservation” is for those individuals who have been successful in amassing a great deal of wealth over the course of their lifetime (wealth in relative terms, that is). Their concerns now transition from protecting their number one asset, which was “their ability to earn an income” (human capital) to protecting their financial capital (in the form of business assets, and/or investment portfolios). Their aim is to minimize the impact that taxes will have on their ability to transfer their wealth in-tact, to the next generation.


The increasing value of a business will mean a growing tax liability. At death, 50% of the increase in the value of the property will be taxed. Any taxable gain that is not sheltered by the capital gains exemption and/or the qualify for a rollover will be subject to taxes. The question then becomes, how do you want to pay for this?


If funds or other assets are not available to pay for this tax liability, the shares or partnership interest may have to be sold, or business assets may need to be liquidated, possibly for a price below fair market value.


Although these options do exist, they’re often not the most cost-effective/efficient use of your hard-earned money. Life insurance may be purchased to provide the necessary funds at the right time to pay for the tax liability. Permanent life insurance is particularly valuable especially when the beneficiaries wish to retain the asset, or the market conditions are not favourable to sell the property at fair market value. In fact, for every net estate dollar needed to pay the tax bill, a business owner’s corporate investment/assets will need to be worth more than a dollar. Life Insurance delivers the same outcome for only pennies on the dollar. The individual can own the life insurance policy, or it can be owned by the corporation or partnership and flowed out to the individual’s estate after death.


Estate Maximization


As in the previous scenario, the motivation to acquire life insurance is more of a WANT than a NEED. In the process of building a successful business, most business owners have identified certain assets that are not needed to support their lifestyle or business goals. Having originated from retained profits or surplus cash of a business, whether held in an operating company or an investment holding company, these assets are often invested in GICs or other taxable investments. Unfortunately, these taxable investments may not be the most advantageous way for the corporation to invest its retained profits. The challenge is the investment growth is taxed each year and most, if not all the dividend distribution to the estate, is taxed (either due to redemption of shares or wind up of the corporation on death). As an alternative to traditional investments, a tax-exempt permanent life insurance plan can offer the opportunity to minimize taxes during the accumulation phase and minimize taxes during the distribution phase (either while alive or on death via CDA). Depending on the client’s objectives, the insurance solution may be designed in such a way as to build up more cash value tax effectively to preserve or improve liquidity for either short-term needs (IFA) or long-term needs (Corp IRP).


Here we find the two most touted solutions promoted in our industry:


1) The Corporate Estate Bond, also referred to as the Corporate Estate/Asset Transfer, Corporate Preferred Estate Transfer, or Corporate Investment Strategy.


2) The Corporate Insured Retirement Plan, also referred to as the Corporate Asset Efficiency and the Corporate Preferred Retirement Solution


By the far, the two MOST POPULAR and therefore the MOST IMPLEMENTED insurance sales concept used in the corporate market space today. The Corporate Estate Transfer strategy is a corporate insurance concept designed to increase the after-tax value of the corporation to the heirs of the business owner. The Corporate Insured Retirement Plan is a corporate insurance concept designed to provide insurance protection for the business or the estate while accumulating funds tax effectively for future needs (most often, to supplement the business owner’s retirement lifestyle). To learn more about accessing cash values, including collateral borrowing (personal vs corporate borrowing), please refer to the articles found in the links below (parts 1 and 2 links below):


https://www.qfscanada.com/post/corporate-borrowing-vs-personal-borrowing-which-is-best-part-1


https://www.qfscanada.com/post/corporate-borrowing-vs-personal-borrowing-which-is-best-part-2


It's here where we get introduced to permanent life insurance as an ASSET CLASS.

Especially in a corporate setting, PERMANENT LIFE INSURANCE can significantly increase the after-tax transfer of wealth to the heirs by virtue of the capital dividend account.


Immediate Financing Arrangement (IFA)


For business owners with multiple needs (insurance and business growth) but only enough internal capital to do one or the other, the IFA may be right for them. The IFA is a great solution for business owners who understand the value of permanent life insurance for all the reasons mentioned above (estate preservation, estate maximization) but also want access to capital to pursue growth opportunities in their corporation. The IFA accomplishes this objective by giving business owner’s both a tax-exempt permanent life insurance policy and access to capital with minimal impact on cash flows.


Here is how it works. While alive…. the corporation purchases and makes premium payments into a permanent life insurance policy. The policy is then assigned as collateral and a loan facility is established (additional collateral may be required in early years if borrowing up to 100% of the premium). The lender advances funds to the corporation and proceeds are invested into business activity or investment opportunities. The corporation makes interest payments (may also borrow to pay the interest). Since the business owner is using loan proceeds to earn business or investment income, the interest on the loan and a portion or all the policy premiums may be tax deductible. This series of deductions results in a significant reduction in after-tax cash flow needed to fund the life insurance. This works best for corporations that are subject to the highest tax rates and to continue to have significant taxable income. At death…a claim is submitted, and the insurer pays off the debt. The insurer then pays the balance of the death benefit to the corporation and a capital dividend account is created (total death benefit less ACB ACB). The net death benefit is paid to the shareholders tax-free via the capital dividend account. As a result, this excess CDA allows other corporate assets to exit tax-free.


Although the prospect of acquiring permanent life insurance with little to no cash flow is attractive to most, the process involved to qualify for both life insurance and a line of credit can derail even the most ambitious goals. A full credit application and disclosures will be required by the lender at the time of issue and throughout the loan period. Lenders often ask for corporate financial statements, personal net worth statements, and tax returns along with insurance policy illustrations. Since it involves carrying debt and tax rules can change….it’s not for everyone. But for those who fit the bill, it can significantly enhance their overall financial outlook.


In these last two articles, we’ve seen the evolution of life insurance throughout the business cycle from a pure needs-based solution (risk management solution) to a wanted most sought-after asset class solution. Initially, in its ability to provide/create an instant infusion of cash at a time when the business needs it most (to allow it to survive and thrive) and later to create a solution that increases the after-tax transfer of wealth to the next generation while addressing liquidity concerns (both short and long term)for the business owner. It’s a solution that has proven to most versatile and integral part of every business owner’s financial plan.



Tony Gallippi, B.A.S (Hons.) CFP CLU

Advanced Case Consultant

QFS

tony.gallippi@qfscanada.com



This communication reflects the views of Qualified Financial Services Inc. as of the date published. The information in this publication is for general information purposes only and is not to be construed as providing individual legal, tax, financial or other professional advice. Qualified Financial Services Inc. assumes no responsibility for any errors or omissions in the information contained herein nor for any reliance placed on such information. Please seek independent professional advice before making any decisions.