Life Insurance Solutions for Business OwnersIwona Nicastri, CFP®, Wealth Advisor
There are over a million small businesses in Canada, and if you own one of them, there’s a very good chance you need life insurance.
Life insurance is an essential part of planning for the future of your company. When you own a business, many people outside of your family depend on you for their livelihoods, and life insurance ensures a future for their job if you pass away.
Here are life insurance solutions for business owners:
Key Person Insurance
Key person insurance is a company-owned life insurance to help keep a business going if the owner or other integral member dies. In this case, the company pays the insurance premiums, and is the beneficiary.
Key person insurance provides immediate cash for business expenses, loans and employee wages from potential income loss—allowing for time to recruit and hire a replacement.
Buy-Sell Funding Agreement
If you own a business with someone, a shareholders’ or partnership agreement is the most important tool for business succession planning.
A buy-sell funding agreement provides the guideline for what happens to an owner’s share of a business if he or she is no longer around. This agreement helps provide financing for the purchase and sale of business interests if an owner dies.
The policy can be structured where the business owners/partners have a policy on each other. Or the business owns, pays, and is beneficiary of the policy, and pays out the death benefit to the estate.
Business Loan Protection
Some financial institutions require life insurance as collateral on a loan for the business or a personally guaranteed loan. If the business owner or other key executive dies, the business may be forced to liquidate key assets, and/or the owner’s estate may be liable for any business dept.
Triggering Capital Gains Tax
Upon death of a business owner, the business shares will be deemed to have been disposed, at fair market value. This may trigger capital gains tax to the estate. If funds or other assets are not available to pay the tax liability, the shares or other business assets may have to be liquidated.
What if You Have Retirement Income?
For business owners who need life insurance, and have maximized Registered Retirement Savings Plan (RRSPs), Registered Pension Plans (RPPs), Tax-Free Savings Account (TFSAs), and have a surplus of savings/investments inside their corporation, a life insurance retirement program can be a good option.
This strategy involves overfunding the insurance policy to build up a cash value. The cash value may be invested and grows tax-free. Upon retirement, a collateral loan is taken out to provide tax-free income to the corporation. This income can be paid out as dividends to the shareholder/business owner. Upon death, the collateral loan is paid off, and the remaining insurance is paid out to the corporation tax-free. This creates a credit to the Capital Dividend Account – which can be paid out to shareholders tax-free.
Creation & Transfer of Wealth
You can create wealth using surplus cash and/or profits to invest inside the insurance policy. By using an exempt, permanent life insurance policy, the cash value growth is tax-deferred and the death benefit is tax-free. If the corporation or business owner needs the money, the cash value could be accessed through withdrawals (may trigger tax) or a collateral loan. If the advances from the collateral loan are for business purposes to earn income, the interest expense may be tax deductible.
If the business owner has a desire to leave a large legacy at death, life insurance can be a great alternative option to taxable investments. The cash value grows tax-free in the insurance policy. Upon death, the proceeds of the life insurance generate a credit to the Capital Dividend Account, which can be paid out to shareholders tax-free.
Life insurance for business offers an instrumental layer of financial protection for your employees and your business—ensuring that your business survives long into the future.