Next week I will tell you a story about a good friend who had a baby, literally while she was driving, but for now there is this other idea. I wanted to fit the full thought in one submission as it is quite important for the right readers: corporate owners.
An idea to move on
with urgency
Due to pending changes in regulation, this idea must be moved upon promptly in order to take full advantage of it.
Corporate wealth transfer strategy
This strategy may be appropriate for you if you have corporate investments or retained earnings available for investment and wish to benefit from a tax-deferred investment in the company. It can create a potentially substantial tax sheltered account in a corporation.
Why this matters
Retained profits or surplus cash in many businesses are invested in taxable investments. Growth of these invested retained earnings will create passive business income which is usually taxed at higher rates than active business income from an operating company.
As these assets grow, so will the tax burden. In fact, the greater the rate of return in your business investment portfolio, the greater the tax liability will be. The end result may be that your hard work and corporate savings will be much less than anticipated once transferred from the corporation to your heirs.
Problems with investing assets in corporate structure
Investing retained profits
Since passive investment income in a corporation may be taxed at a slightly higher tax rate than the top personal income tax rate, this may not be the most effective way to invest all the profits of the company.
Estate planning inefficiency
Typically, upon the death of the sole remaining shareholder of a corporation (including partnership arrangements), the corporation's shares are deemed disposed, triggering capital gains.
The result may require tax to be paid on the share value personally and still leave the liquid investments trapped within the corporate structure. Where no post-mortem tax planning has been implemented, redemption of the corporate investments for any personal or estate use usually requires either a dividend declaration or some other taxable method of withdrawal.
But there exists a much more tax-efficient strategy.
A solution
This solution works for a corporation or owner who:
Has surplus cash/investments available to invest.
Can benefit from a higher immediate estate value and ultimately from a higher tax-free death benefit paid to heirs.
Has a desire to leave a legacy at death while mitigating the often very large tax bill.
Qualifies for a life insurance policy.
How it works
The corporation purchases, owns, and is the beneficiary of a tax-exempt life insurance policy on the life of a shareholder. Premium and policy deposits may be made from excess cash flow or from the reallocation of existing liquid investments. I like to think of this sort of insurance as an asset class rather than an expense. Carve out a portion of your fixed income, which is guaranteed, but with a far better after-tax return than most fixed income today.
And then it gets really interesting
Though policyholders must deposit at least the minimum, they are also allowed to put in as much as the maximum premium. The maximum may be several times more than the minimum, and is dependent on your age, gender, health, and the face amount of insurance coverage.
The difference between the minimum and what you actually deposit is invested in a variety of options, and any growth is tax-deferred, thus creating a very large corporate tax free savings instrument, which you may be able to use in your lifetime. This is a very attractive benefit.
The fact that there are regulated maximums you are allowed to take advantage of says something about how valuable this strategy can be.
The corporate wealth transfer repositions your surplus profits or investments from tax-exposed to a tax-exempt life insurance policy. This permanent policy offers life insurance protection and an investment account that allows for tax-exempt growth.
Accessing capital while alive
It is possible to access the values within the policy while you are still alive in several ways. The policy's cash surrender value may be withdrawn (in whole or in part) or borrowed against. While withdrawing funds may have partial tax consequences, borrowing may allow the corporation to access the investments without any tax at all.
Accessing the capital upon death
The corporate wealth transfer strategy can be an efficient way to pass corporate assets to your loved ones. When you die, the corporation receives the benefit from the life insurance policy tax-free, plus a credit to its Capital Dividend Account (CDA). Tax-free capital dividends can then be paid out by the corporation.
This strategy maximizes the transfer of business assets that have built up within the corporation. The corporation receives the policy death benefit and typically the accumulated investment growth, free of tax.
Death benefit proceeds create a credit to the corporation's capital dividend account for the amount of the life insurance proceeds less the insurance policy's adjusted cost basis. Capital dividends may then be paid by the corporation tax-free.
This benefit will be less attractive in 2017 and beyond
This strategy will still be available after 2017, but at a reduced amount, due to a change in the way the cost of insurance is to be calculated then, to reflect more current life expectancies, and the implied cost of the insurance as a result of those life expectancies.
Because of the extensive timeframe required to process an insurance application, (measured in months, not weeks), it is best that you start very, very soon.
Seriously. Hurry. Call me, or someone like me.
This article is not meant as individualized tax or legal advice, and readers should consult their own professionals before proceeding with a strategy. Mark Ryan is an advisor with RBC Wealth Management Financial Services Inc., and can be reached at [email protected] or 250-960-4927.
