Your life is precious to your family. But if you are a small business owner, your life is also essential for your organization. You are running the show, the decision maker with voting rights. So your sudden demise could impact your organization in many ways. Corporate-owned life insurance can provide several benefits to your business and keep the show running even when you are not around.
What Is a Corporate-Owned Life Insurance?
Corporate-owned life insurance is an insurance policy where the owner and the beneficiary of the policy is a corporation, and the life insured is the shareholder/business owner. This is the policy whose premium is paid by your business, and your business and not your family receive the payout.
Like any insurance, the premium depends on the health of the covered life, and you can redeem the policy for a surrender value. But corporate-owned life insurance has additional benefits. Here, we will discuss three things you, as a small business owner, should know about corporate-owned life insurance.
Tax Benefits of Corporate-Owned Life Insurance
It is efficient to buy life insurance with corporation money. The corporation tax rate (12%) is lower than the personal income tax rate (15%-48%). So if you fall in the 48% tax bracket, to pay a $10,000 annual premium, you will have to set aside $14,800 in before-tax income. But a corporate has to allocate only $11,200 in annual premiums. You save $3,600 and use it to buy new insurance or save for other work. Extra money is never wrong.
This is not the only tax benefit. The life insurance with an investment component grows your money tax-free while you stay invested, just like a registered savings account. Moreover, the insurance proceeds received from the death claim are tax-free. The business can pay out the insurance proceeds to beneficiaries tax-free through a capital dividend account.
Small Business Owners Use Corporate-Owned Life Insurance in Estate Planning
Corporate-owned life insurance is a crucial tool for estate planning. Small business owners can buy such life insurance for multiple reasons:
- When a large part of your estate is your company’s shares, corporate-owned life insurance can help transfer estate tax-efficiently. The shareholder can freeze his assets after a point in trust and buy corporate-owned life insurance with the sum assured equal to the capital gain tax liability. The insurance amount will take care of the tax liability at the time of inheritance, and the beneficiary can get shares’ actual value.
- If you have taken a small business loan, life insurance of equivalent cover can cover the debt repayment. However, a personal guarantee could make the person’s estate liable for outstanding debts.
- Corporate-owned life insurance also comes in handy if you are the key person, and your absence can put financial and operational pressure on the business. The insurance proceeds can give the company the necessary working capital to learn to operate without you.
- Another business case of corporate-owned life insurance is to buy out your shares. For example, if the family is not interested in inheriting the company’s shares, the business can use insurance proceeds to buy out the deceased shareholder’s shares.
But the above uses of corporate-owned life insurance should be documented in the shareholder agreement.
Who Should Buy Corporate-Owned Life Insurance?
While corporate-owned life insurance has several advantages, it has drawbacks and may not be a good fit for certain companies. For example, if you plan to sell or close your company, the life insurance’s cash value will be added to the sale price. The life insurance valuation would depend on the health of the insured and other factors. The buyer might not be willing to pay for the life insurance value. In addition, transferring the life insurance policy between corporations may attract tax as it is considered a disposition of assets.
As the business environment is dynamic and subject to many organizational changes like expansion and downsizing, longevity is a big question. Hence, holding corporate-owned life insurance in a holding company or family trust is recommended, an essential tool for estate planning. The business owner can control their assets through trust.
This is just the tip of the iceberg. Corporate-owned life insurance goes deeper and can have significant ramifications. A professional wealth advisor can help you grow your wealth through corporate life insurance.
Contact McCay Duff LLP in Ottawa to Help You With Estate Planning
Talk to a wealth and business advisor to understand your future tax liability and estate planning options and evaluate whether corporate insurance is for you. At McCay Duff LLP, our wealth advisors can provide services like trust planning and consulting. To learn more about how McCay Duff LLP can provide you with the best estate planning solutions, contact us online or by telephone at 613-236-2367.