Where does corporate-owned life insurance fit for a business owner, and when does it not?

Short answer: It fits when the corporation holds money it will not need for a long time, the shareholder is insurable, and you want a contract rather than a market return to do part of the job. It does not fit if you may need most of the money back within several years, cannot commit to the premiums, or want the lowest possible cost per dollar of coverage. It is one tool among several, and an accountant should confirm the tax treatment for your corporation.

Who is writing this, and what do I get out of it?

I am a licensed life insurance agent. When a client buys a policy through me, the insurer pays me a commission out of the premium. That gives me a reason to want you to say yes, so check what I say against your accountant and, if you like, a second opinion from another advisor. I will tell you plainly when I would not recommend it.

What is a corporate-owned participating whole life contract?

The corporation owns a permanent life insurance policy on a shareholder's life, pays the premiums, and is named the beneficiary. Participating means the policy can receive dividends from the insurer's participating account. Those dividends are not fixed, and the amounts depend on the insurer's results.

How does the cash value grow?

Two things happen with every premium payment. The deposit option in the contract buys paid-up additional insurance, which increases the death benefit right away. And the policy keeps aging, so the cash value keeps increasing. Both happen even if dividends come in at zero. In the contract I set up, that holds as long as the insured is alive and the full premium is paid each year.

Dividends decide how much it grows, and the direction does not depend on them. A policy loan reduces the net value you hold, but it does not reduce the cash value.

What does it do for the corporation?

• Tax treatment of growth. Growth inside an exempt policy is generally not taxed each year, and it does not count toward the $50,000 passive income test that reduces the small business deduction.
• Death benefit. The death benefit is paid to the corporation tax-free. The amount above the policy's adjusted cost basis is credited to the capital dividend account, which lets the corporation pay tax-free capital dividends to shareholders.
• Premiums. They are generally not deductible.
• Access. The corporation can borrow from the insurer as a policy loan, or from a bank using the policy as collateral.

The two loans are taxed differently. A policy loan above the policy's cost basis can create a taxable amount. A bank loan secured by the policy is not a policy loan, so the cost basis does not matter and the loan itself is not income. In both cases there is interest to pay. Choosing between them is an interest-or-tax decision, and your accountant should model it before you borrow.

When does it fit?

• The corporation holds money it will not need for at least ten years.
• You have already built a cash reserve (see how much cash to keep in your corporation).
• The shareholder is insurable at a reasonable rating.
• You can fund the premiums for the full funding period without strain.
• You want part of your wealth to rest on a contract with an insurance company rather than on market returns.

When does it not fit?

• You may need most of the money back within the first several years. Cash value usually trails total premiums paid early on.
• You cannot comfortably commit to the premiums.
• The shareholder is uninsurable or heavily rated.
• You want the highest expected long-term return and accept the volatility. A participating whole life contract usually has a lower expected long-term return than a diversified equity portfolio. You are paying for contractual features, and whether that trade is worth it depends on how much certainty you want from this part of your wealth.
• You need maximum coverage at the lowest cost. Term insurance usually costs far less per dollar of coverage.

Leave it invested in the corporation or put part into the contract?

Related questions people ask

Why does everyone say buy term and invest the difference?

Because it can work. Term costs much less than permanent insurance, and if you invest the difference with discipline for decades, you may come out ahead on cost. The catch is that term ends, and many people stop investing the difference. Permanent insurance does not expire if the premiums are paid. The right answer depends on whether you need coverage for a fixed period or for life, and how disciplined you will be.

What happens if I need the money earlier than planned?

You can borrow against the policy or surrender it. Surrendering in the early years usually returns less than the premiums you paid, and any amount above the policy's cost basis is taxable income to the corporation. This is why the cash reserve comes first.

How is my advisor being paid?

For insurance, advisors are generally paid commission by the insurer out of the premium, and the commission is highest in the early years. Ask any advisor in writing how they are paid and what they earn if you buy. Compare that to a fee-based advisor if you want a view without a sales incentive.

What protects my policy if the insurer fails?

Assuris is the industry protection organization for life insurance policyholders in Canada. Read about it on the page what protects your whole life policy in Canada.

Can anyone buy this?

No. The shareholder has to qualify medically and financially, and the corporation has to have the capital to fund the premiums. Your accountant should confirm that the structure suits your corporation and your shareholder agreement.