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Business Insurance
Part 2Insurance Concepts for
Business Owners
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
> Buy Sell
> Key Person
> Shared Ownership
> Executive Retirement Strategies
> IRS> IPP> RCA
Business Owner Insurance Concepts
1
Business Insurance
Part 1Working with Business
Owners
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
> Self Employed
> Partnerships
> Incorporated private business
> CCPC
> Publicly listed corporation
> Professional Corporations
Business Structures
> Incorporated Private business
> General corporate tax rates> 26% (11% Provincial, 15% Federal)> 25% (manufacturing, farming, mining)
> CCPC> 15.5% (4.5% Federal, 11% Provincial)> On first $500,000
> Publicly Traded companies
> Do not qualify as CCPC
Business Taxation 101
> 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
Capital Gains Exemption
> 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
Calculating CDA
> 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
ACB
> 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
NCPI
> 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
CDA Tax Trap
1
Advantages of Corporate Owned Life Insurance
A PARTNER YOU CAN TRUST.
1
Disadvantages of Corporate Owned Life
Insurance
A PARTNER YOU CAN TRUST.
1
Business Insurance
Part 2Insurance Concepts for
Business Owners
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
> Buy Sell
> Key Person
> Shared Ownership
> Executive Retirement Strategies
> IRS> IPP> RCA
Business Owner Insurance Concepts
Buy Sell
> Establish Value of business
> Determine succession plan
> Estimate succession tax issues
> Recommend solutions
> Resolve issues
> Valuation Issues> Other Triggers
Buy-Sell Advisor Role
> Fixed Price
> Book Value
> Multiple of Book Value
> Capitalization of Earnings
> Independent Appraisal
Valuation Methods
> Accumulated Wealth
> Borrowed Funds
> Purchase over Time
> Sinking Fund
> Life Insurance
Buy-Sell Funding Options
> Death
> Disability
> Retirement
> Dissension
> Bankruptcy
> Marital Breakdown
Buy-Sell Triggers
> Personally owned
> Criss Cross
> Corporately owned
> Share Redemption> Promissory Note> Hybrid Method
Common Buy Sell Arrangements
> 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.ABC Inc.
BB50%50%
BB50%50%
AA50%50%
Personal Criss Cross Buy-Sell
A owns policy on B
A pays premium on B
A is beneficiary on B
B owns policy on A
B pays premium on A
B is beneficiary on A
> Death of a Shareholder
1. Shares of deceased transfer to estate/heirs
2. Death benefit paid to surviving partner
3. Funds used to buy shares from deceased shareholder estate/heirs
4. Surviving partners end up with more shares
Personal Criss Cross Buy-Sell
> 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 Disadvantages
Personal Criss Cross with 5 partners
4 policies8 policies20 policies
> 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 Share Redemption 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 Promissory Note Buy-Sell
> Generally cheaper to use corporate funds
> Premium inequities removed
> No T4A’s for partners
> Creation of CDA
> Watch out for the ACB
Corporate Buy-Sell Advantages
> 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
Corporate Buy-Sell Disadvantages
> Allows parties involved to choose best methodology
> Promissory Note> Share Redemption> Hybrid> or take advantage of new laws in place at time
Optimization Clause
Key Person
> Establish the need for key person
> Determine the value of key person
> Recommend Solutions
Key Person Insurance Advisor Role
> Replace the loss of a key person:
> Owner/partner> Executives> Key sales people> Employees with highly specialized knowledge
Key Person Insurance
For three 40 year- olds the chance of one of them being disabled before
age 65 – about 90%
Chance of losing a 40 year-old to a long-term disability of 3 months or more
before the age of 65 – about 60%
Key Person Risks
> Multiple of salary
> Debt retirement
> Replacement costs
> Lost profits and increased expenses> creditors may reduce or withdraw credit
> may lose customers
> may lose other employees
Value of a Key Person
> Same as Buy Sell
> Insurance
> Life Insurance> Disability> Critical Illness
Funding Solutions
> Corporate owned and funded
> Company is beneficiary> Premiums are not tax deductible
> Creates liquidity for company
> Can create benefits for key person’s family
> Shared ownership
Key Person Insurance
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 seeking retirement funding arrangement
> Shared cost strongly favours the shareholder
Shared Ownership
• Sole Shareholder, age 50 NS
• Corporation has a justification for $1Million corporate owned insurance.
