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As a small business owner, running your company isn’t a solo act. Whether you’re the driving force or share the reins with key partners, each member plays a vital role in propelling your company forward. But what happens if illness strikes a vital team member? The impact can ripple through your entire business plan, jeopardizing growth and stability.
Instead of facing this threat unprepared, imagine a safety net woven together by your corporation and shareholders. Shared ownership critical illness insurance is more than just a financial safeguard; it’s a strategic partnership ensuring both the company and its cornerstone players weather unexpected storms. Not only does it offer peace of mind, but it unlocks significant tax advantages, making it a win-win for all involved.
So, join us as we delve into this innovative approach to risk management. We’ll explore how shared ownership critical illness insurance works, uncover its unique tax benefits, and showcase a case study of how it protects both a business and its key figure. Ready to learn how this financial strategy can empower your company and build a more secure future together? Start reading!
- Key takeaways:
- Shared ownership critical illness insurance offers a strategic solution for corporations and shareholders, providing financial protection against unforeseen health crises.
- The policy structure involves the corporation paying for the critical illness benefit, while the shareholder or key employee covers the return of premium aspect.
- If a critical illness strikes, the corporation receives a tax-free lump sum payout. This vital cash injection helps maintain operations and minimize disruption during a challenging period.
- In the absence of a claim, the individual enjoys the security of a tax-free return of all premiums paid. This provides financial stability and can serve as a valuable savings plan.
What Is Critical Illness Insurance?
Imagine this: your company is soaring, driven by your expertise and leadership. Then, the unthinkable happens—you’re diagnosed with a critical illness. Suddenly, the future of your carefully mapped-out business seems shrouded in uncertainty.
This is where critical illness insurance (CI coverage) steps in. It’s a financial safety net designed to safeguard organizations when unexpected illnesses, like cancer, heart attacks, or strokes, threaten their financial stability. But how does it benefit a corporation, specifically?
- Protects key assets: You and other key employees are the pillars of your business. Losing your expertise and leadership due to illness can stall projects, disrupt operations, and erode customer trust. Critical illness insurance offers a tax-free lump sum payout when a covered illness strikes, providing the resources to manage this disruption and mitigate financial losses.
- Minimizes business disruption: Critical illness payouts can be used to cover a range of expenses during or after an illness, like:
- Hiring temporary replacements or consultants to maintain business continuity.
- Adapting work arrangements to support the recovering employee’s return.
- Replacing lost profits due to the disruption and transition of your business.
- Ensuring solvency to creditors who may call in loans due to the perceived instability of the company.
- Enhances Business Reputation: By mitigating financial risk, you cultivate a positive and responsible image. This resonates with clients, attracts and retains talent, and bolsters the company’s overall reputation.
In the next section, we’ll delve into the key advantages of shared ownership critical illness insurance.
What Is Shared Ownership Critical Illness Insurance?
Shared ownership critical illness insurance—also known as split-dollar critical illness insurance—represents a strategic approach to risk management that benefits both corporations and shareholders, offering a solid financial solution with advantageous tax implications. Here’s how it works:
1. Structure of the policy
- The corporation buys a critical illness insurance policy, which serves as the foundation of the shared ownership arrangement.
- Under this structure, the corporation owns the CI policy and is designated as the beneficiary of the insured shareholder’s critical illness benefits. Consequently, it assumes responsibility for the premiums paid for the benefit.
- From a tax perspective, it is more advantageous for a small business corporation to pay for the critical illness insurance policy since corporate tax rates (9% to 12%, depending on the province) are lower than the personal tax rate (up to 54%).
- However, it’s important to note that premiums paid are not a tax-deductible expense for the corporation. That’s because the expense is not incurred to produce income from a business or property.
2. Return of premium rider
- To enhance the CI policy’s flexibility and appeal, a return of premium (ROP) on cancellation rider is added to the critical illness insurance policy.
- The ROP benefit returns the total premiums paid by the shareholder and corporation if the insured does not suffer a covered illness.
- The insured individual or key employee is responsible for paying for the ROP benefit and is designated the beneficiary. Hence, the term split-dollar critical illness protection.
3. Shared ownership agreement
- A crucial component of shared ownership critical illness insurance is the formalization of the arrangement through a shared ownership agreement.
- This formal legal agreement contains key clauses that delineate the respective roles and responsibilities of the corporation (as the owner of the critical illness benefit) and the shareholder or key person (as the owner of the return of premium benefit).
