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Using Universal Life Insurance with Corporations





This is another guest post by Brian Poncelet who is an insurance specialist and independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning.

  • Most personal finance enthusiasts will know that Universal Insurance may not be the best deal for everyone.  However, there are circumstances where Universal Life can be useful, namely, if you have a holding corporation.  I contacted Brian regarding a question that a reader had regarding the advantages and disadvantages of using UL with corporations.  Here is what Brian came back with:

At the point in time when the death benefit is paid, the type of plan is actually irrelevant.  A term policy for $1,000,000 is equal to a universal life policy for $1,000,000.  The main advantage to buying universal life (UL) is for the tax incentives that this type of plan offer while policy owner is still alive.

Throughout the life of the UL policy, additional deposits can be made which will accumulate over the years.  These additional deposits are allowed to grow within the policy tax free until death or until such time as the funds are withdrawn.  It is the growth of the assets and the deferral of the taxes (on the growth) that enables the individual to increase his estate value which does result in a larger payout at death.

The business owner can benefit in much the same way through the effective use of a holding company which is typically used to hold the shares in the operating company and store retained earnings not required to run the operating company.  The holdco uses these excess funds to buy the UL policy.  The same growth occurs within the insurance policy and this transfer of funds to buy the insurance essentially reduces the FMV of the holdco for the purposes of calculating capital gains tax due upon death.

Should the operating company ever require capital, the holding company can still access the funds in the policy by taking a policy loan, withdrawing the funds or by using the insurance policy as collateral  to obtain a third party loan which may be tax deductible as an operating expense.

Added value for spouses with estate planning, a joint last to die can be structured to take a greater advantage of the FMV calculation.  On the death of the first spouse, the holding company can elect to receive a fund value payout as a tax-free death benefit.

As an example, business owner Chuck Jones is 55 years old.  His holding company buys a $1,000,000 Corporate Estate Transfer Advantage policy from a large Canadian insurance company where the investments are guaranteed 4% in GICs.  To maximum fund this plan, Chuck deposits $72,157 for the first 5 years of the policy.

The illustration below compares the UL policy to an alternative investment in stocks, bonds and mutual funds at 7% growth.  I have shown what it would look like if Chuck dies in year one through thirty (age 85).  Since the alternative investment at 7% would be taxed at the highest level, the taxes would erode any advantage even with a 3% higher rate of return.  The third column is the net difference difference between the insurance solution and the straight investment solution.  Yes, over time net difference is less significant but after 30 years, the insurance solution offers more money for the heirs in the insurance solution and Chuck has taken less risk with his money.

Comparing Estate Values

Insurance Solution Investment Solution The Corporate Estate Transfer Advantage
Year 1 $1,031,844 $36,094 $995,750
Year 10 $1,142,222 $291,025 $851,197
Year 20 $1,199,942 $537,538 $662,404
Year 30 $1,167,903 $957,815 $210,088

Disclaimer: This article and example have been simplified for the purposes of this illustration.  There are other elements to be considered when considering universal life and holding company planning.  Consult your financial advisor and chartered accountant.





31 Comments, Comment or Ping

  1. 1. Chuck

    My understanding is that the universal life policy premiums will be deemed a taxable benefit if your corporation is holding them., or at least that’s what my agent told me.

  2. 2. Rene

    Awesome, thanks for the article! One great potential advantage of UL in a corporation is the ability to draw a loan on the amount. The money grows tax free in the policy and then you can access it, via the loan, without having to take it out of the corporation as a dividend (thereby avoiding the taxes).

    Some of these policies have the loan guaranteed when you sign up for the policy. The thing that worries me about this strategy, though, is that if you access the money earlier in your life (i.e. for a longer time) that the costs of servicing the loan might outweigh the tax deferral and reduced income tax benefits. Apparently the policies can be set up so the investments service the debt when you take the loan.

    For sure, having the independent advice of an accountant would help greatly before committing to such a strategy.

  3. Nice article. With insuranse policies there’s always the posibility that the insurance company denies your claim or makes you wait for your money when you most need it.. Just ask Heath Ledger’s kid :-(

  4. Dividend Growth Investor,

    I think the question is “The Dark Knight” actor died of an accidental drug overdose in January this year, but Reliastar Life Insurance is investigating whether he committed suicide.

