Regardless of whether the need is primarily personal, we almost always recommend owning and paying for life insurance in your Professional Corporation (or Holding Company if you have one). The difference between corporate and personal tax rates can result in a significant savings in premium, while the tax-preferred treatment of the death benefit will still give you the personal protection you need.
Lower after-tax cost
In Ontario, all corporations pay 11.5% tax on the first $500,000 of profit and 26.5% thereafter. Even the lowest personal tax brackets are higher than these amounts, and most dentists will have income in the 43% to 53% tax brackets. As the example below shows, you can take advantage of the difference in these tax rates to lower your after-tax cost.
Example:
You’ve determined that for the protection of your family, you need a term life insurance policy with a premium of $100/month or $1200 per year. You have two choices to pay this premium – you can pay it personally or corporately. In both cases, the premium is NOT tax-deductible – it has to be paid out of after-tax earnings. So let’s assume (1) you earn $160,000 per year personally – putting you in the 48.19% tax bracket for salary and 41.6% for dividends, and (2) the profit in your PC is less than $500,000 – putting you the 11.5% corporate tax bracket.
Corporately-Paid Life Insurance Premiums
The after-tax cost to the corporation is $1200
Personally-Paid Life Insurance Premiums
Option A (Dividends):
The Corporation pays an after-tax shareholder dividend of $2055
The owner pays personal income tax of $855
The owner pays life insurance premiums of $1200
Or
Option B (Salary):
Corporation pays the shareholder a bonus of $2316
Corporation deducts bonus, saves taxes of $266
After deducting the bonus, the after-tax cost to the corporation is $2050
The owner pays personal income tax on bonus of $1116
The owner pays life insurance premiums of $1200
Regardless of the method of personal compensation, the cost to the corporation is about $850 lower when simply paying corporately. This is a savings of over 40% on the cost of life insurance!
Tax Treatment of the Death Benefit
In order to enjoy this premium savings it is important to designate the corporation as the beneficiary of the insurance proceeds. If you designate anyone else, such as a spouse or children, the premiums paid by the corporation would become a taxable benefit to you – undoing all of the savings.
But you may wonder about the tax consequences of getting these funds from your PC to your family, since this life insurance is intended for their protection, not for corporate needs. The good news is that the tax-advantaged treatment of life insurance proceeds will do the trick. Upon your death, life insurance proceeds will be received tax-free by the PC. A corporation receiving an insurance death benefit generates a credit, of almost the same amount1, to the corporation’s Capital Dividend Account. When a corporation has a balance in its Capital Dividend Account it can pay tax-free dividends to shareholders. So on death, after receiving the death benefit, a tax-free capital dividend would be paid by your PC to your estate or to your spouse.
Two Caveats
1. Beware of Corporate Creditors: Because the life insurance must first pass through the corporation on death, the proceeds may be subject to claims of corporate-creditors before they can be paid out as a Capital Dividend.
2. You may have to share the CDA credit with partners: If you are not the sole shareholder of the corporation, Capital Dividends may have to be shared with all shareholders of the corporation. This can be solved with a shareholder agreement and small reorganization that results in each shareholder holding a different class of shares.
Contact us if you are interested in more information info@protectfinancial.ca
1. The amount of the Capital Dividend Account (CDA) credit is actually the amount of life insurance proceeds minus the adjusted cost base (ACB). The ACB equals the sum of premiums paid minus a prescribed value called the Net Cost of Pure Insurance (NCPI). At worst, the ACB will be a very small fraction of the death benefit, and over time the ACB falls to zero. After that point, the entire amount of the policy is paid out tax free.