In April’s edition of Dialogue, we examined the question of passive income in your corporation and its repercussions on your business limit. Some strategies were proposed to reduce the impact of the new measures put forward as part of the federal reform of private corporation tax practices, which came into force in 2018:
- Paying a salary to the shareholder rather than a dividend.
- An investment portfolio focused on growth, which generates capital gains instead of income.
- Realizing losses to reduce annual investment income.
In collaboration with our affiliated company Sogemec Assurances, we suggest that you consider an additional diversification strategy:
- Take out permanent or universal life insurance.
Let’s examine this suggestion in greater detail to show its value.
- 40-year-old doctor.
- Purchases a $1 million life insurance policy, fully payable in 20 years.
- Annual cost of the life insurance for 20 years: $28,390.
- No rider is added and it is not a participating insurance contract.
Purpose of the strategy
By taking out permanent insurance with a high amount of coverage and an accelerated payments option, the annual premium payable will be very expensive. The goal is to anticipate the increase in passive income and to put this strategy in place before the income is too high so that the shareholder can benefit from the full small business deduction.
In the above example, the doctor will pay out $564,600 in premiums for his life insurance over a period of 20 years. Without life insurance, this amount would have gone into investments in the corporation, which would have generated passive income of $28,200 (assuming a return of 5%). Using life insurance as a diversification strategy avoided a $28,200 increase in passive income in the corporation.
Details of the strategy
- Life insurance purchased by the corporation, which is named beneficiary of the policy.
- Premiums paid from the corporation’s surplus. Since the tax rate of corporations is lower than that of individuals, the real cost of the life insurance will be less.
- By using the corporation’s money to pay the life insurance premiums, the corporation’s surpluses – and the increase in passive income – will be limited.
- This strategy effectively limits the reduction in the business limit resulting from excessive passive income. Generally, this income increases considerably in mid-career, when a doctor’s financial and personal situation is stable.
Conditions for the strategy to work
- Must be used from an estate perspective: the goal is to keep the insurance in the corporation until the time of death.
- Do not use this strategy if the intention is to eventually transfer the insurance contract from the corporation to the shareholder, or to cancel the contract and pocket the cash surrender value: the tax consequences could then be costly.
- Since the corporation holds the life insurance, it must remain open until the death of the shareholder. A financial projection could determine whether or not it would be advantageous to wind up the corporation before the death of the shareholder.
- Upon the death of the shareholder, not all the death benefit will be tax exempt if the insurance contract has an adjusted cost base (ACB). The exempt amount will be the difference between the sum insured and the ACB. As for the ACB, it will be taxed when it is paid as a dividend.
Be vigilant: make sure the financial strategies put in place suit you. Apart from tax considerations, your financial needs should guide your choices.
As an incorporated professional, you should deal with firms that know your reality. At Professionals’ Financial and Sogemec Assurances, two affiliates of the FMRQ, we take your professional situation and your goals into consideration to set up a financial plan that meets your expectations. Speak with your advisor and take the time to examine all your options: you can count on our expertise!