Hot Business Insurance Ideas

1. Hot Business Insurance Ideas Kevin Wark, LLB, CFP CIFPS National Annual Conference

2. Something Old, Something New, Something Borrowed…

3. #1 Shared Ownership/ Split Beneficiary • Both concepts involve splitting costs and benefits of a permanent insurance policy between two parties • Can provide lower cost insurance to one party and enhanced investment returns to the other party • Possible applications include buy-sell, key person and collateral insurance

4. #1 Shared Ownership/ Split Beneficiary Removes CSV of Policy from operating company • Capital gains exemption • Sale of Opco • NCPI allocations and CDA maximization • Creditor protection

5. 1. Shared Ownership • Operating company is owner and beneficiary of face amount of universal life policy • Shareholder (individual or Holdco) is owner and beneficiary of cash surrender value • Rights and obligations set out in split dollar agreement • Issues with shareholder benefits and tax arising on future disposition of the policy

6. #1 Split Beneficiary • Usually arranged between Holdco and Opco • Holdco is owner - names itself and Opco as beneficiaries in agreed upon proportions • Holdco receives tax free dividends from Opco to pay its portion of the premium • Opco has no ACB so larger CDA credit • Less complex than shared ownership as don’t have disposition if Opco is sold or beneficiary is changed in the future

7. Pension #2 RCAs • Non-registered supplementary pension plan • Designed for executives and shareholders of private corps earning more than $100,000 pa • Contributions subject to 50% refundable tax and deductible to employer • Earnings subject to 50% refundable tax • Tax refunded when payments made out of the plan and taxed to plan member

8. #2 RCAs Benefits of RCAs: • Creditor protection • Ensures funding in place to pay future benefits • No current tax to plan beneficiaries But not tax efficient vehicles unless…

9. #2 RCAs You use an exempt life insurance policy as a investment in the plan. • Avoids payment of second level of tax on plan earnings. • BUT the death benefit becomes taxable when distributed.

10. #2 RCAs • Can avoid the death benefit being taxable by structuring as a “shared ownership” arrangement • Employer or employee owns the death benefit and funds this cost • RCA owns the cash surrender value and funds this through employer contributions

11. #3 Collateral Insurance Deduction for premiums equal to NCPI if following conditions are met: • Policy is assigned to a “restricted financial institution” • Assignment is required as collateral for a loan • Interest payable on the loan must be deductible for tax purposes

12. #3 Collateral Insurance • Deduction is available for any type of life insurance policy (not just term) • Size of policy must reasonably relate to the amount owing by the taxpayer • Taxpayer claiming the deduction must also own the policy • Premium must actually be paid in the year

13. #3 Collateral Insurance Planning Opportunity: • Bob is shareholder in a successful private corporation (Bobco) • In past 4 years Bob has received additional bonuses totalling $600,000 (to reduce corporate income to $200,000) • Bob has lent after-tax amount of $300,000 back to Bobco

14. #3 Collateral Insurance • Bobco borrows $300,000 from bank and repays Bob • Bobco purchases a life insurance policy for $300,000 and collaterally assigns to the bank • Bob can invest in policy on “shared ownership” basis • Bobco can deduct NCPI in respect to policy • If Bob dies prematurely the bank loan is repaid and his estate can withdraw$300,000 tax-free from Bobco

15. #4 Charitable Gifting • Shareholders in a private corporation have choice of making charitable donation personally or by using corporate funds • There may be significant advantages to structuring the gift through the corporation • Donation by individual is a credit, donation by a corporation is a deduction

16. #4 Charitable Gifting - Example • Joe Dambro is the sole shareholder of Dambro Construction • Joe went through crystallization - $500,000 in preference shares with full ACB • Joe is owed $200,000 by company • Joe in 50% tax bracket, company at 45% tax rate for earnings over $200,000 • Joe wants to make $100,000 charitable gift

17. #4 Charitable Gifting Gift of Insurance • Dambro Construction could be the owner/beneficiary of a $100,000 policy on Joe’s life • On Joe’s death the insurance proceeds would be gifted to charity by the company Note - it is not possible for Dambro Construction to designate charity as beneficiary and claim as a deduction

18. #4 Charitable Gifting Gift of Insurance • Premiums not deductible - slight advantage to company paying premiums • Dambro Construction can deduct gift of $100,000 - $45,000 in tax benefits • Death benefit creates $100,000 capital dividend account - can be paid out tax free to Joe’s estate

19. #4 Charitable Gifting Preference Shares • Joe could gift $100,000 in preference shares to charity other than a private foundation • Dambro Construction would purchase $100,000 of insurance on Joe’s life • On Joe’s death the insurance policy would redeem preference shares owned by charity

20. #4 Charitable Gifting Preference Shares • Joe realizes full benefit of charitable credit ($50,000) as no gain resulting from gift of preference shares • Charity receives dividends on shares while Joe is alive, and $100,000 on his death • Insurance proceeds create capital dividend account - can pay tax-free dividends

