Advisors can clear up misconceptions about insurance by having strong product knowledge and a comprehensive grasp of the client’s personal situation, finances and goals.SB/iStockPhoto / Getty Images
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The increase in the capital gains inclusion rate may force some Canadians to see the crucial role insurance can play as part of a holistic plan for minimizing taxes, building wealth, protecting against life’s uncertainties and leaving a lasting legacy.
Although insurance can be useful to all Canadians with assets, it’s particularly important for business owners and entrepreneurs.
Permanent life insurance in a corporation
Corporate-owned permanent life insurance stands out as one of the most powerful and tax-efficient tools for building wealth and protecting the value of an estate. It allows premium payments with lightly taxed corporate dollars, avoids taxes on passive income, fosters tax-free growth, and facilitates tax-efficient cash flow.
In Ontario, the small business corporate tax rate is only 12.2 per cent on the first $500,000 of active business income compared with personal marginal tax rates as high as 53.53 per cent. By paying premiums with corporate dollars, a client can save 30 to 40 percentage points on the cost of premiums compared with the non-incorporated individual purchasing the same product.
Investment income within a corporate-owned permanent life insurance policy also enjoys tax-free growth, which preserves the small business deduction by not affecting the $50,000 passive income threshold.
In addition, permanent life insurance policies offer flexible options for liquidity through policy loans, dividend payments, partial surrenders, or leveraging the policy as collateral for a loan while incurring less taxes compared with traditional withdrawals from corporate accounts. While these strategies come with their own risks and considerations, they provide a degree of flexibility in times of unexpected need.
Because the death benefit of any life insurance policy is received free of taxes, corporate-held permanent life insurance can pass most, if not all, the funds to estate beneficiaries tax-free. In Ontario, to achieve the same after-tax estate value as a $2-million corporate-owned life insurance policy, one would need roughly $3.8-million in cash in the corporation given the high marginal tax rate on non-eligible dividends of 47.74 per cent.
Permanent life insurance isn’t a silver bullet, though. Most individuals should pursue additional investments and possibly additional term life insurance. While changes in tax policy, economic conditions and personal circumstances can affect the strategy’s viability, integrating a corporate-owned permanent life insurance policy into a well-structured financial plan allows clients to build wealth and protect investments and assets while minimizing taxes.
Owning risk insurance in a corporation
Risk insurance is all about protecting income in the early stages of building wealth and providing for dependents. Life, disability, critical illness and long-term care insurance all fall under this category. The ultimate objective is to amass sufficient wealth to become self-insured, relying on one’s assets to the point at which risk insurance is no longer necessary.
However, the insurance industry often emphasizes the sale of generic, off-the-shelf products, sometimes employing scare tactics and hypothetical worst-case scenarios, rather than tailoring insurance to fit a client’s specific wealth management strategy and lifestyle needs.
In general, life and disability insurance are crucial, while critical illness and long-term care insurance may be considered “luxury insurance” except in certain circumstances, such as being denied coverage from disability insurance. The appropriate level of coverage is highly dependent on the individual and influenced by personal circumstances, spending habits, savings, and a spouse’s earning capacity.
One should also be cautious about riders. Although some are situationally useful, opting for a luxury insurance package with all the bells and whistles can balloon costs with little tangible benefit. For instance, the future insurability option for disability insurance allows one to increase coverage up to 25 per cent, or by a fixed-dollar amount, without going through the underwriting process. This is essentially paying a premium for an insurance plan on an insurance plan. In rare cases, this rider may make sense, but those with no intentions of increasing coverage should save money by removing this rider.
Should risk insurance be owned corporately? Well, it depends. Life insurance should almost always be owned corporately, as proceeds are credited to the estate in a tax-efficient manner. Conversely, unless disability insurance pays out less than $5,000 a month, it should be paid for personally, as the benefits of saving on the premium payments by using after-tax corporate dollars tend to be offset by the taxes paid when amounts are distributed from the corporation. Other types of insurance should be evaluated similarly on a case-by-case basis.
Insurance as part of a holistic plan
The misconception that insurance products are a one-size-fits-all solution has made insurance a polarizing topic among both wealth advisors and clients. The reality is insurance may not be the answer to every financial concern.
It’s up to advisors to clear up misconceptions by not only having strong product knowledge, but also by having a comprehensive grasp of the client’s personal situation, finances and goals to explain how insurance fits into an overall financial plan.
Andrew Feindel is a portfolio manager and investment advisor with Richie Feindel Wealth Management at Richardson Wealth Ltd.
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