Life insurance is important if you have children or a spouse that depend on you financially, and especially if you have a mortgage or other loans that those people would be liable for in the event something happened to you.
There are two main categories of life insurance – term life insurance and permanent life insurance.
For many people, term life insurance is the preferred type. It provides coverage for a specific term (10, 20 or 30 years), and the premiums are the same each year for the length of the term. This type of life insurance is inexpensive when compared with permanent life insurance, as when the term ends, the policy and coverage expire, and the insurance company keeps the premiums you have paid. It is often the preferred choice during working years, to provide funds to replace loss of income and cover liabilities. It is a popular option as it gives people peace of mind at a relatively low cost.
Permanent life insurance provides coverage for life, and premium payments are required for life. It also serves as an investment vehicle, so in the context of building wealth, permanent life insurance is the preferred type, for a variety of reasons. For example:
- There is a cash portion that accumulates over time, and if you were to cancel an insurance policy at any time, the insurer returns an amount of cash to you – the Cash Surrender Value (CSV). Because the CSV is a liquid and secure asset, it can be used as collateral for borrowing. The corporation can borrow against the policy to either reinvest the funds, or make shareholder distributions.
- Although premium payments are required for life, they are often structured so the investment component of the policy funds the premium payments after a fixed term – which results in them being “self-funded”.
- This type of life insurance can provide a tax-deferred investment component. The investment portion can accumulate in value without incurring tax on the earnings, and if such a policy is held until death, none of the benefit paid as a result of death is taxable.
Given the above advantages, permanent life insurance policy premiums are significantly more expensive (10 to 20 times more) than term insurance policy premiums. It is often recommended when investors have otherwise maxed out their contributions to other tax-reducing accounts (RRSPs, TFSAs, RESPs), but still have more savings than they can spend.
An individual may choose to own a life insurance policy personally, or through their corporation. Many people choose to own life insurance personally due to personal estate planning needs – to have funds available to offset the income loss which occurs when the insured passes away or to fund estate taxes. Other choose to own life insurance through their corporation – to provide protection for a key-person, as security when looking to get a bank loan or due to its tax advantages.
The tax advantages associated with a permanent life insurance policy held by a corporation include:
- Cost to fund policy premiums will likely be lower if paid by the corporation rather than personally (usually the corporation’s tax rate is lower than the personal tax rate). When the corporation pays the premium on the life insurance, the corporation should also be the beneficiary.
- If the insurance policy is structured properly, most permanent life insurance policies in Canada are known as “exempt policies”, so any investment income earned inside these policies grows tax-free.
- There will be tax-deferred growth in the value of investments in an “exempt policy” held within the company until disposition. This benefit also applies to such insurance held personally, but where the funds to invest are already in the company, then investing the funds within the company saves the tax cost of paying salary or dividend to the owner, to allow them to invest personally.
- In 2018, the federal government clarified that Canadian-controlled private corporations must keep their passive income at $50,000 or less, if they wish to access the full $500,000 small business deduction limit. A permanent life insurance policy held by a corporation is an effective strategy to keep passive income under this threshold, provided the policy has an investment component.
- Life insurance proceeds over the cost basis of the policy can be paid as a tax-free capital dividend upon death.
Notwithstanding the foregoing, as a business owner, there are a few things to keep in mind with respect to holding permanent life insurance within a corporation. For example, it may affect your ability to claim the lifetime capital gains exemption on the shares of your corporation, since the investment portion of a life insurance policy is not an active business asset. Where the shareholder is the life insured, the life insurance policy will generally be valued at its cash surrender value for purposes of determining whether the share of the company will qualify for the LCGE, and the tax impact of whether your shares qualify may have a material impact on your taxes in the future. Another consideration is whether a permanent life insurance policy might ever need to be disposed of, or collapsed, before an individual’s retirement from the business or their death. If that is a possibility, this may result in income inclusion and reduction of the small business deduction.
This article is a general discussion of certain tax and accounting matters and should not be relied upon as tax or accounting advice. If you require tax or accounting advice, we would be pleased to discuss the issues in this article with you.