- This agreement must be drafted by a qualified legal advisor to ensure clarity and enforceability.
4. If a critical illness occurs
- In the unfortunate event that an insured individual suffers a covered illness, the insurance company pays the tax-free benefit to the corporation, and coverage provided by the critical illness policy ends.
- This influx of funds provides the corporation with the necessary liquidity to navigate the challenges posed by the absence of the key employee while continuing to operate the business effectively.
- While corporate-owned life insurance death benefits can contribute to a company’s capital dividend account (CDA), allowing tax-free distributions to shareholders, critical illness insurance benefits do not create such a credit.
5. If a critical illness does not occur
- Should the benefit not be triggered before the expiration of the critical illness policy, the shareholder or key person is entitled to a tax-free refund of all premiums paid, including for the critical illness benefit.
- Under the return of premium rider, policy surrender results in the return of your paid premiums but also ends your critical illness coverage.
- The return of premium option is a significant tax benefit for the shareholder since it allows access to the premiums paid by the corporation tax-free.
In essence, shared ownership critical illness insurance offers a balanced approach to risk mitigation, providing financial protection for both corporations and shareholders. Through a structured arrangement that combines critical illness coverage with the flexibility of premium return options, this insurance solution not only safeguards against unforeseen health crises but also optimizes tax efficiency.
By formalizing the agreement through a shared ownership contract, both parties can confidently navigate the complexities of this arrangement, secure in the knowledge that their interests are protected.
Who Needs Split-Dollar Critical Illness Insurance?
Shared ownership critical illness insurance is not a one-size-fits-all solution. But if you identify with certain characteristics, it could be a powerful tool for maximizing protection and security for both you and your business. Here’s who shared ownership critical illness insurance might be ideal for:
Business owners
- Canadian-controlled private corporation (CCPC) owners: This structure allows you to leverage tax advantages specific to this legal entity.
- Established & financially stable businesses: Shared ownership critical illness insurance thrives with a solid foundation of excess cash flow or retained earnings to support premiums.
- Actively involved leaders: If you play a vital role in daily operations, protecting your ability to work becomes crucial for business continuity.
- Planning for succession: Transitioning out? Shared ownership critical illness insurance can ease the process and secure the company’s future.
- High-income earners: Facing high taxes due to passive income? Shared ownership critical illness insurance offers tax-efficient savings opportunities.
Targeted age
- 30 to 55 years old: The working age range aligns with both individual and business growth phases, making it an excellent time to establish critical illness protection.
Medical eligibility
- Qualifying for individual critical illness insurance: In order to buy a critical illness insurance policy, the shareholder or key person must be able to qualify for coverage.
- Medical conditions, lifestyle, and family history: To be eligible, insurers assess your lifestyle choices like smoking or risky hobbies, pre-existing medical conditions you manage, and your family’s medical history, particularly looking for recurring instances of specific hereditary illnesses in close relatives. This process is called c.
Additional considerations
- Key employees: While ideal for small business owners, shared ownership critical illness insurance can also benefit key employees, subject to tax implications. However, when the key employee is not a shareholder, the CRA may be of the opinion that the employee receives a taxable benefit when the return of premium benefit is paid.
In the next section, we’ll dive deeper into a case study to showcase how shared ownership critical illness insurance can benefit both the corporation and its key shareholder in action.
Shared Success: A Case Study Of Business Continuity And Personal Security Through Shared Ownership Critical Illness Insurance
Meet Alex: A driven entrepreneur, Alex owns and operates TechPro, a thriving software development company. Alex, 45, plays a critical role in TechPro’s success, handling both technical leadership and client relations.
The challenge: Understanding his crucial place in the company, Alex acknowledges the real financial risk TechPro faces if he were to fall ill. Concerned his high tax bracket would impact his investment return, he also desires a tax-optimized strategy to access his corporation’s retained earnings to fund his retirement starting at age 65.
The solution: Enter shared ownership critical illness insurance. Alex explored this option with his insurance advisor. They designed a policy where:
- TechPro funded the critical illness benefit: The corporation paid the premium for a $500,000 critical illness payout, securing TechPro’s financial stability if Alex experienced a covered illness. Beyond the main critical illness coverage, a death benefit rider was included, guaranteeing the corporation the return of all premiums paid should Alex pass away during the policy term.
