Corporate Owned Life Insurance

If you are a business owner and need life insurance, you have two options: 

• Buy a life insurance policy that you own as an individual

• Buy a life insurance policy that is owned by your business corporation (or group of corporations or a trust)

Business life insurance works in the same way as individual life insurance. When you pass away as a business owner, the life insurance company pays a death benefit to the beneficiaries. These could be your company or a loved one, such as your spouse.

Corporate owned life insurance (COLI) may also include an additional savings component, depending on the type of policy you purchase. Regardless, life insurance that a corporation owns is a great investment in the event any life-threatening risks were to happen to you or someone with higher status in the company.

The primary purpose of corporate owned life insurance is to help your company in recovering from the financial loss caused by the death of an owner. However, business life insurance also has different uses or cases. For example, corporate owned life insurance can be used to secure a business loan (or loans), fund a buy sell agreement, and plan for business succession.

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Why would a business owner want corporate owned life insurance?

Corporate owned life insurance can protect your company from financial difficulty in the event of your death. In addition, it can help with the following:‍

     1. Securing a business loan

If you as a business owner want to take out a business loan, you can use your corporate-owned life insurance policy as collateral. This also comes with many customization options in the form of a rider (or riders). ‍

     2. Protecting your business 

By taking out a life insurance policy on a key employee (like a business partner or a senior executive), you as a business owner can help reduce business interruption if that person passes.

     3. Succession planning

Life insurance can play a vital role in business succession planning. For example, let us say you have multiple heirs. You want to treat all your heirs equally, but only one of them is interested in running the business. Life insurance can help you pass the business to that person and leave a cash equivalent for the other family members (to pay for things like a mortgage).  ‍

     4. Tax-free growth

Permanent life insurance provides access to cash which can be used by the business to pay off debts or be borrowed against. This cash value is accessible tax-free.

Can a corporate owned life insurance policy on an employee?

Yes, a corporation can buy a corporate owned life insurance policy on an individual shareholder or employee in your home country. This type of term life insurance coverage is known as key person insurance. 

Companies often purchase insurance on specific individuals, usually the owners, founders, senior executives, or other employees who are crucial for the company’s survival.  The company owns the policy, pays the premiums, and is usually also the policy beneficiary. In the event of the insured’s death, the business receives the policy proceeds, which it can use to cover the cost of replacing the deceased, or other expenses.

Key person insurance works exactly like personal life insurance. The contract involves three parties:

• The life insured (the employee on whose life the key life insurance policy is taken out)
• The policyholder (the company is the policyholder and responsible for paying the policy premiums until disposition)
• The beneficiary (usually, the company is listed as the beneficiary, meaning it will receive the death benefit payment upon the insured’s death)

It's worth noting that life insurance policies held corporately has come under scrutiny in the past. This is due to concerns about the use of the death benefits from term life insurance and the potential for abuse in retirement. As a result, regulations and restrictions have been put in place in some states to limit the use of COLI policies.

What are the advantages of corporate life insurance policy?

Some of the advantages of corporate owned life insurance include: 

     1. Cheaper after-tax premiums

Generally, corporations have a lower tax rate than people in general. As such, the cash flow required to fund policy premiums will be lower if you use corporate dollars to buy insurance instead of after-tax personal dollars. To put it another way, with the same cash flow, you can purchase more coverage with corporate dollars than with personal dollars. 

For example, Miles is the owner of a Canadian Controlled Private Corporation (CPCC) and wants to take out a life insurance plan with a monthly premium of $400. Miles’ corporate tax rate is 10% while his personal income tax rate comes to 40%. If Miles were to buy life insurance as an individual, he would need to earn $667 a month. In the other case, if Miles buys the same policy through his corporation, the monthly cash flow required reduces to $444. That means a corporate-owned policy will save Miles $223 a month.

Since life insurance premiums are payable for many years, buying corporately owned policies can result in substantial savings. 