    Every insurance policy includes a 2 year suicide and contestibility clause because, let’s face it, there are people who take out insurance with the intent to defraud or to commit suicide. If this provsion was not in place, you and I would not be able to afford the cost of insurance. In the U.S. insurance companies cannot deny a claim after this 2 year period. One can only assume that Heath Ledger’s policy was issued within the 2 year period and the company has every right to investigate. Let’s not lose sight of the fact that the majority of claims are paid in good faith, these are the success stories that no one talks about…regards Brian

  5. Hi Chuck,

    I will try to answer your question “universal life policy premiums will be deemed a taxable benefit if your corporation is holding them”

    The premiums are paid by the Holding Company for the life insurance, excess monies go into investments like GICs, Index funds,etc. The Holding Company is named beneficiary. The death benefit is paid and the tax-deferred cash value will go to the Holding Company. The beneficiaries receive ownership of the shares of the Holding Company.

    The death benefit, minus the Adjusted Cost Basis (ACB) of the policy, flows to the capital dividend account of the Holding Company and the ACB is paid out as a taxable dividend. Over time the ACB will be zero, meaning the entire death benefit and investments can distributed to the beneficiaries as tax-free dividends.

    regards,

    Brian

  6. 6. Henry

    Hi Brian,

    Thank you for such a informative article, I have been hearing more lately about Participating Life Insurance being a better choice than Universal, wherether its’ held in a Holdco or not, can you explain what situations and settings that a PAR may be a better choice than Universal?

  7. Brian,

    Thanks for taking the time to answer my question. I realize I didn’t have all the facts and that I was referring to the story that was widely publicized in the media.

    Good luck in your practise!

    DGI

  8. 8. Ed Rempel

    Hi Brian,

    Informative article. A couple of questions.

    1. Can a business owner get a similar situation with the classic “Buy term and invest the difference” in his corporation?

    2. Can the investment part get the same tax treatment while you are alive by, for example, putting it into a corporate class fund? Are there other ways to essentially defer tax until death or withdrawal?

    3. Are you still ahead with UL even after the tax saved on the death benefit (in a buy term and invest the difference scenario) when you include the tax on insurance premiums into the UL?

    4. Are there ways to address the lower investment returns in UL’s resulting from the limited investment options in UL’s and higher MER’s in most seg funds?

    Ed

  9. Henry,

    Participating Life Insurance is when the life insurance company looks at expenses like mortality, taxes, etc. If there is a “surplus” the insurance company as approved by the board of directors gives a dividend to the policy owners, this amount can change from year to year. Policy owner doesn’t manage investment component.

    The big advanatage I see with Universal Life is the flexibility of premium payments which could go up or down. Plus ability to manage investment mix.

    Please note this is a big subject and I have given only a snapshot of the two products.

    regards,

    Brian

  10. 10. Little Ms.Scrooge

    Thank you for the very informative article. Just a couple of questions Brian- when you say holding co., is it adding another layer within the corporation? Is it more paperwork to create in addition to the corp.?
    At what stage in professional life is it better to start the UL?.
    If you are not leaving much in corp a/c at the end of each year- paying out wages/benefits/taxes- how beneficial is it to start UL. I hope my Qs makes sense to you.
    Thank you

  11. Hi Ed

    Before I answer your questions, here is a brief review of the holding company scenario. The purpose is move extra money not needed in the operating company.

    “The business owner can benefit in much the same way through the effective use of a holding company which is typically used to hold the shares in the operating company and store retained earnings not required to run the operating company. The hold co uses these excess funds to buy the UL policy. The same growth occurs within the insurance policy and this transfer of funds to buy the insurance essentially reduces the FMV of the hold co for the purposes of calculating capital gains tax due upon death”

    Question #1 & 3.
    Looking at my example again, Male, age 55, sole owner of a growing business. A term policy for $1,000,000 will cost $3,000 per year. At age 65 the policy will renew at roughly $20,000 per year. At age 75 he will pay $72,000.

    Alternatively, he can apply for a NEW term policy at age 65 and prove his insurability again. If, and I stress IF, he is healthy, this new term policy will cost him $8,900 per year. Since most companies will not issue a new term policy beyond age 70, he can no longer go through the underwriting process again.

    While the initial term cost might be favourable, the renewals grow significantly. If the individual is not able to support the renewal, it is unlikely that we will be able to “invest the rest”.

    So now he is 75 years old and is paying $72,000 per year until age 80 when the insurance expires. But his business did well and he has a sizable estate that he would like to pass intact to his heirs. There is still an insurance need that might have been addressed with a UL policy when he was 55.

