Chats 1-7

CHAT 1:

Let’s define the insurance need.

Business owners of Canadian corporations are often the ypes of clients involved in affluent insurance cases. Let’s consider a 55-year-old business owner client whom we’ll call Bill. Not only is Bill wealthy, but he also stands to benefit even more by having  his life insurance owned by his corporation. Let’s assume he’s
medically insurable.

Any licensed life insurance advisor should surmise that Bill will have a human capital protection need. In other words, if he were to die prematurely, any or all of the following could happen:

• his family will miss the income he generated;
• his business may suffer financially without him there to run it; and
• if Bill was wise enough to have a buy-sell agreement for his corporation. It will need to be funded.

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All three of-these consequences suggest the need for an appropriate (likely large) amount of term insurance. The latter two risks can be mitigated through a policy or policies that are owned by the corporation, Usually the owner(s) of the business and their accountant will see the merits of protecting against these risks. The risks are temporary in nature but significant, so the term premium is therefore seen as reasonable and affordable.  Some advisors will conclude this first chat and settle a good-sized term sale. But top advisors will continue to have a second chat with their client.

 

CHAT 2:

How about we take a longer-term perspective?

Like most successful business owners, Bill has an ever-increasing tax liability associated with the capital gain on the value of his business. Any experienced advisor will recommend a life insurance policy is the most cost -effective way to fund an estate tax liability.  But before settling on term to satisfy the short-term need, how can
we show Bill the merits of going with a higher premium permanent life insurance policy that will cover off this longer-term need as well?

To minimize the potential “sticker shock” associated with permanent life insurance, many advisors will recommend a Term-to-lOO policy or a minimum-funded Universal Life policy with level cost of insurance. This could be owned personally, but if owned by the corporation, the premiums will be paid corporately and the company, as beneficiary, will receive the death benefit tax-free. The proceeds (less the adjusted cost basis of the policy) could then flow to the new shareholders tax-free via the Capital Dividend Account (CDA). Since Bill’s will leaves his company shares to his family, he’s managed to pay for his policy in a tax-efficient manner using corporate dollars while still achieving his legacy objectives.

By covering both the temporary and permanent life insurance opportunities at once, we’ve likely tripled the size of the sale. This stage typically takes more effort than the first as we explain the merits of permanent insurance and justify the larger premium to the business decision makers, but with insurance as in business, taking the long-term perspective is the right thing to do.

 

CHAT 3:

Let’s consider some options to maximize your estate.

What happens if Bill has a lot of passive investments in his holding company? The high tax rates on passive
investment income mean Bill’s corporate assets grow at a much slower rate. If the investments are liquidated when Bill dies, corporate taxes must be paid on any deferred capital gains. On top of this, the after-tax value would be paid out of the company as a taxable dividend, further reducing the amount available for Bill’s beneficiaries.

In such a scenario, we can inform Bill and his accountant that we can significantly reduce his annual tax burden and maximize his after-tax estate value. In the previous stage, the insurance premiums paid by the corporation essentially convert taxable investments into a large CDA that Bill’s beneficiaries can access tax-free upon Bill’s death. Since Bill has significant passive assets in his holding company, we can increase the merits of the life insurance policy two- or three-fold. We can both accelerate and increase the tax benefits by recommending a participating life insurance policy. The dividend option for the policy could be set to purchase additional insurance coverage. The higher premium associated with PAR will reduce the taxable investments sooner and the increasing death benefit will increase the CDA benefits substantially.

 

CHAT 4:

Do you have concerns about this commitment?

By this stage, we’ve gone a long way from simply protecting Bill’s business against some short-term risks. He has now covered off some permanent needs, reduced some annual taxes and increased the after-tax value of his estate. But we also increased his annual premiums. And for many, locking into a lifetime commitment can be uncomfortable.

Participating life insurance has two features designed to address this concern. Some products come with a guaranteed 20-pay option, whereby premiums are only payable for 20 years. And the majority of PAR policies have a premium offset feature¹, whereby accumulated and future dividends pay the policy premiums after some point in time (often less than 20 years). In fact, it may be possible to go on offset after 10 years or less. So, if Bill has enough passive assets to pay 10 premiums easily, this feature could alleviate his concern of having to pay premiums over and above the level of assets in the holding company.

 

¹ Premium offset is an administrative feature (not a contractual right under the policy) that may allow a client to use dividends and accumulated value within the policy to help pay future premiums if certain conditions are met. The premium offset date is not guaranteed. It may occur sooner or later, or not at all, depending on future dividend scale changes. If and when the policy goes on premium offset, at some point the client may have to resume out-of-pocket premium payments.

 

CHAT 5:

Do you have concerns about liquidity?

If Bill and his corporation are still active, the idea of locking up company assets may not be appealing. The corporation may see several uses for those investments down the road, ranging from acquisition to keeping the company solvent in business down cycles. If this is a concern, Bill will want his corporate assets to be liquid, even though he understands the tax consequences of holding them in passive investments.

This is where certain participating policy designs come into play. A few companies offer a PAR design with high early cash values. These plans can generate a first-year cash value that equals half of the premium and a cash value after five years approximately equal to the sum of the premiums paid over the five years. This design has two additional benefits over some other designs: 1) the asset side of the company balance sheet will show a minimal impact from owning the life insurance policy; and 2) Bill can easily access the equity in the life insurance policy – its cash surrender value. At this stage, we explain to Bill that he’d have the option to take a loan from the insurance company against the policy’s cash value (noting that there could be tax implications) or alternatively, go to a bank and use the cash value as collateral against a loan.

 

CHAT ‘6:

Can your business outperform an investment in permanent
insurance?

If Bill and his corporation are still active, they may not have a lot of assets sittingin passive investments. They might have their money constantly in motion as they believe their company’s performance is generating the best return on their assets.

If this is the-case, all is not lost in this permanent insurance conversation. Bill can still benefit from all the merits of a high premium participating life insurance policy. He’ll just have to borrow money to replace what was used to pay the premiums. And by doing so, he may be able to deduct the interest paid on the loan for tax purposes. If Bill and his corporation ‘are familiar with corporate borrowing, it will be fairly straightforward.

 

CHAT 7:

What’s your retirement vision?

If Bill doesn’t need to finance his premiums, he may find another purpose for borrowing against his life insurance policy. If for any reason, he finds he is a bit strapped covering his desired retirement lifestyle, he can look to his Participating life insurance policy as a source of additional cash flow because the cash value is growing each year he pays his premiums. This can provide significant equity for Bill to borrow against to supplement his other retirement income flows if his needs or wants change down the road.

Through the process, Bill has gone from considering an annual insurance expense of $15,000 to making an annual investment 10 times larger. Few advisors have the confidence and knowledge necessary to make this recommendation to clients like Bill.  As advisors aspire from good to great, have some comfort knowing it is possible and that clients like Bill will thank us for protecting the promises they’ve made to their families, their businesses and themselves.