How to use life insurance for corporate investing?

If you are a business owner, you may be wondering: Can I use life insurance for investment purposes?

The short answer is, yes. 

Life insurance and corporate investing often go hand in hand for small or medium-sized business owners. A corporate-owned life insurance policy can lead to substantial savings on insurance premiums over time, provide access to liquidity, make it easier to get a business loan, and help transfer the death benefit to the your estate as a tax-free capital dividend.  

Continue reading to find out how to use life insurance inside a corporation as a tool to accumulate wealth.  

What is life insurance?

Life insurance is a financial product that provides a lump-sum payout to your beneficiaries upon your death. Life insurance policies generally fall into two categories:

1. Term Life Insurance policy: Temporary coverage designed for short-term protection without any savings or investment component.
2. Permanent Life Insurance policy: Long-term coverage that includes a savings component, often referred to as the cash surrender value, which grows tax-deferred. 

Term Life Insurance Policy

Often referred as the purest form of life insurance, term life has only one goal: to provide your loved ones with a financial safety net in the event of your demise. Term life plans last a specific period, which can be as short as one year or as long as 30 or 35 years. When this period ends, the coverage terminates, unless you renew the policy or convert it to permanent life insurance. Term life insurance doesn't accumulate wealth and on average is 5-15 times more affordable than permanent life. 

Permanent Life Insurance Policy

With a permanent life policy, you get lifelong insurance protection. These types of insurance policies also include a savings component, called the cash value. You can borrow money against your policy's cash value or withdraw it, either partially or fully, at any time while you are still alive. 

Only permanent life insurance policies that build cash value can be used for investment purposes. You can use such a policy to diversify your investment portfolio, supplement qualified retirement savings vehicles, like an RRSP, or to save for a future expense, like a down payment.  

Pros and cons of permanent life insurance?

Permanent life insurance has its benefits, like lifetime coverage and cash value. But it is not the right type of policy for everyone. Knowing about its pros and cons can help you decide if it fits your long-term financial goals. 

Pros 

1. Tax-deferred growth

The main purpose of life insurance is to provide a cash benefit to your family when you pass. Permanent life insurance policies do that and can also become an asset over time. These plans come with an investment component that gives you an opportunity to accumulate wealth on a tax deferred basis. 

Tax-deferred growth means you will not pay tax on any interest or investment gains on the cash value until you withdraw it. This arrangement offers two main benefits: 

• Your cash value grows faster since tax is not deducted from the interest or investment gains every year
• Withdrawing your money when you are in a lower tax bracket will result in a lower tax bill

You can access the cash value at any time and for any purpose. But keep in mind there may be tax consequences. Specifically speaking, the part of the borrowed or withdrawn amount that exceeds the policy's adjusted cost basis (ACB) is subject to taxation. For example, if your policy's ACB is $10,000 and you withdraw $12,000 from the cash value, you will pay tax on $2,000. 

2. Lifelong coverage

Permanent life insurance policies do not have an expiry date. While not everyone needs life insurance throughout their entire lives, some do. If you have a disabled child or want to leave a financial legacy, you may want to look at a policy that pays out regardless of when you die. The guaranteed payout feature also makes permanent life insurance a good fit for those who want to use life insurance for estate planning or a buy-sell agreement. 

3. Flexibility

Life insurance needs may change with time. If you think there's a chance you will need more or less coverage than what you need today, universal life insurance (a subtype of permanent life insurance) may be right for you. Some universal life plans allow you to adjust the death benefit, within limits, as your insurance needs change. 

4. Potential to earn dividends

Some permanent life insurance plans gives you the opportunity to earn annual dividends, which you can use in different ways. You can invest them in the built-in investment account to accumulate wealth more quickly. Or you can use this money to purchase more coverage or pay off the premium. 

Cons

1. Higher cost

The biggest downside of whole life insurance is its high cost. Expect to pay anywhere between 5 to 15 times more than a comparable term life plan. 

2. Cash value grows gradually

In general, cash value takes several years to grow to a meaningful amount. 

3. Safer investment returns

The return rate on the cash value is pretty moderate. For instance, whole life plans typically offer an annual return rate of 1% to 3.5%. You will likely be able to get better yields from other investment vehicles, such as mutual funds, stocks, and bonds.  

4. Cash value withdrawal isn't free

If you take out a policy loan, you are expected to pay it back with interest. Otherwise, the insurer will deduct the principal amount and interest from the death benefit. Withdrawing the cash value allows you to escape this penalty, but the benefit will get reduced by the amount you withdraw. 

