Life Insurance 201. Is There A Role For Life Insurance In My Corporation?
Introduction
We're back with Alison Hughes, Director of National Distribution at Lawyers Financial. In our first conversation, Hughes laid out the differences between term life insurance (the kind of insurance you rent) and permanent life insurance (the kind of insurance you own). Today, Hughes explains some of the tax-efficient reasons why you might choose permanent life insurance if you're one of 17,000 Canadian lawyers who've incorporated their practice.
Tax-Efficiency Benefits of Permanent Life Insurance Inside a Corporation
Permanent life insurance can offer a range of tax-efficient benefits, especially if you're a business owner in an incorporated practice. Let's break it down.
When you buy corporately owned permanent life insurance, your corporation owns the policy, pays for it, and receives the payout upon your death. This structure provides significant tax savings, as premiums are paid with corporate dollars, which are taxed at corporate rates rather than higher personal tax rates.
Tax-Sheltered Growth of Cash Value
Permanent life insurance offers more than just a death benefit—it includes a cash value component that grows over time. The money invested in the policy is pooled into a large, professionally managed "participating account." The dividends earned from this account grow tax-sheltered, which can offer another level of tax advantage, especially if you've already maximized your personal retirement savings options like RRSPs and TFSAs.
This cash value can be accessed by your corporation during your lifetime, through either partial/full withdrawal, a policy loan, or by using the policy as collateral for a third-party loan. Notably, using the policy as collateral doesn’t trigger a tax consequence, as borrowing doesn’t count as a taxable event.
Retained Earnings and Passive Income
A significant advantage of permanent life insurance is that any growth within the policy doesn’t count as passive income. Normally, income from investments like dividends, interest, or capital gains is taxed as passive income and could affect your small business deduction if it exceeds $50,000 annually. However, gains inside a permanent life insurance policy are exempt from this rule, allowing you to preserve your small business deduction while still growing your assets within the policy.
Accessing the Cash Value
While you're alive, your corporation can access the cash value of the policy using one of three methods:
- Partial or Full Withdrawal: Withdraw funds directly from the policy.
- Policy Loan: Take a loan against the policy’s cash value.
- Collateral Loan: Use the policy as collateral for a loan from a third-party institution like a bank.
Each option provides flexibility, and using the policy as collateral doesn’t incur tax consequences, which is a key advantage over other forms of accessing funds.
What Happens to the Cash Value After Your Passing?
When you pass away, the death benefit from the permanent life insurance policy is typically much larger than the cash value accumulated during your lifetime. The beneficiary (your corporation) receives this lump sum, which will be used for the corporation's needs or to cover any remaining financial obligations.
Conclusion
Incorporating permanent life insurance into your corporation can be an incredibly effective way to grow wealth in a tax-efficient manner. With benefits like tax-sheltered growth, the ability to access cash value without triggering tax consequences, and the preservation of your small business deduction, it’s an option worth considering for those with incorporated practices. Consulting with financial advisors ensures you can choose the best insurance plan suited to your needs and secure your business’s long-term success.
This article is written for educational purposes.
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