Incorporating your business is a smart move. As a corporate structure, you enjoy limited liability and potential tax deferral. Other benefits include business continuity, lower income tax rates (thanks to the small business tax deduction), and easier access to capital.
Now that you have an incorporated business, it is essential you consider corporate-owned insurance. Unlike the insurance you purchase for your business operations, corporate-owned insurance is a life insurance policy a corporation buys on the life of a shareholder. Both insurance policies are a must, but the latter helps protect the business if the shareholder dies.
Here are some benefits of corporate-owned insurance;
Personal vs. Corporate Dollars
Purchasing life insurance with corporate dollars rather than personal income is more economical in the current tax environment. Let’s drive home this point with an instance. If you run a Canadian-controlled private corporation entitled to the small-business tax deduction, your tax rate would be around 11%, depending on the business’ province. So, only $89 out of every $100 revenue after tax will be used in paying the insurance premiums.
If an individual with a marginal tax rate of 50% wants to do the same, they can only net $50 from a $100 revenue. That means the corporate can fall back on more after-tax dollars to pay for the life insurance premiums. Often, the insurance premiums are not deductible to either the individual or the corporation.
Access to alternative Investment
Compared to when you invest the same amount in a corporate investment account, you can create improved asset values with corporate insurance. This is because life insurance policies attract preferential tax treatment. Under the Income Tax Act, companies can invest and grow funds on a tax deferred basis within an insurance policy, thus setting up a system similar to the RRSP within the corporation. But withdrawals could be taxed in this case.
An insurance policy can be used as collateral to obtain a loan from any financial institution. You can invest the proceeds in the business or for other personal uses like investment or setting up a retirement income. However, always consult your Ottawa Certified Financial Planner or tax specialist to ensure everything is appropriately set up.
You have the advantage of implementing other excellent business strategies with insurance purchased within your corporation. These include key-person coverage, buy-sell agreements, and more.
Capital Dividend Account
The Capital Dividend Account (CDA) plays a crucial role in estate and tax planning for shareholders. This is because life insurance proceeds go into CDA without being taxed. The shareholders can now receive the credited proceeds as a tax-free capital dividend.
Do not go into the purchase of corporate-owned insurance without making some important considerations. Ottawa CFPs advise against having the insurance policy owned in the operating corporation considering the asset would be subject to creditor claims. Another reason to avoid corporation-owned ownership is it is impossible to transfer the insurance to the shareholder on a tax-efficient basis, provided the policy is to be maintained.
The more common move is to hold the insurance in a holding corporation while the operating corporation remains the beneficiary. You will need a shareholders agreement and factor-in other issues when dealing with multiple shareholders.