Life Insurance – How much is enough for Private Companies?
Very few individuals or companies that I see are properly insured.
I believe that this is not because they don’t buy enough, but that we do not advise them to buy enough. This is particularly true in corporate situations.
Operating companies are unique entities who pay tax at a low rate when they earn income from active business, but there is a second tax when profits are taken out of a company by their shareholder.
Investment companies pay tax at a very high rate when income is paid or payable to the corporation, but then the company gets a refundable dividend about equal to the tax paid personally when the dividend is taken by the shareholder to avoid Double Taxation. Since corporate investment tax is higher than the top personal rate, most often salary is paid to shareholders and taxed at the lower personal rate.
To begin with, there are two simple but seldom discussed reasons why we should sell MORE corporations life insurance.
It is less expensive to buy life insurance in the company. It is not deductible. Paying for it with after tax profits taxed at 15% is more efficient than paying for it with after 44% taxed income. In fact it is about 25% less expensive. The family of the business owner may still need considerable insurance to repay debts and taxes. It seems that this point is overlooked when deciding how much insurance a company can own.
It is a more effective tax-shelter for passive investment companies. A higher corporate investment tax rate means that tax-shelters save more tax. Several insurance policies are established with minimum cost insurance within a Universal Life policy. These plans are designed to be “a mutual fund with a blood test” according to Mike Tavares of AIG. Many companies have introduced no fee mutual funds to compete head to head with non-registered investments. Insurance policies are designed to walk the upper limit of tax sheltering.
Finally, I would like to address the most important reason for corporations to own life insurance: Death benefits are accompanied by The Tax-Free Capital Dividend Account.
This is an advantage, a tool, and properly structured Life Insurance can be the golden fleece of tax planning for private corporations. Companies with a sufficient Tax-Free Dividend Account can pass active businesses down from one generation to the next with absolutely no tax shrinkage to the family.
Now I will finally answer the question I posed in the title.
The company must have enough life insurance to match 25% to 50% of any unrealized internal capital gain plus the retained earnings.
Life insurance is a “GET OUT OF COMPANY TAX-FREE” card.
You should have as much as it takes to remove all of the taxable value in your company.
Minimized Joint-Last-to-Die Insurance and Joint-First-to-Die Insured Annuities are two of the most effective planning strategies we use for Canadian Private Companies.
Written by Doug Markewich