     2. Tax Advantages of the death benefit

The life insurance proceeds over the cost basis can be paid tax-free to the deceased’s estate or a shareholder through capital dividends. 

     3. Cash surrender value as an asset

The cash surrender value of any permanent life plan owned by a corporation is regarded as an asset. That is because the corporation does not have to pay tax (or taxes) on any unrealized gain unless it cashes the policy. Cash surrender value is essentially the policyholder's invested component of the policy, but it is important to note that cash surrender value applies only to permanent life insurance, not term life insurance.

     4. Loan collateral

A business can use the life insurance policies owned by it as collateral for a business loan to help build wealth. 

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What are the downsides?

There are several advantages to a corporate owned life insurance policy as a Canadian, but do consider the potential downsides before signing up. 

Mainly: what happens if you leave the corporation? In this scenario, getting a life insurance policy out might create tax problems. At the same time, you might not want to leave the term life insurance in the company since that would only benefit the remaining shareholders. So if you are planning to take out a corporation owned life insurance policy, make sure you include it in your exit strategy. 

Also, ensure the tax advantages of purchasing a corporate-owned life insurance do exist. Typically, the life insurance proceeds policy minus its adjusted cost basis can be added to the company’s (or holding company) capital dividend account. Then, the capital dividend account can be distributed tax-free among shareholders through a capital dividend. However, if the capital dividend account’s balance is negative, the shareholders will receive less than the intended amount or, in the worst-case scenario, no money at all.  

Thirdly, if the company does experience financial difficulty, shouldering the annual insurance cost can prove difficult, particularly if several key employees are insured. 

Corporate Owned Life Insurance Scenario

Scenario #1 - Fund a Buy-Sell Agreement

Corporate owned life insurance is frequently used for funding a buy-sell agreement, which details how an owner’s interest in the business can be sold to other business owner in the event of death. 

Consider a scenario where a business has two owners, and both want to gain full control over it after the death of the other owner. In this situation, each of them can take out a life insurance policy on the life of the other owner that is equal to the latter’s stake in the business. When an owner dies, the surviving partner will use the paid out insurance proceeds to buy the deceased’s stake or assets. 

Scenario #2 – Estate equalization 

Let's say you own a family-owned business, which forms a large part of the value of your estate. You have three daughters — Ria, Sara, and Alanis — but only Ria is involved in running the business. Naturally, you want Ria to inherit the business after you pass, but there is not enough cash to provide equivalent value to the other daughters.

By taking a corporate owned life insurance policy and naming Sara and Alanis as the beneficiary, you can ensure each daughter receives an equal share of your estate. 

Scenario #3 – Loan protection

As an business owner with shares in a small business, if you apply for a business loan, lenders will likely require you personally guarantee the loan. Often, lenders may also require you buy life insurance that lasts until the loan is paid off. Even if life insurance is not a prerequisite for the business loan, it is a good idea to buy it. Otherwise, if you die unexpectedly and your business defaults on the loan, the lender could recover the outstanding amount from your estate. 

Scenario #4 – Key person protection

Loss of a key employee can financially impact a business. Usually, it is difficult to find a suitable replacement. Even if you found one relatively quickly, it could take that replacement several months to work at the same level as the deceased employee.  This could disrupt your business and reduce its profits.

Life insurance proceeds can help offset lost passive income due to the death of a key employee and cover the cost of hiring and training a replacement.

Is corporate owned life insurance right for you?

You can use corporate owned life insurance to meet the specific needs of your business, including covering the most important employees, funding buy-sell agreements and securing additional funding. Tax-deferred growth, tax-advantages of death benefit, cheaper after-tax premiums, and a range of insurance options make business owned life insurance a worthy option for business owners.

At Dundas Life, we can provide you a great services experience for securing the right corporate owned life insurance coverage — be it term or permanent — at the most affordable price. We help our clients choose the right life policy for corporations, which is a worthy investment for any organization in any country. Talk to one of our licensed advisors today to learn more information.