    In most situations, the goal at age 55 is “estate preservation” as there are no longer dependant children. The cost of UL can be lessened by the use of a JLTD (Joint Last to Die) policy between husband and wife, which is not available on term. A joint equivalent age is calculated which is less than the premium for the single life policy because the death benefit is not paid until the second death. Assuming the husband dies first, the holding company can elect to receive a fund value payout as a tax-free death benefit. That amount minus the policy’s ACB is credited to the holding company’s CDA (capital dividend account) and can be paid to the Canadian-resident shareholder tax-free.

    Another benefit with the JLTD: If our 55 year old is not insurable due to recent cancer history, he can still be included in a JLTD policy and still be able to take advantage of the Universal Life tax benefits.

    Question #2. The same tax treatment is available with the corporate class funds but in the end you have no lump sum insurance payout.

    Universal Life investments include GICs. These types of investment appeal to the older individual and pay much higher interest rates than the corporate class money market account. GIC’s are not available in the corporate class funds.

    There are probably other ways to defer your tax but it is beyond the scope of this article.

    4. Fees: Some insurance companies charge the same MER on funds you would to sell to your clients. Is there a choice of 4,000 funds, no, usually 50 funds or more. Some “fee only advisors” could get some of these funds cheaper, but would of course charge a fee for their advice.

    regards,

    Brian

  12. Hello Little Ms.Scrooge,

    If I understand your question… when is the best time to set up a holding company? When you have extra money you do not need in your operating company. That’s when you set up a holding company.

    Until you reach this point, looking at UL, doesn’t make much sense. Get some term insurance and replace it when your cash flow is better and when the holding company is set up.

    regards,

    Brian

  13. Hi Ed,

    Now that the markets have gone down around the world, 4% guaranteed vs. investing the difference with term, sometimes being more conservative with extra cash in a holding company is better. Also, term becomes more expensive later in life. So you have investments which may take years to recover…

    Brian

  14. 14. Ed Rempel

    Hi Brian,

    One short term bear market and you are advocating GIC’s? Do you know how many times higher stock market returns are than GIC’s over the last 30 years? This argument makes sense short term, but not for a 30-year term.

    In your article above, when you compared investment returns to universal life insurance, did you assume the investments are taxed every year or only at the end? I quick future value of 5 investments of $72,157 @7% for 30 years, I get a future value of $2,410,000. After capital gains tax in the estate, I get $1,939,000. This is almost double your figure and far higher than the UL death benefit of $1,167,903.

    Did you also assume the premium tax withdrawn from the estate value in the UL, but not with regular investments? I guess the higher MER would not apply if you are only investing in GIC’s?

    What would happen if the client bought a term 100 and invested the difference? This would definitely give them the $1 million tax-free payout at death, plus a decent investment portfolio.

    Ed

  15. Hi Ed,

    Please read the case study again. Chuck Jones is 55 years old. He puts in over $72,000 per year for five years. One can assume if he buys insurance and looks at his age he is conservative.

    Term to 100 seems like a good idea, but the money must be withdrawn from a side account every year which would be taxed first. Money cannot be put into GICs or it will be taxed unlike a UL policy;

    regards,

    Brian

  16. Hi Ed,

    Here is the part that might help you from the case study.

    The holdco uses these excess funds to buy the UL policy. The same growth occurs within the insurance policy and this transfer of funds to buy the insurance essentially reduces the FMV of the holdco for the purposes of calculating capital gains tax due upon death.

    You can not do this with buy term and invest the difference.

    Brian

  17. Hi Ft,

    Is 4.25% still a good rate for GIC’s in a UL policy? I quoted 4% in my case but I think anything above 4% is good.

    I forgot to point out each account is protected up to $100,000 by Assuris see http://www.assuris.ca/ it is a not for profit organization that protects Canadian policyholders in the event that their life insurance company should fail.

    regards,

    Brian

  18. 18. LOOPS

    Brian, as an insurance advisor, I am glad you highlighted this particular strategy.

    So, thank you Brian.

    You were right in saying that it is more complex than the bit you were able to get into wrt the strategies that can be implemented with a UL. And it is not for everyone, but it certainly can work for many, if used correctly, as with any other investment strategy.

  19. First I want to admit from being from the US but intrigued. I was wondering about the use of a Whole Life policy from a mutual insurance company as an alternative to the UL. The whole life will build cash value that I’ve seen compete or outperform the ULs fixed rates of returns. With the changes in the insurance industry WL policies have become as flexible as UL. They also give you an increasing death benefit. I’m not sure if I’m missing anything as I’m sure things are different in Canada.

  20. 20. rob

    hi Brian,

    based on your experience, which insurance company has the lowest MER for UL..i would prefer an index fund..thanks..

