Business owners are reluctant to spend money on life insurance because it interferes with their cash flow. Few people like buying life insurance anyway!
This is probably why businesses buy Term life insurance…..It’s cheap and it interferes with their cash flow the least (for the time being!). But is this really the best use of a business’s cash? Is Term insurance cheap? Why buy a short term solution for a long term problem?
It comes down to perception. Because a business owner writes a “small” cheque every year for a Term life insurance policy it feels like low cost. It may not be.
By the way that small cheque gets exponentially larger every ten years or so just because of the provisions in the Term insurance contract.
We understand that business owners need to keep the cash in the business to invest in business growth. However, expanding the business value can also result in the growth of their estate liabilities which in turn can create a larger estate liquidity problem!
There are strategies such as an Estate Freeze where the shareholder exchanges existing common shares for preferred shares. The preferred shares can be in either the operating company (under Section 86 of the Income Tax Act); or in a holding company that owns the operating company (under Section 85(1) of the act).
This Estate Freeze fixes the value of the preferred shares issued in exchange for the common shares often held in a Discretionary Trust. Therefore, the capital gain is fixed on those fixed value preferred shares for purposes of valuation under Section 70(5.1) of the Income Tax Act.
Alternatively, if a wasting freeze is followed, taxes will paid each year as the fixed value preferred shares are redeemed. However, along with this annual redemption could come loss of voting control of the corporation. There could still be an outstanding tax bill unless all the preferred shares are redeemed before the death of the shareholder.
Because the Estate Freeze fixes the capital gain on the preferred shares the shareholder can plan for the estate liquidity needed to pay any tax obligations on those shares.
Many business owners like the idea of deducting life insurance premiums and often think the whole premium is deductible. Not so! First there are specific conditions that may create deductibility of the premiums. Then there is a more complicated formula to determine the actual amount of the premium that can be deducted.
Deductibility of life insurance premiums is prohibited under the general limitation for payments on account of capital in Paragraph 18 (1) (b) of the Income Tax Act.
However, there are a few exceptions, one of which is when a life insurance policy is collaterally assigned to a restricted financial institution (as per Sec 248 (1)) as security for a loan. If the loan interest is deductible, then it follows that a portion of the life insurance premiums can be deductible.
But deductibility can be only part of reducing the cost.
Depending on the age of the clients and their objectives there may be more efficient ways to fund an estate liquidity need rather than writing a “small” cheque every year (until the premium goes up!) and maybe getting nominal deductibility.
Working closely with clients and their tax advisors we design and present a range of liquidity funding options. We use our proprietary software and underwriting expertise to custom design plans that can reduce the interference with business cash flow to lower than Term insurance cost and produce enhanced tax benefits in the longer term.
As a result, the client keeps more money invested in the business and reduces the real cost of providing liquidity obligations on the business or estate.
You can easily book a time to chat to see if we can help.