Business
Insurance
Part 2
Insurance Concepts for
Business Owners
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Business Owner Insurance Concepts
> Buy
Sell
> Key
Person
> Shared
Ownership
> Executive
> IRS
> IPP
> RCA
Retirement Strategies
Business
Insurance
30
second
RECAP!
Part 1
Working with Business
Owners
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Business Structures
> Self
Employed
> Partnerships
> Incorporated
private business
> CCPC
> Publicly
listed corporation
> Professional
Corporations
Business Taxation 101
> Incorporated
> General
Private business
corporate tax rates
26%
> 25%
>
(11% Provincial, 15% Federal)
(manufacturing, farming, mining)
> CCPC
>
15.5%
> Publicly
> Do
(4.5% Federal, 11% Provincial)
> On first $500,000
Traded companies
not qualify as CCPC
Capital Gains Exemption
> First
$750,000 of capital gains are tax-free
> Qualified
small business shares
> Qualified Farm property
>
50% of assets “actively” used in the business for the last 24 months
>
90% of assets “actively” used in the business at time of sale
>
Shares owned by individual for last 24 months
Calculating CDA
> CDA
= Life insurance death benefit – ACB
> Life
insurance death benefit
net of policy loans
> not net of collateral loans
> Applies to permanent and Term policies
> Applies whether there is cash value or not
>
> Notes:
>
>
ACB usually goes to zero after 20+ years, cannot be negative
CDA has to be paid out equally to all shareholders of the same
class
ACB
> ACB
– Adjusted Cost Basis
Ensures that corporate money gets taxed properly in
personal hands
> The ACB of policy tracks the original premium paid by a
company for life insurance minus the NCPI
>
> Formula
Premiums Paid increase ACB
> NCPI decreases ACB
>
NCPI
> NCPI
>
– Net Cost of Pure Insurance
Net amount at risk (NAAR) for the year multiplied by the
probability of death in that year, ie: similar to T1 rates
> Based on 1975 Select and Ultimate mortality table
> Costs for any benefits or riders removed
> Removes any ratings on substandard risks
CDA Tax Trap
> Problem:
> Potential
death benefit shortfall created by CDA/ACB
> Net death benefit may fall short of required amount
>
Buy-sell
> Solution:
> Face
plus fund plus ACB
Increases face amount so that CDA paid is equal to or
greater than original death benefit
> Removes risk of the ACB tax grind on CDA
> Removes risk of underinsuring the need
>
Advantages of Corporate
Owned Life Insurance
A PARTNER YOU CAN TRUST.
1
Disadvantages of
Corporate Owned Life
Insurance
A PARTNER YOU CAN TRUST.
1
Thank You
Jorge Ramos, CFP, CLU
Director of Advanced Marketing
416-206-7050
jorge.ramos@inalco.com
Business
Insurance
Part 2
Insurance Concepts for
Business Owners
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Business Owner Insurance Concepts
> Buy
Sell
> Key
Person
> Shared
Ownership
> Executive
> IRS
> IPP
> RCA
Retirement Strategies
Buy Sell
Buy-Sell Advisor Role
> Establish
Value of business
> Determine
> Estimate
succession plan
succession tax issues
> Recommend
> Resolve
solutions
issues
> Valuation
Issues
> Other Triggers
Valuation Methods
> Fixed
Price
> Book
Value
> Multiple
of Book Value
> Capitalization
> Independent
of Earnings
Appraisal
Buy-Sell Funding Options
> Accumulated
Wealth
> Borrowed
Funds
> Purchase
over Time
> Sinking
> Life
Fund
Insurance
Buy-Sell Triggers
> Death
> Disability
> Retirement
> Dissension
> Bankruptcy
> Marital
Breakdown
Common Buy Sell Arrangements
> Personally
> Criss
owned
Cross
> Corporately
> Share
owned
Redemption
> Promissory Note
> Hybrid Method
Personal Criss Cross Buy-Sell
> Set-up
> Personally
owned policies
> Partners own policies on each other
> Premiums paid personally
> Partners are each others beneficiaries
> Premiums can be paid by company but treated as
taxable benefit
Personal Criss Cross Buy-Sell
ABC Inc.
A
B
50%
50%
A owns policy on B
B owns policy on A
A pays premium on B
B pays premium on A
A is beneficiary on B
B is beneficiary on A
Personal Criss Cross Buy-Sell
> Death
1.
