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

Short answer: It fits when your corporation holds money it will not need for ten years or more, and you want that money building an asset the business can borrow against instead of sitting in an account that leaks tax every year. A participating whole life contract owned by your corporation is defence and offence in one. The defence is a death benefit paid to the corporation. The offence is a contract whose value grows every year the premium is paid, and which gives the corporation access to money without selling anything. It also fits owners who may not be able to sell their business and need to plan how they get paid when they leave. It does not fit if you need most of the money back in the first few years, or if you only want market upside.

What is it, in plain terms?

It is a contract. The corporation owns a permanent life insurance policy on a shareholder's life, pays the premiums, and is named the beneficiary. In return, the insurance company is obligated to pay a death benefit, and to keep the contract's value growing as long as the premium is paid.

Participating means the insurance company shares its profits with its policyholders. The insurer collects premiums and has to grow them to cover its future expenses. When it earns more than it needs, it pays the surplus back to its participating policyholders as a dividend. You choose what to do with it. In the contracts I set up, the dividend buys more death benefit.

What is cash value?

This is the most misunderstood part, so it comes first.

Cash value is not an account with cash in it. It is the value of the contract at any point in time. Think of it as the present value of the death benefit, combined with the age of the person insured. It is what the insurance company would pay you to give the contract up.

There is a product called universal life that does have an actual account inside it, and that account is also called cash value. The two are entirely different things, and people confuse them all the time. In a participating whole life contract, there is no account. There is an obligation, and cash value is what that obligation is worth today.

How does the value of the contract grow?

Start with the premium. Paying it is the corporation's obligation, and it keeps the insurer's obligation alive. The premium has two parts.

The first part is required. It keeps the death benefit at the level you agreed to.

The second part is optional and is called the deposit option. When it is paid, it immediately buys more death benefit. The insurer is now obligated to pay more, so the contract is worth more, and the cash value rises.

Time does the rest. Every day that passes, the person insured is a day closer to the day the death benefit is paid, according to the actuaries. That also makes the contract worth more.

So cash value grows because the full premium is paid and because time passes. That holds in the contract I set up as long as the insured is alive and the full premium is paid each year, and it does not depend on dividends.

Dividends add to it. Remember that the insurer has to grow the premiums it collects. When it earns more than it needs, it pays the surplus to all of its participating policyholders. If you have the dividend buy more death benefit, it is generally not taxed, the insurer's obligation gets larger, and the cash value rises with it. Market results contribute to the growth, but they are not all of it, and the contract does not need strong markets to keep growing.

Insurance companies state clearly that annual dividends are not guaranteed. Canada Life reports distributing participating-policy dividends every year since 1848, and Equitable Life reports crediting them every year since it introduced participating whole life in 1936. Past dividends do not guarantee future ones.

It is a lot like starting a new business. It takes a push at the start. Then each full premium adds more cash value than the year before, and in a well-designed contract it typically passes what you put in and keeps growing. How soon depends on the design and the insurer.

Why would a business owner want it?

Because it does a job that most places for surplus cash do not do together.

• It is your emergency fund, in more than one way. The contract's value is there to borrow against when you need it, so you never have to sell anything or interrupt the growth. And in the emergency nobody plans for, death, the death benefit is paid to the corporation.
• It is an asset, not an expense. Premiums are not deductible, but what you pay becomes cash value that sits on the corporation's balance sheet and keeps growing.
• It is tax-advantaged. Growth inside an exempt policy is generally not taxed each year, and it does not count toward the passive income test that can reduce the small business deduction.
• It pays out tax-free. 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.

Is this an investment?

Most of us were taught that building wealth means investing. It does not have to.

If your goal is cash flow later in life, or protecting and preserving what you have built, or access to your money with little tax impact, you can pursue all of that without taking on market risk. Investing has made millions of millionaires and will keep doing so. It is expected to work out. But there are no assurances, so a strategy built on investing is built on hope. That is fine. Let's just call it what it is.

Hope is not an obligation. A contract can obligate someone to deliver your goals, both the defence and the offence. Participating whole life happens to be a very efficient way to match those goals to something that exists at scale.

How do you get at the money?

The corporation can borrow from the insurer as a policy loan, or from a bank using the policy as collateral. A policy loan reduces the net value you hold, but it does not reduce the cash value, which keeps growing.

The asset and the loan are two different accounts. The asset's cash value should only ever increase. A responsible business owner and their advisor monitor both at the same time to make sure the goals are being met.

When does it fit?

• The corporation holds money it will not need for at least ten years.
• You have already set aside the working cash the business needs (see how much cash to keep in your corporation).
• The shareholder, or someone else with an insurable interest, 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.
• You may not be able to sell your business and need to plan your exit. This contract can create a personal pension of sorts. That is a more advanced topic of its own.

When does it not fit?

• You will need most of the money back within the first few years. A contract takes a push at the start, and how soon the cash value passes your premiums depends on the design. If you need all of it back right away, the timing may not suit you.
• You cannot comfortably commit to the premiums.
• Nobody connected to the corporation is insurable at a reasonable rating.
• You want every dollar chasing market upside and you are comfortable with the swings. This contract does a different job. It is built for certainty, access and a death benefit, not to compete with the market, so money you want exposed to the market belongs elsewhere.
• You need the largest possible death benefit for the lowest premium over a fixed period, and you do not need the contract to build an asset. That is a job for term insurance.

I set these contracts up for a living, which is why I list the cases where I would not.

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 term costs less. Compare first-year premium to first-year premium and term is the cheaper option, and the idea is to invest what you save.

Here is how I look at it. Term is pure defence. It is an expense. If you outlive the term, which most people do, the premiums are gone and nothing is left. Whole life is defence with offence. The death benefit is still there, and the contract also becomes an asset. Planned properly, that asset can often be structured to be worth more than the sum of the premiums within a few years, depending on the client and the insurer, and it keeps growing.

"Invest the difference" also depends on you actually investing the difference, every year, through every market. A contract does not rely on that discipline, because the premium is an obligation.

If the difference is invested inside a corporation, passive income investments can be extremely punitive from a tax perspective. Anyone doing it needs to be fully aware of the pitfalls and the potential tax bombs at the CRA.

Term is still the right tool if you need the largest death benefit for the lowest premium over a fixed period and you do not need the contract to build an asset.

What happens if I need the money earlier than planned?

You can borrow against the policy or surrender it. Borrowing keeps the contract intact and the cash value growing. Surrendering very early may return less than the premiums you paid, depending on the design, and any amount above the policy's cost basis is taxable income to the corporation. This is why working cash comes first.

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 insured person has to qualify medically and financially, and the corporation has to have the capital to fund the premiums. The structure also has to suit your corporation and your shareholder agreement.