- Alex added a return of premium on surrender or cancellation rider: He personally paid the premium for this rider, ensuring a tax-free return of all his and his corporations’ contributions if no claim was made throughout the policy term. This offered him a tax-advantaged savings plan.
The assumptions: Here are some basic assumptions for Alex and TechPro:
- Male, aged 45, non-smoker
- Critical illness benefit amount: $500,000
- Annual cost of critical illness benefit and return of premium on death rider: $8,010
- Annual cost of return of premium on cancellation rider: $6,060
- Premium split: 57% corporation, 43% personal
- Total premiums per year: $14,070
- Type of critical illness insurance policy: Term-75 with return of premium on death and cancellation
- Marginal tax rate: 53.5%
The outcome:
- Peace of mind: Both Alex and TechPro gained significant peace of mind knowing they were financially protected. This reduced stress and allowed them to focus on their respective goals.
- Financial security: When Alex unexpectedly suffered a heart attack at age 50, TechPro received the $500,000 payout. This crucial funding helped the company maintain operations smoothly during a challenging period, covering lost productivity and facilitating a seamless transition to a new leadership team (see line 1 in the figure). If, instead of suffering a critical illness, Alex passed away at age 65, the policy provides a $281,400 death benefit, further supporting TechPro’s stability and future ownership transition (see line 2).
- Tax-optimized savings: Had Alex avoided a critical illness diagnosis, the shared ownership CI policy still delivered on its promise, returning $281,400 as the total premiums paid by him and TechPro tax-free at age 65, solidifying its appeal as a smart savings strategy (see line 3). The critical illness policy generated an after-tax rate of return of 7.48%, equivalent to a 16.09% return at his top marginal tax rate.
Other Key Details About Split-Dollar Critical Illness Coverage
Should your Holdco or Opco own the critical illness policy?
The split-dollar critical illness financial strategy can be applied to both operating companies (Opco) and holding companies (Holdco). However, which corporation owns the CI policy can severely impact how the policy functions and who benefits.
Joint Ownership with Opco:
- Benefits: Immediate access to critical illness and death benefits for Opco’s needs.
- Challenges: The benefits are accessible to creditors in case of insolvency. A shareholder agreement is crucial if multiple shareholders exist to ensure the benefits are used according to your intentions.
Joint Ownership with Holdco:
- Benefits: Protection of benefits from Opco’s creditors and sole control over distribution to Opco.
- Challenges: If you only have a Holdco, justifying the need for critical illness coverage may be more challenging. Additionally, establishing a clear procedure for the operating company (Opco) to access the benefits for its needs becomes crucial.
What if you retire early?
In the event of a successful succession plan implementation and your diminished key role within the company, the shared ownership critical illness coverage might no longer be necessary. At this point, you have two options:
- Terminate the policy with the company’s signing authority approval and receive the ROP benefit.
- Transfer ownership of the policy to yourself personally to maintain individual coverage.
What if you sell or wind up your company?
Life throws curveballs, and sometimes, your business plans shift. Whether through consolidation, restructuring, or selling your shares, it’s crucial to understand how these changes might impact this financial strategy. Here’s what you need to know:
- Transparency is key: Inform your legal and tax advisors about the policy. Together, develop a plan for various scenarios, like selling your shares or winding up the company.
- Benefit distribution: Remember, new shareholders hold the reins once you sell. While you might not receive the critical illness or death benefits personally, the new owners may need to retain the critical illness insurance policy if you remain a key employee.
- Termination or transfer: If the company no longer needs coverage, you can choose to receive the ROP benefit or transfer ownership to yourself personally.
- Preparedness is power: Your formal legal agreement should outline these potential scenarios, ensuring both you and your company are ready for whatever the future holds.
Shared Ownership Critical Illness Insurance: A Collaborative Strategy For Mutual Protection And Tax Advantages
As Alex’s story demonstrates, shared ownership critical illness insurance can be a powerful tool for both businesses and their shareholders. It offers a unique blend of financial security, tax advantages, and peace of mind, protecting against unforeseen circumstances while potentially generating tax-free returns.
Remember, split-dollar critical illness insurance isn’t a one-size-fits-all solution. Whether you’re a business owner, a key employee, or simply looking to enhance your personal financial planning, a free, no-obligation consultation can help you explore if this innovative approach aligns with your specific needs and goals.
Don’t hesitate to reach out to us at info@briansoinsurance.com or 604-928-1628 to discuss your unique situation and discover how this unique financial strategy can empower you to face the future with greater confidence.
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