Life is good… your business is up and running and the future is looking bright!
And then the tragic and unexpected happens – your business partner suddenly passes away. You have not only lost your dear friend, colleague, collaborator, right-hand person, your “I could never do it without you” person, but your income could drop to zero as unexpected costs start piling up. Additionally, as an entrepreneur, you are likely to be the primary source of your business’s value, which means that profits can suffer if you were unable to run the business and lenders may call in the loans.
While the above scenario is tough to think about and hard to imagine that it could happen to you, the reality is that it can happen to anyone. This is where planning ahead for the worst-case scenarios is invaluable and where life insurance for small businesses can help.
The different types of life insurance for small businesses in Calgary
Getting life insurance as a business owner is not only an effective way to protect yourself financially, it also comes with several benefits such as obtaining or settling loans, buying back your shares in the business, covering the cost of a replacement for you or your partners, settling any liabilities, and possibly funding the retirement of a partner.
When it comes to life insurance for your business, you essentially have two types of policies: Term and Permanent. Both have their pros and cons and if you’re looking for small business insurance in Calgary, the more knowledge you have, the better. Let’s dive right in!
Term is also a good option for business owners with partners who only need coverage for a set period of time. Below are some of the advantages of term insurance:
- Provides coverage for a specific term, typically 5, 10, or 20 years.
- Premiums stay the same for the duration of the term.
- Relatively inexpensive form of life insurance.
- Often used during working years to provide funds in the event the business owner dies to replace the loss of income and cover liabilities.
For example: imagine Shelly and Christie own a business together. They have an agreement that if either passes away before a future retirement date, the other partner would buy the deceased’s half of the business. They might each take out term policies, making the other partner the beneficiary.
If Tracey dies, Christie would receive a life insurance payout that she could use to buy Tracey’s half of the business from her heirs (such as spouse or children who automatically inherit her portion of the business).
The downside to term is that it’s only good for a specific length of time. If you and your partner(s) plan to stay in the business for an undetermined amount of time, but your term insurance is over after 20 years, you could be without coverage. As people get older, term insurance is more expensive and it functions comparably to car insurance. It is there when an accident happens but once the policy is terminated, you don’t get any money back.
Unlike term, permanent insurance is just that – permanent. It can stay with you for as long as you live but if you decide to cancel, most permanent life insurance policies also carry a cash value that is paid out, distinguishing them from term life policies. This can prove to be a major benefit to a business at any stage of development. In addition to this, permanent insurance can:
- Provide funds in the event the business owner dies to replace loss of income, cover liabilities, or buy out shares from heirs.
- Provide both insurance protection and a tax-deferred investment component.
- Include a cash value component that accumulates over time and can be used as collateral for borrowing money
- Fund the partner’s retirement.
Permanent policies offer both insurance and an investment component held within the policy, generally called “cash value.” The cash value offers:
Corporately owned tax-exempt life insurance provides tax-deferred growth, which is especially attractive for business owners who have maximized their total contribution room to their registered accounts (such as an RRSP). The cash value grows on a tax-deferred basis in addition to a tax-free death benefit. This gives rise to a tax minimization strategy whereby a business owner reallocates funds, within the corporation, that would otherwise be subject to tax, into a corporately owned life insurance policy.
Cash value options
A corporately owned tax-exempt life insurance policy can provide more than a tax-free death benefit. In fact, during the life of the policy, the cash value can provide funds to the business owner for personal or business reasons. There are three options when accessing the cash surrender value:
1. Partial or full withdrawal of funds within the cash-value account.
2. Obtain a policy loan against the cash value from the insurer.
3. Collaterally assign the policy to secure a loan.
What makes permanent life insurance attractive from an income tax perspective is that the investment portion of the policy can accumulate in value without incurring tax on the earnings.
If such a policy is held until death, the benefit paid as a result of death is not taxable. If the policy is cashed in prior to death, some portion of the proceeds received will be taxable. However, in either case, there’s no current taxation, allowing either a tax deferral on investment income or a complete exemption from tax.
The downside to permanent life insurance is the cost. Compared to term life insurance policies, permanent life insurance can require you to pay significantly higher premiums.
A common question is, “Should the owner of the life insurance policy be the business or the individual?” The answer is: it depends. There is no wrong answer and ownership depends on a number of factors unique to your situation. Reviewing some of the advantages and disadvantages of business and personal ownership should help you, together with your financial advisor, decide the best solution to your situation:
Personally owned policy
- The policy and its proceeds may be creditor protected (depending on who the beneficiary is).
- Any beneficiary(ies) can be named.
- Cash value within the permanent policy will not affect the lifetime capital gains exemption upon sale of the business.
- More pre-tax dollars may be required to pay the premium if the personal tax rate is greater than the corporate tax rate.
- One business partner may pay higher premiums than the other.
- Equalization of the premiums, if one partner/shareholder has higher premiums (which can be a result of one being older than the other or medical conditions).
- Ease of administration, especially if multiple policies are required.
- Fewer pre-tax dollars may be required to pay the premium if the corporate tax rate is less than the personal tax rate.
- All or part of the premium may be deductible for tax purposes if the policy is required to be assigned as collateral for a loan and the loan interest is deductible as a business expense for tax purposes.
- The death benefit (less any adjusted cost basis) can flow through the corporation’s notional capital dividend account by way of capital dividend and be received tax-free by any remaining shareholders and/or the shareholder’s estate.
- Not protected from corporate creditors.
- The corporation can be the only beneficiary to avoid taxation.
- If you choose to transfer the ownership from a business to a personally owned permanent policy, it can trigger tax consequences.
* A note on premiums – A business that is a Canadian Controlled private corporation (CCPC) is eligible for the small business tax deduction and pays a lower rate of tax than if the premiums were paid with after-tax personal income. For example, the combined federal and provincial tax rate for a CCPC is 9-12% (as of 2022), whereas personal income can range from 36-53.5%. Therefore, the corporation will not need to earn as much money to pay the premiums compared to the personally paid policy.
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Key Person Life Insurance
Key person life insurance provides your business with funds if an essential employee, such as the business owner, happens to die.
A buy-sell agreement is a contract between you and your business partner, which you can use individual life insurance to fund. If one of the partners dies, a buy-sell agreement allows the surviving partner to buy out the deceased business owner’s share of the business.
To make sure the partner has the money to purchase the share, some business partners take out life insurance policies on each other. For example, say your buy-sell agreement stated that the surviving partner could buy the other half of the business for $1 million. Your partner could take out a $1 million life insurance policy on you that lists them as the beneficiary. If you died, your partner would receive the $1 million they needed to buy out the company from your family or estate.
Life insurance is an essential part of any company’s risk mitigation plan. If you don’t have life insurance for small business, now is the time to speak to one of our advisors and protect yourself, your business partner, your company, and your family.
Starting and operating a business comes with inherent risks. Our goal is to help protect you from legal liability and financial losses should any unforeseen circumstances happen. As an independent insurance broker, our advice is unbiased – you can rely on our team of advisors to give you meaningful recommendations tailored to your business.