We have all been extolled the benefits of having a life insurance policy to provide for our loved ones when the inevitable happens. However, not everyone has been given the tools necessary to get their life insurance policy to work for them today.
Based on your personal situation, it could be possible to move your life insurance policy into your corporation to reduce the net cost of premiums, unlock some retained earnings without incurring personal income tax liability and ensure that the death benefit still flows to your beneficiaries on a tax-free basis.
The process is known as Life Insurance Valuation and it might be going the way of the Dodo in an upcoming federal budget. However, for now the opportunity exists to increase the benefit of your life insurance policy. The first step in the process is to obtain an actuarial report of the Present Value of your personally held life insurance policy.
There is a cost to obtaining this valuation, but we can consider certain factors to determine if it is worthwhile to pursue the actuarial report. Those factors include:
- The length of time that you have held the policy,
- Your health,
- If the policy is a term life policy can it be converted and what is the remaining term, and
- If the policy is whole life what is its surrender value compared to death benefit.
Contrasting this against a policy that:
- Has a short term,
- Was recently purchased,
- With a high surrender value, and
- You are in great health.
The more factors you meet from the initial list, the more likely there will be a benefit to determining the Present Value of your policy. Many valuators will provide a quote at low or no cost. This quote will further inform the decision whether to proceed
with the transaction.
Once an actuarial report on the Present Value of your policy is obtained, you will be able to sell the policy to your corporation using the Present Value as the fair market value for the policy. This will allow you the ability to strip retained earnings equal to the Present Value from the corporation as tax-free dollars.
If your corporation does not have the retained earnings to pay the purchase price at this time you could take back a promissory note in the amount of the purchase price. In utilizing a
promissory note you will be able to unlock future retained earnings on a tax-free basis as payments of the principal amount of the promissory note. You will need to charge interest on the promissory note at the prescribed rate (currently 1%) which will be taxable.
Once the policy is owned by the corporation, its premiums can be paid by corporate dollars rather than personal dollars. Depending on the cost of the premiums this could represent a significant reduction in the net cost of the insurance to the insured. As the saying goes, "it is better to pay from your suit pocket than your jeans pocket".
Once the policy is in the corporation's hands, the corporation should be named as the beneficiary of the mortality benefit. The mortality benefit is not taxable to the beneficiary, and when a corporation is named as the beneficiary, the proceeds can accrue to the capital dividend account. These funds can be paid out as a tax-free capital dividend to the shareholders of the corporation.
At this time the shareholders of the corporation will be the beneficiaries of your estate. Provided you have ordered your estate with dual wills to avoid probate on the shares of your private corporation, then the beneficiaries of your estate can receive the mortality benefit, as a capital dividend, tax-free. With a little planning, you can unlock your retained earnings, reduce the net cost of premiums and ensure that your loved ones are still protected - all without triggering increased tax liability.
