Life insurance is used on a routine basis to reduce risk exposure on a person’s death. The insurance benefit is used to provide financial security to loved ones, provide cash flow for businesses to compensate for the loss of a key employee or to fund the buyout of corporate shares from the estate of the deceased shareholder. In this blog, I want to focus on personal life insurance and how a business owner may consider restructuring their insurance so that the premiums are paid on a more tax efficient basis.Typically, personal life insurance is paid by the individual through monthly or annual premiums. The payment of the premium is funded with after-tax dollars earned by the person. If you are in the highest tax bracket, you are being taxed as high as 46.5%. As a result, for every dollar you earn in the highest bracket, you are left with 53.5 cents after tax. In the result of your death, the insurance proceeds are non-taxable which is a key benefit. For a person with an annual life insurance premium of $5,000, they would need to earn $9,350 to fund the payment of their premiums after tax.
For business owners, you may want to consider funding your life insurance premiums using your business. Since the business has a lower tax rate than individuals, the corporation has more after-tax purchasing power. Currently, the tax rate for small businesses with taxable income below $500,000 is 15%. Using the same insurance premium amount above, the corporation has to earn only $5,900 to fund the premium. As a result, using the corporation is more tax efficient.
Insurance premiums received by corporations are still received on a tax-free basis. These proceeds are captured and tracked for tax purposes in an account called a capital dividend account. Upon filing of an election with the Canada Revenue Agency, a special dividend can be paid out of the capital dividend account on a tax-free basis to the shareholder’s estate for distribution to the named beneficiaries. If the election and payment are done properly, the estate would receive the same amount in insurance proceeds that they would have had the policy been held personally by the deceased individual.
The process of changing the ownership and named beneficiaries of an insurance policy is relatively easy, but I recommend that you speak with your accounting professional and insurance advisor before making any changes. There are many different types of life insurance products on the market today and you may need a professional to assess whether there are any adverse tax effects resulting from the changing of the policy.