Corporate Owned or Personally Owned Life Insurance: Which is best?
Of all the questions I’ve fielded in my almost 30 years in the industry, I must say, this one comes out on top. Like everything else, there are usually pros and cons on both sides of the fence. The best place to start is to have a clear understanding of the facts of the situation. Generally, there are 3 questions that need to be answered:
What is the purpose of insurance?
When and where will the life insurance proceeds be needed?
Where are the funds available to pay the life insurance premiums?
Life insurance is generally purchased because there’s a need for cash on the death of the life insured. Funds may be required to replace lost income, make a gift to charity, pay capital gains or other estate liabilities, fund a buy-sell agreement, pay off outstanding loans or absorb the loss of a key person in the business.
Once the purpose is determined, it’s generally obvious where and when the proceeds of life insurance are required: in the corporation, in the estate or some other beneficiary. It’s important to ensure that the ownership structure allows the proceeds to flow to it’s intended destination.
In other cases, there may not be a particular need for capital, but the objective may to maximize estate values and/or diversify an estate plan. In this situation, it’s important to determine where the cash is available to fund the life insurance policy. If for example the funds are available in the holding company, it’s best to have the holding company own the policy.
Even after all these questions are answered, it’s still possible that either alternative (Corp or Personal) will accomplish the desired objective. Let’s now weight the pros and cons of each ownership by addressing some of these other factors:
Cheaper After-Tax Dollars: Probably the single most important factor discussed by most advisors when weighing the two alternatives available, is about using “cheaper after-tax corporate dollars” to fund the policy. Although premiums payable for life insurance are generally not deductible for income tax purposes (unless it meets the CRA criteria for collateral insurance deduction), the fact that the corporation is generally in a lower tax bracket then the individual shareholder, which in turn generates a tax savings, is typically enough of a reason to favour corporate ownership. For example, an individual shareholder with a marginal tax rate of 50% would need $2,000 of income to pay a $1,000 insurance premium. That same shareholder’s corporation, subject to the small business tax rate of 12%, would require only $1,136 (pre-tax income) to pay the same premium. The assumption here, is that the funds required to pay the premiums, originate from the corporation. If the client has other personal funds from which to pay the premiums, whereby the tax has already been paid, this may not matter, and owning the policy personally may make sense.
Impact on Estate values: Although the death benefit paid is tax free to the corporation, the corporation may be limited in distributing these funds on a tax-free basis using the capital dividend account (CDA). This occurs when the policy has a positive adjusted cost basis (ACB), as the CDA credit is the death benefit less the ACB. Generally, as the insured approaches life expectancy, you can expect the CDA credit to equal the total death benefit. For the most part, renewable term insurance (not T100), has nominal to no ACB throughout the policy term.
Creditor protection: Although there are specific classes of beneficiary designations that protect policies against the creditors of the policy owner, unfortunately corporate beneficiaries are not one of them. For this reason, corporate owned policies which designates itself as the beneficiary, can expose both csv and death benefit proceeds to creditors of that corporation. This problem can be avoided by allowing a holding company to own and be the beneficiary of that policy, assuming of course, that the creditors potentially only reside in the operating company. Provided that the Holdco has not guaranteed the obligations of the Opco, this option should work fine. In theory you may also consider designating another person or corporation as beneficiary (to protect death benefit only, not the csv), but this may not be practical due to the taxable benefit situation that it creates (ie owner: corporation, beneficiary: spouse of insured).
Valuation of shares and other tax considerations: Since a corporate owned policy is a corporate asset, in most circumstances it’s the cash surrender value (not death benefit) will affect the fair market value of the shares of the corporation. This will contribute to the capital gains tax assessed on deemed/actual disposition of those shares. There are other scenarios, although few, whereby the CRA may consider other factors to determine the value of the corporate policy (beyond the csv). This can result in a valuation that lands somewhere between the csv and the death benefit of the policy.
In addition, a life insurance policy is generally considered a passive asset. For this reason, the value of the policy (generally the csv) can affect whether the shares qualify for the lifetime capital gains exemption. Life insurance tracking shares may be one way to address these concerns (stay tuned for a future article on this topic, July 2022)
Potential transfer of ownership: Consideration should be given as to whether the corporation may be sold in the future. If this is the case, the insured may want to keep the policy and therefore transfer the policy prior to the sale. A subsequent transfer of a policy triggers a policy disposition, which may have tax implications for both the corporation and the shareholder/employee. In these scenarios, it’s usually suggested that the policy be held in a Holdco, since it’s usually the Opco that’s being sold.
· Post-mortem planning and Stop-Loss (we’ll explore this in the next article (June 2022)
· Pertaining to Buy Sell agreements
-policing of policy premiums (easier, if corporate owned)
-allocation of cost of premium (more equitable, when corporate owned)
-ease of administration (easier, when corporate owned)
-family law (Ontario) (favourable, if personally owned)
Although, we’ve discussed many different factors that can weigh into the decision as to where the policy ownership should land, most often then not, it’s where the “funding originates” that takes the lead. Ideally, cheaper after-tax corporate dollars in a multi-layered corporate setting can produce the best results and continue the tax deferral benefits of corporate surplus funds.
Advanced Case Consultant
Qualified Financial Services
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.