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additional deposits are allowed to grow within the policy tax free until death or until such time as the funds are withdrawn.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|
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.