2.
3.
4.
of a Shareholder
Shares of deceased transfer to estate/heirs
Death benefit paid to surviving partner
Funds used to buy shares from deceased
shareholder estate/heirs
Surviving partners end up with more shares
Personal Criss Cross Disadvantages
> Premiums
paid out of after-tax personal funds or paid
corporately but as a taxable benefit
> Can
create inequities in premium payments
> Complicated
if more than 2 partners
Personal Criss Cross with 5 partners
8
4 policies
policies
20
policies
Corporate Share Redemption Buy-Sell
> Set-up
> Company
buys insurance on partners lives
> Company pays for premiums
> Company is beneficiary of all policies
Corporate Share Redemption Buy-Sell
Death of a Shareholder
1.
Shares of deceased transfer to estate/heirs
2.
Death benefit paid to Corporation
3.
Corporation redeems deceased shares with death
benefit proceeds
4.
Corporation cancels deceased partners shares
5.
Surviving partners shares increase in value
proportionate to cancelled shares
Corporate Promissory Note Buy-Sell
> Set-up
> Company
buys insurance on partners lives
> Company pays for premiums
> Company is beneficiary of all policies
Corporate Promissory Note Buy-Sell
Death of a Shareholder
1.
Shares of deceased transfer to estate/heirs
2.
Surviving Partner buys shares with Promissory note
3.
Death benefit paid to Corporation
4.
Corp. issues a tax-free dividend to surviving partner
5.
Surviving partner uses funds to retire promissory note
6.
Surviving partner receives shares from deceased
partners estate
Corporate Buy-Sell Advantages
> Generally
> Premium
> No
cheaper to use corporate funds
inequities removed
T4A’s for partners
> Creation
of CDA
> Watch
out for the ACB
Corporate Buy-Sell Disadvantages
> No
tax deduction for premiums
> Policy
is asset of company
> Subject
to creditors
> Affects balance sheet
> May affect CGE of company
>
Fund value considered a passive asset
> Stop-loss
rules may apply
> Changing
policy from corporate to personal
> Taxable
disposition could apply
Optimization Clause
> Allows
parties involved to choose best methodology
> Promissory
Note
> Share Redemption
> Hybrid
> or take advantage of new laws in place at time
Key Person
Key Person Insurance Advisor Role
> Establish
the need for key person
> Determine
the value of key person
> Recommend
Solutions
Key Person Insurance
> Replace
the loss of a key person:
> Owner/partner
> Executives
> Key
sales people
> Employees with highly specialized knowledge
Key Person Risks
Chance of losing a 40 year-old to a
long-term disability of 3 months or more
before the age of 65 – about 60%
For three 40 year- olds the chance
of one of them being disabled before
age 65 – about 90%
Value of a Key Person
> Multiple
> Debt
of salary
retirement
> Replacement
> Lost
costs
profits and increased expenses
>
creditors may reduce or withdraw credit
>
may lose customers
>
may lose other employees
Funding Solutions
> Same
as Buy Sell
> Insurance
> Life
Insurance
> Disability
> Critical Illness
Key Person Insurance
> Corporate
owned and funded
> Company
is beneficiary
> Premiums are not tax deductible
> Creates
> Can
liquidity for company
create benefits for key person’s family
> Shared
ownership
Shared
Ownership
Shared Ownership
> Corporate
Key-person/Buy-sell insurance required
> Corporation
has cash not required for growth of
business
> Shareholder
wants to move corporate cash into
personal hands
> Shareholder
> Shared
seeking retirement funding arrangement
cost strongly favours the shareholder
Shared Ownership Case Study
• Sole Shareholder, age 50 NS
• Corporation has a justification for
corporate owned insurance.
• Corporation has excess cash not
• necessary for growth
• Shareholder wants to maximize
retirement income tax-efficiently.
$1Million
Corporation pays fair value
for the assigned Face Amount
Face Amount paid to the
Corporation (CDA Credit)
Genesis UL
Face
Amount
plus
FUND
Shareholder Purchases Policy
Shareholder Dies
Shareholder
assigns
‘Face Amount’
to Corporation
‘Fund Value’
paid to
shareholder’s
beneficiary
Corporations share
• Survey the T100 market for a rate to use
(Shareholder plans to stay in business beyond normal retirement age)
• Calculate the present value of T100 premium from now to
life expectancy (approx. age 85 for a M50NS)
• Spread the Net Present Value out over the 10 year
premium payment period
Executive
Retirement
Adequate Pension
“a normal level of benefits would be the same
benefits provided under a registered pension plan
without regard to the Revenue Canada maximum.