• Corporation has excess cash not • necessary for growth
• Shareholder wants to maximize
retirement income tax-efficiently.
Shared Ownership Case Study
Face Amount paid to theCorporation (CDA Credit)
Corporation pays fair valuefor the assigned Face Amount
Shareholder Purchases Policy
Genesis UL
FaceAmount
plusFUND
Shareholder assigns
‘Face Amount’to Corporation
‘Fund Value’ paid to
shareholder’sbeneficiary
Shareholder Dies
• 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
Corporations share
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
The concept in 4 steps:
Corporate IRS
Step 1: Implementation
1. The company is owner and beneficiary of the contract
2. Premiums are paid by the company from the excess retained earnings
3. Insurance premiums are not tax deductible
Corporate IRS
Corporate IRS
• Minimum of 10 to 15 years
• Contract options
• deposit level
• number of accumulation years
• date retirement income begins
Step 2: Accumulation period
Step 3: Payout at retirement
Corporate IRS
Two possibilities
• Loan by the company
• Re-lend to individual
• Dividend
• Loan by the shareholder
• Guarantee Fee
Death benefit
Step 4: Death and repayment
CDACDA
Heirs
Repay loans and
Balance retained by
heirs
Non-taxable CDA dividends
CDACDA = Death = Death
benefit Less benefit Less ACBACB
ACB ACB credits credits
Retained Retained earningsearnings
Regular taxable dividend
Corporate IRS
Individual Pension Plan
Individual Pension Plan
> Registered pension plan
> Increases contribution room beyond RRSP limit
> Defined benefit
> Employer funded
> Tax 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 plan with CRA
> Annual statements
> Pension adjustment calculation
> For Quotes: [email protected]
RCA’s
> Defined benefit pension plan
> Tax deductible contributions
> More room than IPP
> Creditor protected
> Does not affect personal RRSP room
> Alternative to “Bonus down” strategy
> Removes capital from balance sheet
> Often used as Golden handcuffs
Retirement Compensation Arrangements
RCA Mechanics – Non Insurance
OPCOOPCO
RCARCATRUSTTRUST
Refundable Refundable Tax Tax
AccountAccount
RCA RCA INVESTMENTINVESTMENT
ACCOUNTACCOUNT
tax deductibletax deductible
contributionscontributions
50%50% 50%50%
50% of realized growth50% of realized growth
RCA Mechanics – using Universal Life
OPCOOPCO
RCARCATRUSTTRUST
Refundable Refundable Tax Tax
AccountAccount
RCA RCA INVESTMENTINVESTMENT
ACCOUNTACCOUNT
tax deductibletax deductible
contributionscontributions
50%50% 50%50%
50% of realized growth50% of realized growth
RCA Mechanics upon Retirement
RCARCATRUSTTRUST
$2$2 $1$1
TaxableTaxableIncomeIncome
RCA RCA INVESTMENTINVESTMENT
ACCOUNTACCOUNT
Refundable Refundable Tax Tax
AccountAccount
PensionerPensioner
$3$3
RCA Example
• 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
Expected Pension (indexing 5% to age 65, 70% of final 5 year average) =
$321,647 annual income
RRSPRRSP
RCARCA
RCA Disadvantages
> 50% of contributions go to CRA RTA account
> No growth on these funds
> 50% of growth goes to CRA RTA
> Can require large top-up deposits by Corp. if interest rates decline as it is a defined benefit plan
RCA Advantages
1
Business Insurance
Part 2Insurance Concepts for
Business Owners
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
> Buy Sell
> Criss Cross vs. Share Repurchase
> Key Person
> Shared ownership policies
> Executive Retirement strategies
> IRS> IPP> RCA
Business Owner Insurance Concepts
1
Business Insurance
Part 3 Servicing Corporate Owned
Insurance Policies
Jorge Ramos, CFP ,CLUDirector of Advanced Marketing
A PARTNER YOU CAN TRUST.
