How to Use Life Insurance as a Tax Shelter for Business Owners

Daren Givoque, Financial Advisor

O’Farrell Wealth & Estate Planning | Assante Capital Management Ltd.

In January 2018, the Canadian government put the new tax on split income (TOSI) rules into effect which caused many business owners to have to rethink how to withdraw money from their corporations.

After the new rules came into play a client of mine came to me, unsure of how he could withdraw money from his business without paying tons of tax with the new TOSI rules. Before the change in legislation he was taking advantage of income sprinkling by including his wife and two young children as shareholders in the business so he could pay them each a salary and reduce his family’s overall tax bill. The new TOSI rules meant that in order to continue to do this he would have to prove that the salary being paid to his wife and children were reasonable related to the job they were doing associated with the business. His children were still too young to play an active role in the company and his wife was busy at home with the children and her own small business. In short, there was no way to ever claim that the money being paid out to his family was fair under the new rules. Now that it was clear that he had to reorganize how he withdraw money from his company, he was unsure of how to protect his money from heavy taxation and save for the future.

It is true. There is no longer a straightforward way for business owners like my client to withdraw money from their corporation without being heavily taxed. However, I was able to let him know that there is still one great product out there that could help him protect his money from being taxed heavily.

Life Insurance.

It may seem strange but buying certain types of life insurance can help you withdraw money from the corporation and shelter it in a tax-free environment. It is essentially a tax-free savings account for businesses.

So how does this all work?

Normally excess corporate profits stay trapped within the company. If the money sits idle and doesn’t earn anything there will be no growth to tax, but if it is passively invested and the gains are not directly attributable to the active growth of the company it will be subject to aggressive taxation. With tax-exempt life insurance there is a way to shelter your surplus as a corporate investment. The main types of tax-exempt life insurance policies are Whole Life insurance, Universal Life insurance and Universal Life insurance with guaranteed investments. The difference between these products and regular term life insurance is that they include a cash value, which is essentially a savings component. At the end of the day money that has been invested and the growth within the savings portion of the life insurance policy can flow to the business owner tax-free when they choose or to their heirs in a very tax efficient way on their estate.

It is important to note that this is a long-term game and should be considered for retirement or long- term cash flow for the company. Insurance is a great investment for corporations, but it is 10-15 year commitment. Business owners who invest money in life insurance products should be comfortable with have limited ability to access it in the first five years.

Any tax-exempt life insurance products can be used as a tax-shelter. The best one for you will depend on your unique situation. Talk to an advisor to see how your can use life insurance to your advantage and save your hard-earned money from taxation.