By Jim Sanderson
How life insurance can play a key role in worry-free business succession planning.
By Jim Sanderson
You’ve probably been in that family conversation about what will happen to your business when you retire.
You’ve probably been in that family conversation about what will happen to your business when you retire. And then, you touch on the fact that you are not going to get out of this world alive. According to the film director/comedian Woody Allen, “There are worse things in life than death. Have you ever spent an evening with an insurance salesman?” Once the butt of many jokes, this long-suffering professional may now have more influence on the future well being of your beneficiaries and business than you ever imagined.
Whether you plan to gift the ownership of your business when you die or plan to bring in an estate freeze strategy (please see my article addressing the estate freeze that appeared in Aggregates and Roadbuilding September/October 2010) the proceeds of a life insurance policy can be used to help cover the taxes payable resulting from the years of growth of your business. A life insurance policy can also ensure that each heir receives their fair share of your estate and possibly increase the amount of money you leave behind.
You can use insurance to cover your tax bill at death in two ways:
Taking out a personally owned life insurance policy. When you die, your beneficiaries will receive the policy’s death benefit tax-free, which could be used to cover the taxable capital gains that come due on the growth of your company’s shares. And to the beneficiaries, the death benefit is free of probate fees, immune to creditors’ claims and is quickly paid out once the death certificate has been presented.
Naming the corporation as the owner and beneficiary of the life insurance policy may reduce taxes upon your passing. Corporations tend to have lower income tax rates and the after-tax cost of the insurance premiums tend to be less than personally held insurance. Since your corporation would receive the life insurance proceeds this will create the opportunity to pay a tax-free dividend to the shareholders who could then address the taxes.
Understand your children’s wishes early
Most people want to ensure that all their children are treated fairly when the will is read.
All of your children may not be active in your business. Perhaps only one may have what it takes to lead the business into the future and ensure its prosperity to benefit the next generation. You can use life insurance to ensure that those children who are not active in the business receive an equitable inheritance. At your death, the active child or children would receive your shares of the business and the inactive children would receive the tax-free proceeds of the life insurance, thus ensuring an equitable distribution of your estate.
Maximize the value of your estate and create cash flow for retirement
Insurance can help you create a larger estate by letting you move corporate investments or retained earnings in a corporately owned tax-exempt life insurance policy, thus creating tax-free dividends for the estate.
A Corporate Insured Annuity allows excess capital that may be conservatively invested by a corporation, (typically a Holdco) to be put into a life annuity, which will spin off increased lifetime income. This can be very useful when your last day on the job arrives and your personal cash flow is top-of-mind. While the taxes on a corporately held annuity tend to be higher earlier on in the life of the annuity and reduce over time, the net income tends to be higher than what the alternative fixed income investments might generate – a real plus in a low interest rate environment.
Where life insurance helps …. again
The increased value of your estate stems from the life insurance component of this strategy. Basically, the corporation owns and is the beneficiary of the life insurance policy. The proceeds from the policy replace the capital invested in the annuity and allow for the payment of a tax-free dividend to your estate, which increases the net estate value of those corporate assets.
A Corporate Estate Reallocation
strategy is another solution to consider. It lets you shift a portion of your company’s retained profits or surplus cash into a life insurance policy where your investments grow on a tax-deferred basis during your life, and at death, are paid to your beneficiaries tax-free. Moving capital from a tax-exposed environment to a tax-deferred one may significantly increase the value of your estate, especially when those assets are currently sitting in a small business corporation or Holdco. There are even strategies to access this cash value prior to death and we may cover this information in future articles.
Consult your expert advisors on any of these strategies, presented here to help you start a conversation about which insurance solution may be best for you.
Jim Sanderson of the Jim Sanderson Group of ScotiaMcLeod is a certified financial planner and wealth manager.