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What is corporate-owned life insurance?

Corporate-owned life insurance is exactly what the name suggests — life insurance for corporate investing. Typically, the insured is a business owner or partner, a senior executive, or any other employee vital for the company's success. The company is both the policy owner and the beneficiary, meaning it is responsible for paying the premiums and receives the policy proceeds upon the insured's death. 

The corporation can use the death benefit to pay for the cost of replacing the deceased employee, fund a buy-sell agreement, or transfer most (if not all) of the proceeds to deceased's estate as a tax-free capital dividend. Additionally, it can also serve as loan collateral when the company needs to raise capital. 

Why Use Life Insurance for Corporate Investing?

Key Benefits:

• Lower premiums: Corporate tax rates make funding premiums cheaper than using personal after-tax dollars.
• Liquidity: Policies with cash surrender value can serve as collateral for loans or be accessed for business needs.
• Tax-free death benefit: Under the Income Tax Act, most proceeds can be transferred to the estate or shareholders as a capital dividend.
• Loan Collateral: A corporate life insurance policy can be used as collateral for business loans, helping companies secure favorable terms while retaining access to its cash value for other financial needs.

Corporate life insurance policy is not only a risk management tool but also a strategic financial asset that offers unique advantages for businesses. By integrating life insurance into corporate planning, companies can unlock several financial and tax benefits while ensuring long-term stability and growth.

1. Lower Premium Costs

One of the most significant advantages of corporate-owned life insurance is its cost-efficiency. Premiums paid using corporate dollars are significantly cheaper than those funded with after-tax personal income. This cost advantage is due to the typically lower corporate tax rates in Canada compared to individual tax rates. By utilizing corporate funds, businesses can secure robust coverage at a fraction of the cost, freeing up personal resources for other investments or expenses.

Example:
Consider a business owner with a marginal personal tax rate of 50% and a corporate tax rate of 12%. To fund a $1,000 monthly premium personally, the individual would need to earn $2,000 in pre-tax income. However, paying the same premium through the corporation would only require $1,136 in pre-tax earnings. This translates to substantial savings over the policy’s lifetime.

2. Tax-Free Death Benefit

Corporate-owned life insurance allows businesses to leverage the death benefit as a tax-efficient tool. Upon the insured's death, the proceeds can be paid to the corporation tax-free, in accordance with one Income Tax Act.. The company can then distribute a substantial portion—or even the entirety—of these proceeds to shareholders or the deceased's estate as a capital dividend, which is tax-free to the recipient. This feature makes corporate life coverage a powerful tool for estate planning, ensuring that wealth is preserved and transferred without incurring additional tax liabilities.

Estate Planning Benefits:
For family-owned businesses, this tax-free transfer can help equalize inheritances among heirs, fund buy-sell agreements, or provide liquidity to cover estate taxes without forcing the sale of critical business assets.

3. Tax-Deferred Cash Value Growth

Whole life insurance policies with a built-up cash value offer a dual advantage: lifetime coverage and a tax-deferred investment component. The cash value within the policy grows without being subjected to annual taxation, allowing businesses to accumulate wealth more efficiently. This tax-free growth enhances the policy's value over time, providing the corporation with a growing financial asset.

Liquidity for Business Needs:
The cash value can be accessed at any time to meet business requirements, such as funding operations, seizing investment opportunities, or addressing unexpected expenses. Withdrawals or loans against the cash value, however, may have tax implications and should be carefully managed to maximize benefits.

4. Loan Collateral

A Corporate life coverage can serve as collateral for business loans, creating a flexible source of security. This capability provides businesses with an additional advantage when seeking to raise capital. By assigning the policy as collateral, companies can secure favorable loan terms while retaining access to the policy's cash value for other financial needs.

Practical Application:
For example, a growing company might need capital to expand operations or invest in new technologies. By leveraging a corporate life insurance policy as collateral, the business can secure the necessary funding without tapping into other assets or incurring high-interest debt.

Maximizing Business Growth Through Strategic Insurance Planning

Corporate-owned life insurance (COLI) goes beyond providing financial protection; it also acts as a powerful instrument for business growth. By leveraging the unique benefits of COLI, companies can enhance their financial flexibility, attract investors, and position themselves for sustainable success. Here's how businesses can use COLI to drive growth while maintaining financial stability.

