Provided by: MNP
Life insurance is an essential tool in traditional estate planning for business owners, providing liquidity and peace of mind in the event of an emergency. It can also be an essential tax and estate planning tool if structured properly and can provide significant benefits today —– not just after your death. This article discusses:
- Why life insurance plays a role in estate planning
- What corporate-owned life insurance is
- How corporate-owned life insurance supports estate planning objectives
- The tax benefits of corporate-owned life insurance
- How life insurance fits alongside other estate planning tools
Business owners and investors often build wealth inside their corporations over many years. While this strategy can be tax efficient during your lifetime, it can create complexity at death. This includes significant tax exposure, limited access to cash, and challenges in transferring value efficiently to the next generation.
Life insurance is an essential tool in traditional estate planning for business owners. It provides liquidity at the time of an individual’s death and offers peace of mind knowing your family is covered in the event of an emergency. However, life insurance isn’t only beneficial in an emergency. It can also be an essential tax and estate planning tool if structured properly.
Why life insurance plays a role in estate planning
Estate planning challenges are often driven by timing and liquidity rather than a lack of assets. Taxes triggered at death may be substantial, while business assets are frequently illiquid or operationally critical — making them difficult to sell without disruption. Life insurance is commonly used in estate planning to provide liquidity at death, helping ensure your plan can be executed as intended.
What is corporate-owned life insurance?
Life insurance generally falls into two categories — term and permanent.
TERM INSURANCE
Term insurance is the basic and affordable type of life insurance. It covers you for a fixed period, typically five, 10, or 20 years. Every year of the term has a set premium, with a fixed amount of insurance available during that time. The policy and insurance coverage expire when the term ends. Term insurance is generally used to protect businesses and families against short-term risk due to its nature and is not used for longer-term tax and estate planning.
PERMANENT INSURANCE
Permanent insurance provides guaranteed coverage for life. The policy pays out the death benefit, regardless of your age or changes to your health, assuming you pay your premiums. Many permanent insurance policies include an investment component in addition to underlying insurance.
Permanent insurance policies can be structured so the investment component of the policy funds the premium payments after a fixed term. This means that you might only make premium payments for 10, 15, or 20 years and the policy will continue to grow tax-free even after the payment period is over. The self-funding nature of these policies makes them a reliable method of creating wealth in the long term without encumbering capital for your entire life.
How corporate-owned life insurance supports estate planning objectives
FUNDING TAXES AT DEATH
Corporate-owned life insurance can provide liquidity to help fund tax liabilities triggered at death, such as capital gains on shares. This can reduce pressure on your estate to sell business assets or shares quickly or at an inopportune time. Alternatives to using life insurance to fund estate taxes are generally less tax-efficient, thereby reducing the overall of the value of the estate.
Preserving business value and continuity
Life insurance can help maintain operational stability and protect business value during ownership transitions by providing cash at the death of a shareholder. This is particularly important where your business is intended to continue under the next generation or management team.
Providing fairness among beneficiaries
Life insurance can help equalize value without fragmenting ownership or forcing asset sales in situations where some beneficiaries are involved in your business and others are not.
Supporting shareholder and succession agreements
Life insurance is often used to fund the buy/sell clause of a shareholder agreement. This helps ensure that ownership transitions are financially manageable and do not strain your business or remaining shareholders.
Tax benefits of corporate-owned life insurance
Cost to acquire policy
Using your business or corporation to purchase insurance allows for faster accumulation of wealth. The same level of corporate income can purchase significantly more insurance by using corporate dollars taxed at a lower rate instead of personal funds taxed at a higher rate to pay for the policy.
Tax-free accumulation
Permanent life insurance policies in Canada are known as Exempt Policies as any investment income earned inside these policies grows tax-free.
Additionally, investments within an insurance policy tend to outperform other low-risk investments within a standard investment account on an after-tax basis. This is due to the personal and corporate tax rates on investment income.
Tax-efficient distributions
Your business receives the tax-free death benefit upon your death — including both the base amount and any accumulated growth in the policy’s investment component.
The amount by which the death benefit exceeds the adjusted cost basis of the policy is added to your business’ capital dividend account. It can pay this out tax-free to the remaining shareholders or estate, creating an extremely tax-efficient outcome.
Leveraged insurance options
Most policies include a guaranteed cash surrender value (CSV) and a variable component based on the growth in the investment part of the policy.
Financial institutions use the CSV as security for a loan since the CSV is a liquid that will not depreciate. Financial institutions typically lend up to 100 percent of CSV. You could access the value of the policy while you are alive by borrowing and using the policy as collateral as the policy may be more than you intend to leave to your estate.
With leveraging, you can access the wealth accumulated within an insurance policy during your lifetime, not just after your death. There are several ways to structure the borrowings. Your business can borrow against the policy to either reinvest the funds or make shareholder distributions. Interest on the borrowed money will be tax deductible when those funds are reinvested.
How life insurance fits alongside other estate planning tools
Corporate-owned life insurance does not replace estate planning documents or succession strategies. Instead, it supports them by addressing one of the most common gaps in an estate plan: access to liquidity at death.
Tools such as wills, estate freezes, succession plans, and shareholder agreements define how assets are transferred and who will assume ownership or control. However, they do not generate cash to fund taxes, redeem shares, or equalize beneficiaries on their own. Even well-designed plans can place pressure on your business or force unintended outcomes without liquidity.
Corporate-owned life insurance helps bridge this gap by providing cash at the moment it is needed. Insurance proceeds may be used to fund share redemptions under shareholder agreements, support ownership transitions, or provide value to non-business beneficiaries without fragmenting your business or disrupting operations. Personal insurance may still play a role for lifestyle or spousal needs, but corporate-owned insurance is typically considered where significant value is retained inside the corporation.
Is corporate-owned life insurance right for you?
Corporate-owned life insurance is an effective estate, tax, and liquidity planning tool if used properly. The type, amount, and structure of insurance needed may vary significantly depending on your personal needs and circumstances. Contact a member of Insurance Team today to learn whether corporate-owned life insurance could help you reach your personal and professional goals.
This article is provided by MNP. It is for informational and educational purposes only as of the date of writing. This information should not be considered investment, tax or legal professional advice. For specific advice about your situation, please consult a tax, accounting, legal or financial professional. The information contained in this report has been drawn from sources believed to be reliable but is not guaranteed to be accurate or complete. CDSPI, CDSPI Advisory Services Inc., MNP and our affiliates are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.