Using Tax-Exempt Life Insurance to Reduce Corporate Passive Income

Sep 24, 2018 | Joshua Opheim


Have you ever considered the variety of wealth management solutions that can be addressed through the ownership of life insurance? We take a look at the 2018 Budget, specifically the new details surrounding small business tax reform.

The 2018 Federal Budget included new taxation rules that directly affect Canadian-controlled private corporations (CCPC). In particular, changes to the passive income rules for CCPCs may be the driving force for corporate investment adjustments. This is because for CCPCs that want to take full advantage of the small business deduction (SBD) cannot generate over $50,000 of passive income or the SBD limit will be reduced by $5 for every $1 of passive income above the new threshold.

There are a number of ways a business owner can reduce their passive income including: investing to earn capital gains, investing outside the corporation, establishing an individual pension plan (IPP) and via the ownership of corporately owned tax-exempt life insurance. Tax-exempt insurance typically refers to a life insurance policy that includes an investment component. The investment component in these policies allows for growth without tax within certain limits. See table below for a comparison.

Each strategy listed above reduces the adjusted aggregate investment income allowing business owners to preserve more of the small business deduction. However, tax-exempt life insurance may have a greater impact on your portfolio as it potentially offers the most flexibility from a financial planning standpoint. Take into account that although the funds invested within a life insurance policy are primarily used for the reduction of passive income, life insurance can also help with many different solutions for a business owner such as: 

  • Key person insurance
  • Business loan protection
  • Funding buy-sell agreements
  • Charitable giving
  • Funding capital gains tax at death
  • Executive compensation
  • Retirement funding
  • Estate tax and equalization
  • Tax sheltered wealth accumulation

Consider: Policy is held until death
Most insurance policies funded by corporations are held until death of the insured without accessing any accumulated cash value of the policy. Upon death of the insured the proceeds of a life insurance policy are received by the corporation. Proceeds in excess of the adjusted cost basis (ACB) are credited to the capital dividend account (CDA). This plays a major role in estate planning and business continuation for private business owners. Ordinarily, any capital taken out of the corporation as income is done so as a taxable dividend. The CDA credit, created by the receipt of insurance proceeds or an existing balance in CDA, allows shareholders to withdraw at least a portion of that capital, if not all of it, tax-free.

Consider: Utilizing tax-exempt life insurance to fund your retirement
You may want to access the funds within the policy before or during retirement. You may access the cash value of the policy in three ways: partial or full withdrawal of the cash surrender value, obtain a policy loan or collaterally assign the policy to secure a loan. The first two methods could result in a deemed disposition resulting in a taxable policy gain. It is possible for the interest rate on the bank loan to be less than the dividend rate attained within the life insurance policy. Utilizing cash surrender values as collateral to obtain a bank loan is commonly referred to as an insured retirement plan (IRP). The IRP is a retirement planning strategy that uses corporately owned tax-exempt life insurance to accumulate wealth and provide the following: (1) shelter capital growth on a tax-deferred basis, (2) provide tax-free supplemental retirement income utilizing policy values to obtain a loan and (3) provide a tax-free death benefit net of any outstanding collateral loans. Contact us today for further guidance on this.