Written by Mike Veldhuizen
Most of you know that life insurance can be used by individuals to cover their debts and funeral expenses as well as to provide a financial cushion to their families after death. You may even have considered purchasing life insurance to finance the tax bill that arises from the deemed disposition of your private company shares upon your death. However, did you know that life insurance can also be taken out and used by your company to settle various problems that could also arise upon your death, such as the payment of business debts, the capital support necessary for the operating the business and buying or redeeming the shares of a deceased shareholder?
Types of life insurance
There are several types of life insurance, which are basically classified as “temporary” or “permanent” insurance.
- Term life insurance is the simplest form of life insurance. It provides protection for a specified period in the event of death and is the least expensive type of insurance.
- Permanent insurance is designed to be maintained for the long term until death and includes 100-year universal, whole and term life insurance policies.
Universal and whole life insurance policies offer an investment component that allows additional funds to be paid into the policy beyond the cost of insurance. These additional funds form an investment component; they can grow tax-free and increase the proceeds of the policy on the death of the insured person. The details of permanent policies are complex and vary widely from policy to policy. You should discuss the details of any permanent policies with your insurance broker before purchasing them.
Buy life insurance in a company
A company can be the beneficiary of a life insurance policy, which generally allows it to pay the premiums linked to this policy and to collect the proceeds after the death of the insured person. In most cases, premiums are not deductible, but can still be paid out of corporate funds, which is an advantage over using after-tax personal funds. When the product is finally received, it is non-taxable for the company and an equivalent amount (after deduction of the adjusted basic cost) is added to the company's capital dividend account, which can be paid tax free to the shareholders. as a capital dividend. The adjusted cost base of the policy is determined by the insurance company and is calculated by subtracting the pure cost of life insurance from the premiums paid.
It is important to ensure that any insurance held by a company designates the company as the beneficiary and as the owner of the policy, and the shareholder as the covered person.
Practical Uses of Company-Owned Life Insurance
Death taxes and equity. Imagine that the shares of a family business make up the bulk of an individual's estate and that there are multiple beneficiaries, some of whom are not actively involved in the business. It is common to find that the shares of the family business are bequeathed to family members who take an active part in the business of the business while the other assets of the estate are distributed among the other family members. In this situation, there may not be enough cash to pay the taxes on the deemed disposition of the shares and even less to provide equivalent value to family members not involved in the business. Life insurance held by a company can be used to finance any tax liability and distribute the value equitably among the beneficiaries, by paying the proceeds to the estate through capital dividends.
Loan protection. In small businesses, it is often the case that lenders require that the loans be personally guaranteed by the owners. In some cases, lenders may also require that key people life insurance be purchased for the duration of the loan. Even if lenders do not require life insurance, it is advisable to have one. A personal guarantee becomes a liability for the estate and the estate could therefore be responsible for all unpaid debts which the company is unable to repay. Purchasing life insurance can also improve the company's ability to obtain financing.
Protection of key persons. The death of a shareholder or key person can put pressure on a company's finances in a number of ways. It is often very difficult to replace a key person and it can take several months or even years before a competent replacement, once found, can bring the business back to the same level of profitability. This can be very disruptive for a small business and cause problems with efficiency and profitability. Life insurance can provide the business with the cash flow it needs to consolidate working capital or pay down debts, or to provide the funds needed to hire and train a replacement on the death of a key person in the business.
Purchase and sale agreements. Life insurance is often used by private companies to finance purchase and sale transactions triggered by a shareholder agreement following a death. In many cases, surviving shareholders of a business do not want the family of their former partner to participate in the business, nor do families want to do so or give up the proceeds of the estate. The life insurance product can be used to finance the purchase or redemption of shares held by the estate of a deceased shareholder. Using life insurance owned by a company to finance the purchase or purchase helps the business continue to operate while providing cash to the beneficiaries of the deceased. There are a number of methods to use the life insurance proceeds to finance the purchase or redemption of the shares of a deceased shareholder. For example, the proceeds can be used to redeem shares or be paid as a capital dividend to finance the purchase by surviving shareholders of shares in the estate of the deceased.
Where possible, the specific redemption process should be reflected in the shareholders' agreement to avoid confusion and conflicts later. The intended use of the life insurance product and the capital dividend account should also be discussed.
While buying and using life insurance through a private company has many advantages and flexible planning opportunities, there are a number of additional complexities that should be considered. Corporate tax issues, shareholder agreements, accounting for permanent insurance values and additional compliance requirements for capital dividends are just a few examples. You should always consult the appropriate accounting, tax, legal and insurance advisors to ensure that your planning is carried out correctly and that administrative and compliance matters have been taken into account. This will allow you to sleep on both ears.