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The Capital Dividend Account (CDA): Beyond Life Insurance

I’ve heard it referred to as the “magic sauce” behind all corporate insurance strategies. Quite frankly, I think it’s a well-deserved title. The capital dividend account (CDA) is the mechanism that allows a death benefit received by a private corporation to flow out tax-free to a shareholder(s). It’s truly the reason why life insurance within a corporate setting can outpace/outperform traditional investments. Creating a channel that allows funds to exit a corporation tax-free as opposed to as a taxable dividend (which in some provinces can be as high as 48.96%) is an incredibly attractive feature. But is life insurance the only thing that creates a CDA balance? In this article, I will explore the various components that determine the balance of the CDA and the rules affecting the calculation of the CDA as it relates to life insurance. The purpose will be to avoid some of the pitfalls advisors periodically encounter when discussing the CDA.

Why the need for a CDA?

First, why does the capital dividend account exist in the first place? Well, in fact, it all comes downs to the principle of “tax integration”. In theory, integration is supposed to produce a similar after-tax payout regardless of where the income originated. Whether it’s derived from a private corporation (via a taxable dividend), or the corporation’s income was earned directly by the shareholder(s), the after-tax results should be the same. One mechanism used to achieve this is a private corporation’s “capital dividend account (CDA)”. This is a notional account, and its purpose is to keep track of certain tax-free amounts received by private corporations that would also be tax-free if received directly by the shareholder(s). There are four main components of tax-free amounts that determine the CDA balance:

  • Capital Dividends received by a corporation including those received via a trust.

  • The excess of the non-taxable portion of capital gains over the non-deductible portion of capital losses (realized directly or through a trust).

  • The non-taxable portion of gains resulting from the disposition of eligible capital property (for example, goodwill).

  • The proceeds of a life insurance policy, less the policy’s adjusted cost basis (discussed in the section titled “CDA and life insurance”).

The CDA allows these various corporate surpluses to maintain their “tax-free status”. Without it, these amounts would need to be distributed as “taxable” dividends.

A balance in the CDA can be paid out to a Canadian resident shareholder as a tax-free capital dividend. A non-resident withholding tax would apply to a capital dividend distributed to a shareholder who is a non-resident of Canada. The CDA is not linked to the insurance payout received by the corporation. This comes into play in scenarios where key person protection is purchased and the proceeds are used by the corporation for business purposes (i.e., repayment of corporate debts, replacing key person, etc.). Although funds are spent, the balance to the CDA is still maintained, which allows for future surplus to be distributed tax-free. This is also, the case when permanent life insurance is collaterally assigned to a bank for a loan. Although all or a portion of the insurance proceeds are first used to repay the bank loan, the corporation still obtains a CDA based on the total death benefit value less the ACB of the policy. This is NOT the case for policy loans. In addition to the policy’s ACB, the value of the policy loan would be deducted from the total death benefit payout. Lastly, any capital dividends already paid would reduce the CDA balance.

Now for the not-so-common discussion around CDA but still VERY IMPORTANT. What are the rules affecting the calculation of the CDA as it relates to life insurance:

  • The calculation of CDA is cumulative. As a result, a full historical calculation of the CDA is required before paying a capital dividend. Will see why this is important in a sample case study below and sometimes catches advisors and clients offside.

  • A CDA balance can be calculated at any point in time, not necessarily at the company’s year-end. This means a CDA balance can be calculated and paid out following the realization of a capital gain or the receipt of a life insurance death benefit.

  • A negative amount in one component of the CDA calculation identified above doesn’t affect the other components. For example, a capital loss realized from the sale of property isn’t subtracted from the calculation that includes the receipt of a life insurance death benefit.

Case study: the cumulative effect!

Since the CDA calculation is done on a cumulative basis, transactions and capital dividends distributed in prior years will impact the calculation in the current year. Let’s look at an example. Here is the sequence of events: (SEE TABLE BELOW)

  1. In Oct 2014, a capital gain of $1.5 Mil. is realized on the sales of a stock portfolio. Since 50% of this gain is ‘non-taxable’, $750,000 was added to the CDA. CDA balance is $750,000.

  2. In Dec 2014, Holdco declared a capital dividend of $750,000.

  3. In March 2018, a capital loss of $1 Mil. is realized on the sale of another stock portfolio. Since 50% of this loss is “non-taxable’, $500,000 was included in the cumulative calculation of the CDA.

  4. In July 2020, the key shareholder of Holdco dies, and Holdco receives a death benefit of $3 Mil. Since the policy’s ACB was $500,000, the credit to the CDA was $2.5 Mil.

  5. Actual CDA balance remaining in Dec 2022: $2 Mil.

When we speak to our clients about the CDA balance created by a life insurance policy, we discuss this in isolation and generally do not discuss the other factors (or components) that can affect this amount. In this example, most advisors would tell the client that the insurance created a CDA balance of $2.5 Mil. when in fact what’s available in Dec 2022 is only $2 Mil. This approach is partially correct, since we may not have access to all the information and/or do not know what the future holds, let alone have control over the situation. This being said it is important, as this example illustrates, that we inform our clients that other factors may, in fact, reduce this insurance induced CDA balance even though we may not have access to the actual numbers. This most often occurs when a capital gain is realized, followed by a capital dividend payment, further followed by a capital loss realized, and subsequently followed up by an insurance payout. This sequence of events will result in some of the CDA credit created by the life insurance payout, being reduced.

Does this mean that the insurance strategy is less appealing? Of course not! What it really means is that the shareholder received a pre-payment of the CDA due to the timing of the non-capital gain and non-capital loss transactions, in relation to death benefit payout. Nonetheless, it’s important we inform our clients about the potential factors that may impact the CDA balance so as not to get caught off guard when their accountant brings it up.

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

Director, Advanced Planning, Insurance


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.


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