Tax-free dividend with life insurance
How corporate-owned permanent life insurance may potentially increase the after-tax value of your corporation to your estate.
Updated 
4 min. read
The scenario
Imagine this scenario. You are the primary shareholder of a Canadian controlled private corporation (CCPC). Locked inside your company is $500,000 of surplus capital for which you have no immediate personal need, but to which you will eventually want your heirs to have access.
Two potential non-insurance options
- If you receive the surplus capital in the form of dividends, a considerable amount of it may be subject to tax. And if you receive the entirety of the $500,000 in a single taxation year, you might find yourself paying some of that tax at the highest marginal rates.
- If you leave the surplus capital in the corporation as part of an investment portfolio, the resulting income will be taxed at the highest corporate tax rates which, in some cases, might be higher than your personal income tax rate. As well, earning (passive) investment income can reduce the CCPC’s ability to access the small business deduction (SBD) on the active business income it earns. If the shareholder was looking to access the Lifetime Capital Gains Exemption (LCGE) on a sale of the CCPC’s shares, a corporate investment portfolio is a passive asset that could jeopardize the Qualifying Small Business Corporation status.
The permanent life insurance option
Compared to the two options above, the strategic use of life insurance may significantly reduce the tax cost of retaining/distributing your private corporation’s shares. By transferring the $500,000 into a corporate-owned permanent life insurance policy, the funds may grow on a tax-advantaged basis in a manner that does not reduce the CCPC’s access to the SBD. And while a permanent life insurance policy is not an active business asset, the size of its passive-asset component is typically limited to the policy’s cash surrender value.
Upon the death of the insured, the corporation (if named the beneficiary of the policy) receives a tax-free death benefit that may provide significant liquidity to the corporation. In addition to the death benefit itself, an amount [typically calculated as the insurance payout less the policy’s Adjusted Cost Basis] is credited to the corporation as a component of its Capital Dividend Account (CDA). The balance in the CDA, of which the life insurance credit is a component, can be paid out to Canadian-resident shareholders (e.g. your heirs) as tax-free capital dividends.
Who can benefit from this solution?
Life insurance may be useful for those who:
- Own an incorporated business that has surplus capital (retained earnings); and
- Have no personal need for the surplus capital, i.e., it is likely to eventually form part of his or her estate.
Additionally, if you own a company that has sold assets for cash, or if you have sold a business that had been owned through a holding company that you retain, putting those sales proceeds into permanent life insurance may provide the solutions you need.
Life insurance can provide financial security for your business
You’ve worked hard to build your business. A product of sacrifice and dedication, your success deserves to be protected from events beyond your control.
Permanent life insurance may offer that protection. It may help your business continue to operate and retain its value in the event of your death, or the loss of a partner or key employee. Contact your insurance advisor to learn more about converting a taxable dividend into a tax-free dividend through life insurance.
How does it work
Let's look at an example.
John, 72, and his wife, Susan, 71, both non-smokers, own a business that has a cash surplus of $500,000. They need $1 million of permanent life insurance.
They are evaluating two options: the surplus could be invested inside the company at 4% or transferred into a permanent life insurance policy such as a Universal Life or Whole Life.
For example, the $500,000 could be used to buy a Universal Life policy with a face amount of $1,000,000 and a projected rate of return of 3% (a more conservative rate for the life insurance policy reflects its long-term nature). The surplus would be transferred into the policy over five years.
The following table illustrates the difference in projected estate values between the two options.
| Years | Ages | After-tax value of the life insurance strategy at 3% | After-tax value of funds footnote star left in the company invested at 4% footnote star, star | Projected life insurance advantage |
|---|---|---|---|---|
| 1 | 73/72 | $1,037,885 | $41,105 | $996,780 |
| 5 | 77/76 | $1,277,894 | $288,974 | $988,920 |
| 10 | 82/81 | $1,326,295 | $335,967 | $990,328 |
| 20 | 92/91 | $1,423,203 | $445,135 | $978,068 |
Footnote star detailsThe amount is paid as a taxable dividendFootnote star, star detailsThe dividend amount includes any RDTOH (Refundable Dividend Tax on Hand)
Disclaimer:
Information contained in this article is general in nature and should not be construed as legal or tax advice. You are encouraged to seek the advice of other professionals such as legal and tax experts. Please consult the appropriate policy contract for details on the terms, conditions, benefits, guarantees, exclusions and limitations. The actual policy issued governs. Each policyholder’s financial circumstances are unique, and they must obtain and rely upon independent tax, accounting, legal and other advice concerning the structure of their insurance, as they deem appropriate for their particular circumstances. BMO Life Assurance Company does not provide any such advice to the policyholder or to the insurance advisor.
Insurer: BMO Life Assurance Company
1067E
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