21. #4 Charitable Gifting Shareholder Loan • Dambro Construction would borrow $100,000 to repay part of shareholder loan • Joe would gift $100,000 to charity (can be a private foundation) • Dambro would purchase $100,000 insurance on Joe’s life - could be assigned to repay new loan

22. #4 Charitable Gifting Shareholder Loan • Portion of premiums could be deductible as collateral insurance • Joe can claim charitable credit of $100,000 ($50,000 tax savings) • Loan is repaid on death with insurance • Insurance proceeds would create credit to capital dividend account

23. #5 Corporate Back to Back Objectives • Increase investment yield and cash flow • Increase estate by reducing taxes • Facilitate distribution of corporate assets on tax-effective basis

24. #5 Corporate Back to Back • Typical client is 65+ and shareholder in private company with large accrued capital gain and taxable investments • Company purchases T100 or min pay UL100 (no CSV) on shareholder’s life - company is owner and beneficiary • Company liquidates investments and borrows funds to replace investments

25. #5 Corporate Back to Back • Corporation purchases a non-prescribed annuity on shareholder’s life with a zero guarantee period • Annuity payments sufficient to fund insurance premiums and after-tax cost of interest payments • Death benefit repays loan to bank

26. #5 Corporate Back to Back Tax consequences during lifetime • Annuity is non-prescribed and taxed more highly in early years • Interest expense deductible (subject to October 2003 REOP proposals) • NCPI deductible

27. #5 Corporate Back to Back Tax Consequences on Death • Company shares deemed to be disposed of at fair market value - insurance and annuity have no value for these purposes • Company value also reduced by bank liability • CDA credit generally equal to death benefit that can be flowed out tax-free to estate

28. #5 Corporate Back to Back Risks • liquidation of corporate assets may have tax consequences and/or penalties for early termination of contracts • interest rate fluctuations • Lack of flexibility - no commuted value • different insurers recommended

29. #5 Corporate Back to Back Risks - “GAAR” • could the CCRA treat this as one non-exempt life insurance policy? • has fair market value of corporation really been reduced? • is interest deductibility really appropriate? (Singleton case supports deductibility but must now consider October 2003 REOP proposals)

30. #5 Corporate Back to Back Risks • May 2002 - CCRA provided verbal interpretation regarding taxation of annuity contract under Regulation 301 • adversely affects calculation of income earned by annuity contract • issue appears to arise through drafting error - correction being sought by insurance industry

31. #6 Leveraging • Corporation owns policy on key shareholder and max funds the policy • On retirement shareholder borrows for personal purposes • Corporation guarantees loan and uses insurance policy as security

32. #6 Leveraging • 1% guarantee fee recommended • Loan interest is capitalized • Insurance proceeds paid through capital dividend account and used to retire loan including capitalized interest • Excess insurance proceeds for estate purposes

33. #6 Leveraging Tax Consequences • Policy accumulations tax-free in corporation • Assignment of policy as collateral not a taxable disposition • Loan payments to shareholder tax-free • Taxable benefit minimized by guarantee fee

34. #6 Leveraging Tax Consequences • Interest deductible if loan is for business or investment purposes (subject to October 2003 REOP proposals) • Insurance proceeds through CDA tax-free

35. #6 Leveraging Risks • Arrangement being treated as an RCA • Taxable benefit from corporation guaranteeing shareholder loan • Creditors of corporation • Sale of business • Impact on capital gains exemption

36. #7 “10/8” Programs • Target market – business owners and high net worth individuals aged 40-60 • Designed to reduce costs of permanent insurance protection • Provides access to cash values for investment purposes

37. #7 “10/8” Programs Overview of Program • UL policy with special policy loan provision at 10% • Collateral loan account earning 8% • Guaranteed “spread” and/or rates in the policy

38. #7 “10/8” Programs • Interest on policy loan deductible (subject to October 2003 REOP proposals) • Investment return in UL policy is tax deferred and on death converted to tax-free death benefit • Net return is positive due to interest spreads and deductibility

39. #7 “10/8” Programs Example • Client in 46% tax bracket borrows $10,000 from UL policy at 10% • After-tax cost of interest is $540 (5.4%) • Compares with after-tax interest earned of 8% (positive spread of 2.6%)

40. #7 “10/8” Programs The Problem • Policy loan is a disposition for tax purposes • Amount of loan – ACB = taxable income • ACB is reduced by NCPI • Cannot withdraw full amount of premiums on tax-free basis

41. #7 “10/8” Programs The Solution: • Shared ownership with private corporation owning the death benefit • NCPI allocated to corporation as death benefit owner (larger CDA credit) • Allows shareholder to loan out full premiums without taxable income

42. #7 “10/8 Programs Interest deductibility essential to program • Money borrowed to earn income from a business or property • Must complete Form 2210 and have approved by insurance company to claim deduction • REOP test – requires sufficient “profit” to utilize interest deduction over a long period of time • “profit” does not include capital gains

43. There are Great Opportunities for Selling Life Insurance in the Corporate Market!