Advisor walks through benefits, caveats of whole life insurance as a planning tool in corporations
For some incorporated business owners looking for tax-efficient way to grow money in their corporation, permanent life insurance might be an ideal option, according to one advisor.
“There's no other way to grow money in a corporation, tax-free, but through an insurance plan,” says Andrew Feindel, portfolio manager and investment advisor at Richie Feindel Wealth Management in Toronto.
According to Feindel, incorporated Canadians have to pay only a 12.2% tax on money they put inside their corporation, making it a compelling tax-planning option. But investing in a corporation comes with a tax of essentially 50.17% on returns made.
Whole life insurance: paying dividends over time
When it comes to using insurance in a corporation, Feindel recommends the use of permanent insurance as it creates an opportunity to take positions that capitalize on features of the tax code. It allows the incorporated business owner to build up tax-deferred savings inside a corporation, and to grow that tax-free.
Under the umbrella of permanent insurance, clients may opt for either whole life or universal life insurance. While acknowledging there are pros and cons between the two, Feindel prefers to use whole life for corporate planning purposes as it eliminates much of the market risk.
"Depending on the company that you use, the dividends that get paid in whole life can never be negative,” he says. “In a year like last year, where both stocks and bonds went down, or a year like 2008, we don't have to be concerned about that; dividends still, historically, have been paid every year. And once they’re vested, they’re vested, and they compound over time.”
For many universal life policies, the proposition is that they allow the policyholder to invest in broad market indices like the TSX or the S&P 500, for a nominal fee. But because market performance can vary over the years, Feindel argues, it introduces an extra layer of risk into financial plans that are built on at least decade-long timelines.
Creating a financial legacy
From a financial planning perspective, Feindel says the killer application of life insurance in corporations is for clients to leave a financial legacy, allowing them to pass money on to the next generation, to charity, or to their estate in a very tax-efficient manner.
“Right now, the tax rate at the top tax bracket in Ontario for dividends is 48%,” he says. “If someone were to die with $3.8 million in their corporation, their kids would inherit about $2 million. But with permanent life insurance policies, for the most part, the payout is tax-free.”
The growth in permanent insurance policies tends to be conservative; a 50-year return on a plan, Feindel projects, would require an average gain of 11% in the market. Though that might sound tame, he argues a majority of clients would have lower risk tolerances 50 years down the road, with portfolios leaning farther toward bonds, GICs, or cash accounts than equities.
“In my career of doing this for 20 years, I have not seen active managers consistently get those rates of return over a long period,” Feindel says. “That's why I think it creates a very tax-efficient rate of return down the road.”
Another benefit of permanent insurance is the ability to borrow against it through a policy loan, though Feindel cautions that comes with a host of caveats. Borrowing against the cash surrender value might be sensible when interest rates are low, but not as much when rates are elevated.
“If you're borrowing at age 80 or 90, that's different than if you start borrowing at age 60, earlier in retirement,” he adds. “Some might not want to have debt compounding for 10, 20, 30 years in my retirement. … it could be a bit of a risky move, if used too aggressively.”