1. Access to Capital for Growth Initiatives

Whole life insurance policies often include a cash value component, which grows tax-deferred and can be accessed during the policyholder’s lifetime. Businesses can strategically use this cash value to fund growth opportunities, reducing reliance on costly external financing.

• Funding Business Expansion: Businesses aiming to grow can use the cash value of COLI policies to support major initiatives, such as purchasing new equipment, hiring additional staff, or opening new locations. This approach allows companies to reinvest directly in their future without interrupting cash flow.
• Maintaining Financial Flexibility: Accessing funds from COLI policies enables businesses to address urgent financial needs without incurring high-interest debts or diverting resources from ongoing operations. This flexibility is particularly valuable for small and medium-sized enterprises.

2. Strengthening Creditworthiness

The presence of a corporate life insurance policy can significantly enhance a business’s financial standing.

• Collateral for Loans: Lenders view the cash value of COLI policies as valuable collateral. This reduces risk for the lender, allowing businesses to secure loans at more favorable rates. By offering a stable financial asset, COLI helps businesses access the funding they need for strategic projects.
• Boosting Balance Sheet Strength: The cash surrender value of COLI policies is recorded as an asset on the company's balance sheet. This improves the overall financial profile of the organization, making it more attractive to investors and creditors alike. A strong balance sheet not only supports loan applications but also increases the business's appeal for future partnerships or acquisitions.
• Active Business Income: By utilizing COLI strategically, businesses can also generate active business income, which further improves their tax position and financial flexibility. This active income is considered a part of the company's operational activities and provides an additional layer of security and profitability.

3. Attracting and Retaining Investors

Investors prioritize businesses with robust risk management strategies and long-term growth potential. COLI policies contribute to both, making businesses more appealing to current and prospective stakeholders.

• Demonstrating Financial Prudence: By incorporating COLI into the company's financial strategy, leadership signals foresight and preparedness to manage risks. This reassures investors that the business is well-positioned to withstand unexpected challenges, such as the loss of a key executive or economic downturns.
• Providing Security for Investors: COLI ensures that the company has access to liquidity in times of crisis. This stability enhances investor confidence and showcases the organization’s commitment to protecting its value.

4. Supporting Mergers and Acquisitions

Mergers and acquisitions are complex transactions that require significant financial resources. Corporate life coverage can simplify and support these processes.

• Facilitating Buyouts: COLI proceeds can be used to fund buyouts during mergers or acquisitions. For example, in a situation where one business partner wishes to buy out another, the insurance payout can provide the necessary liquidity without disrupting the company's operations.
• Mitigating Financial Risks: Acquisitions often come with unforeseen costs. The cash value or death benefit from a COLI policy can be used to address these financial uncertainties, ensuring a smoother transition during ownership changes.
• Preserving Operational Stability: In the event of the death of a key individual during a merger, the policy’s death benefit can cover immediate expenses or gaps, ensuring that operations continue without interruption.

The Bottom Line

By integrating COLI into their financial strategy, businesses can achieve more than just risk mitigation—they can create opportunities for growth and stability. From funding expansion and strengthening creditworthiness to attracting investors and navigating mergers, COLI provides a versatile, strategic tool for long-term success. This makes it an essential consideration for any business aiming to secure its future while maximizing its potential.

Want to learn more about life insurance strategies for corporate investing? Reach out to a Dundas Life licensed advisor today.

Frequently Asked Questions

Is life insurance a good investment?

The primary purpose of life insurance is to provide financial protection to your dependents after you pass. Using it solely for investment doesn't make sense since other investment vehicles typically offer far better returns.

That said, high-net-worth individuals who need life insurance protection may find the investment component of a whole life insurance policy to their liking, particularly if they want to diversify their portfolio or have already maxed out traditional retirement savings accounts, like the RRSP. 

What are the benefits of owning a life insurance within a corporation?

Owning a life insurance policy within a corporation has three main tax benefits: 

• The cost of a life insurance policy is much lower when premiums are paid by a corporation rather than an individual
• The cash value grows tax-free until withdrawn
• A considerable portion (if not all) of the death benefit can be passed to deceased's estate or the surviving shareholders in the form of capital dividends

Who can use corporate owned life insurance?

Corporate life insurance policy can be a good fit for professionals with their own practices, like dentists or doctors. It can also provide important benefits to small- and medium-sized business owners. 

Curious to see if insurance is a smart investment strategy for you? Reach out to a Dundas Life licensed advisor today. We specialize in helping business owners and high-net worth individuals with insurance and estate planning.