Two Main Benefits of Investing in a Corporate-Owned Permanente Insurance Plan

Insurance plan disclaimer and contract

Below are the two main reasons owners of a Canadian-controlled private corporation (CCPC) invest some of their profits into a tax-exempt permanent insurance policy (an exempt insurance policy is defined in regulations 306 and 307 of the Income Tax Act (ITA).

Tax-sheltered growth from investing in an insurance plan

Significant cash values can accumulate on a tax deferred basis in the policy within the maximum deposits permitted by the Income Tax Act. The deposits can be designed so that they remain tax-sheltered within the contract. The key here is the tax-exempt limit. This is the maximum savings allowed inside a policy at a given point in time before it would lose its exempt status.

Tax-free distribution on death

There’s a mechanism that allows the death benefit proceeds to go tax-free to shareholders through the corporations capital dividend account (CDA). The CDA credit is unique to corporate-owned life insurance plan. Upon death of the insured, a private corporation receives the death benefit tax-free. That amount less the adjusted cost basis (ACB) of the policy is added to the corporations CDA.

This is a notional account and appears on a company’s financial statement which will have a significant benefit for owners of CCPC. The balance in the CDA can be paid out to shareholders as a capital dividend and thus be exempt from tax. The death benefit of a corporate-owned life insurance policy is one item that can be credited to the CDA tax-free.

Changes  After December 31, 2016:

  • The amount of tax-exempt growth allowed inside corporate-owned policies will be significantly reduced. Corporations will have less tax-sheltered accumulation room inside their policies reducing the amount of cash input available. This means more tax will be paid because your corporate savings is not being tax-sheltered.
  • The amount of life insurance proceeds allowed to be distributed tax-free through the capital dividend account (CDA) to shareholders of a private corporation will also be reduced.

Because of the reduced mortality rate, the majority of insurance contracts will have a lower net cost of pure insurance (NCPI). This will cause the adjusted cost base (ACB) to decrease more slowly and take longer to reach zero (the ACB is the amount used to calculate the taxable gain in a life insurance policy). To get the most tax-free money to your shareholders on death, you want a low ACB that reduces to zero quickly.

Specifically, for universal life products (a type of permanent insurance plan with a savings component) the level cost of insurance will increase. Depending on your age and other policy factors, a level cost universal life insurance policy could take anywhere from 8 to 18 years longer to reach an ACB of zero. This would result in a lower CDA credit which means your corporation will pay more tax on capital dividends paid to shareholders on death.

  • It will take longer for a permanent insurance policy to be paid up. Depending on the product you choose and other variables, you may have to pay an extra 8 years in insurance premiums for your policy to be paid off.

Despite the changes, corporate-owned insurance continues to be an excellent tax-advantaged investment option for Canadian corporations.  Investing in corporate-owned insurance significantly reduces the amount of tax that a company pays on its investment earnings.  In addition, the death benefit immediately increases the value passed on to heirs since it flows tax-free through the company’s capital dividend account.

Investing in traditional guaranteed products, such as GIC’s, could result in at least one-third of business assets ending up going to Revenue Canada on death if there is no spousal rollover provision.  Much will depend on the type of post-mortem planning done.

If the intention is to reduce your corporate tax bill, manage risk, and leave most of your corporate assets to immediate family members, then a tax-exempt insurance plan will continue to be an important part of an overall estate plan.