This would be 2% x years of service x final
average earnings or about 70% of pre-retirement
income for an employee with 35 years of service.”
CCRA roundtable discussion (1998)
RRSP Limits
Max. Contribution
Max. Income
> 2012
$22,970
$127,611
> 2013
$23,820
$132,333
> 2014
$24,270
$134,833
Executive Retirement Strategies
> IRS/IRP
> IPP
> RCA
Insured
Retirement
Corporate IRS
The concept in 4 steps:
Implementation
Accumulation
Disbursement
Death and
repayment
Corporate IRS
Step 1: Implementation
1. The company is owner and
beneficiary of the contract
Implementation
2. Premiums are paid by the
company from the excess
retained earnings
3. Insurance premiums are not tax
deductible
Corporate IRS
Step 2: Accumulation period
• Minimum of 10 to 15 years
• Contract options
• deposit level
Accumulation
• number of accumulation years
• date retirement income begins
Corporate IRS
Step 3: Payout at retirement
Two possibilities
• Loan by the company
• Re-lend to individual
Disbursement
• Dividend
• Loan by the shareholder
• Guarantee Fee
Corporate IRS
Step 4: Death and repayment
Death benefit
CDA
= Death
benefit Less
ACB
Death and
repayment
Heirs
Non-taxable CDA
dividends
CDA
ACB
credits
Retained
earnings
Regular taxable
dividend
Repay loans
and
Balance
retained by
heirs
Individual
Pension Plan
Individual Pension Plan
> Registered
> Increases
> Defined
pension plan
contribution room beyond RRSP limit
benefit
> Employer
> Tax
funded
deductible contributions
> Creditor
Protected
> Reduces
RRSP Room through pension adjustment
RRSP vs. IPP
IA IPP Support
> Prep
and quote plan
> Initial
actuarial valuation and on-going monitoring
> Past
service calculation
> Register
> Annual
statements
> Pension
> For
plan with CRA
adjustment calculation
Quotes: Paul.Vanderkolff@inalco.com
RCA’s
Retirement Compensation Arrangements
> Defined
> Tax
> More
deductible contributions
room than IPP
> Creditor
> Does
benefit pension plan
protected
not affect personal RRSP room
> Alternative
to “Bonus down” strategy
> Removes
> Often
capital from balance sheet
used as Golden handcuffs
RCA Mechanics – Non Insurance
OPCO
RCA
INVESTMENT
ACCOUNT
RCA
TRUST
Refundable
Tax
Account
RCA Mechanics – using Universal Life
OPCO
RCA
INVESTMENT
ACCOUNT
RCA
TRUST
Refundable
Tax
Account
RCA Mechanics upon Retirement
RCA
INVESTMENT
ACCOUNT
RCA
TRUST
Refundable
Tax
Account
RCA Example
RRSP
•
•
•
•
•
•
•
•
Male
Non-Smoker
45 years of age
earns $200,000
RRSP of $200,000
Max. RRSP contrib.
35 yrs of service at
retirement
retires at 65
RRSP Retirement Income
(assuming 5.5% ROR from
age 65 to age 82) =
$95,632 annual income
RCA
Expected Pension (indexing
5% to age 65, 70% of final 5
year average) =
$321,647 annual income
RCA Disadvantages
> 50%
of contributions go to CRA RTA account
> No
> 50%
> Can
growth on these funds
of growth goes to CRA RTA
require large top-up deposits by Corp. if interest
rates decline as it is a defined benefit plan
RCA Advantages
Business
Insurance
10
second
RECAP!
Part 2
Insurance Concepts for
Business Owners
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Business Owner Insurance Concepts
>
Buy Sell
>
Criss Cross vs. Share Repurchase
>
Key Person
>
Shared ownership policies
>
Executive Retirement strategies
>
>
>
IRS
IPP
RCA
Business
Insurance
Part 3
Servicing Corporate Owned
Insurance Policies
A PARTNER YOU CAN TRUST.
Jorge Ramos, CFP ,CLU
Director of Advanced Marketing
1
Thank You
Jorge Ramos, CFP, CLU
Director of Advanced Marketing
416-206-7050
jorge.ramos@inalco.com