  21. Hi Rob,

    Great question. Short answer is I don’t know. With UL, I stick to GIC’s or bonds.
    Why? The purpose of the insurance is be conservative. With index funds maybe market will go up or down, Taxes is a bigger worry, so why gamble with the market, when CRA can and does more money than any returns you will get from an index fund.

    Generally the UL policies charge more(on funds) than you can get elsewhere, the insurance industry generally doesn’t care. Look at what the insurance does, tax free growth, coverage if you die too soon or live too long. If you look at my case study above can you get an index fund with a 7% or better return guaranteed?

  22. 22. rob

    hi Brian,

    thanks for your learned reply…your posts have set me thinking about safety in UL..when i checked Manulife …//////////////

    INTEREST GUARANTEE
    The effective annual interest rate for this account is set at least weekly and is guaranteed to be at least:
    •90% of the weighted average yield over the past 15 years on current coupon Government of Canada Bonds with terms to maturity of 10 years or more less 2.25%, or
    •3%,
    whichever is greater
    //////

    ANNUAL COMPOUND RETURNS (as at February 28, 2010)
    This table shows the historical annual compound return of the underlying index and the universal life accounts that are linked to this index.

    1 Year 2 Year 3 Year 5 Year Since Inception Date of Inception
    UNIVERSAL LIFE ACCOUNTS
    Average GIA Account
    Security UL (On or after June 23, 2001) 3.100% 3.070% 3.060% 3.060% 3.200% Jan 2002
    Security UL (Prior to June 23, 2001) 3.100% 3.070% 3.060% 3.060% 3.200% Jan 2002
    UNDERLYING INDEX
    Government of Canada Bonds 10yrs or more 3.850% 3.940% 4.090% 4.200% –

    Past results are not necessarily indicative of future performance and investment returns will fluctuate.
    ///////////////////////////////
    your inputs on this product..please

  23. Rob,

    Another idea (depends on your situation) is to consider Participating Whole Life.
    If you have a 15 year time frame or more this can sometimes work better than UL.
    The investment part is bonds, mortgages and some stocks…MER about .50. Generally UL looks better in the early years but Whole life is better by year 15 plus.

    This is complex to go over everything here, but if you want something to read let me know.

  24. Didn’t I already mention participating whole life insurance? It can definitely outperform UL policies. Anyone who truly understands the internal structure and mechanisms will be able to tell you that a good whole life insurance will work better. When designed properly you can get the early cash value out of a whole life very easily. It all comes down to the way in which the policy is funded. I would even argue that today’s whole life policies are more flexible than UL policies. Unfortunately, for the internal design of ULs they are struggling mightily in this financial environment. The dividend interest rates are up around 6.5%-7% right now.

  25. 25. rob

    hi Brian,

    1)you had mentioned a week or so back that Manulife does not have wholelife..

    2) the 3% int guarantee by Manulife..do you think the 3% would hold good for all my life..or could they reduce it..

    thanks again..

  26. Rob,

    If they are saying 3% is guaranteed… read the contract it should be there.
    Manulife does not have wholelife….they did years ago.

  27. Evolution of Wealth,

    Since you are from the US, there is some differences up in Canada. The cash (whole life) values here are lower (first 10 -15 years). Later, years 20 plus our plans look better.

    Plus I think you can roll other other cash values form other life plans without paying any taxes into a new plan.

  28. Brian, not sure if you are still following this thread but how is the ACB of the premiums calculated if there is an insurance payout?

  29. FT,

    If the UL policy is structured correctly, any value will be paid as well as the death benefit tax free.

    Right now some whole life policies have more cash value for the same death benefit protection. For similar premiums!

    As you are aware insurance companies make their money on interest rates so any one who plans on getting buying now saves on two fronts. Their age (younger the better) and because of interest rates so low (I assume for a long time) prices for Universal Policies have been going up.

    So waiting to buy permanent coverage costs more guaranteed.

    One may want to review http://www.milliondollarjourney.com/how-annuities-work.htm again.

    As an aside, even today’s market a male looking to buy an annuity (life time payout) at 71 can get over 8.3% guaranteed on his RRIF. I don’t know anybody that rate guaranteed.

  30. 30. rodney

    Hey Guys

    London life has a great par product called 20 Pay. Which you pays for 20 years at the most. Can be be earlier if you want.

    Dividend for 2011 was 6.9%, dividend for 2012 is 6.5%. It was been paying a dividend out since 1886. Beat Universal Life.

    Rod

  31. Hi Rodney,

    You made a great point about London Life, however there is a few other companies that I believe are excellent as well.

    Currently, with UL and the low interest rates…”participating” whole life is in fact better in some cases.

    Trackbacks

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