Corporate insured Corporate insured annuity annuity A strategy for enhancing after- tax estate values & unlocking the value of the business. Presented by: Jim Whittaker, IG. Insurance Services This material is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. Individual circumstances may vary and specific legal and tax advice is recommended.
A strategy for enhancing after-tax estate values & unlocking the value of the business.
Presented by: Jim Whittaker, IG. Insurance Services
This material is for information purposes only and should not be construed as legal or tax advice. Every effort has been made to ensure its accuracy, but errors and omissions are possible. Individual circumstances may vary and specific legal and tax advice is recommended.
Report on family business Report on family business BDO Dunwoody/CompassBDO Dunwoody/Compass
“Entrepreneurs are great at entrance strategies. After all, they’ve created companies, often from scratch. Their weakness is exit strategies.”
44 per cent claim to have an exit strategy 37 per cent if less than 10 employees If clients are 60 years or older, 57 per cent claim to have an exit strategy Of those above, only 16 per cent were “in the early stages of thinking about
the matter”
Most business owners’ exit strategies: 26 per cent sell to an outsider 17 per cent sell to a relative 17 per cent pass it onto family members to run 12 per cent sell to an employee Nine per cent keep until death, non-family run Three per cent close the business down
– Source: BDO Dunwoody/Compas Report on Family Business
Business succession planningBusiness succession planning In the next decade, close to one trillion
dollars of net worth in Canada will transfer to the next generation.
Succession planning has become very important for all businesses.
But...– Only eight per cent are doing something about it– Of those, only 1.5 per cent plan on closing it
downThis means…
– 98.5 per cent want the most tax-effective and efficient business transition and still maximize their personal estates, but have not formulated the best way to approach it.
As an ideal client for this strategy, you:Are a major shareholder of a private
corporation with surplus capital that is not required to operate the business
Are interested in maximizing after-tax retirement income
Are concerned about guaranteesAre looking to enhance the value of your
estate for heirs or your favourite charity
Key questions to ask yourselfKey questions to ask yourself
1. Am I using non-registered fixed income investments to
supplement my retirement income?2. Do I have heirs or a charity to whom I want to
transfer my assets?3. Do I have a desire to maximize my after-tax
retirement income?4. Am I willing to commit to a long-term planning
strategy?
The situationThe situation
Your business has surplus capital invested in fixed-income investments to help supplement your retirement income.
- The Corporate insured annuity strategy’s combination of a life annuity contract and permanent life insurance policy provides an opportunity to assist in enhancing your estate values and increasing after-tax cash flow in retirement.
The situation - cont.The situation - cont.
During an estate transfer, the shareholders are deemed to have disposed of all shares in the corporation at fair market value including investment assets.
- Permanent life insurance policies without cash value (e.g. term 100 policy) have a zero value for the purpose of share valuation.
- For income tax purposes, the corporation can reduce the value of the corporation by replacing the fixed-income portfolio with a life annuity.
Holding companies (Holdcos) are usually created to protect, from potential liabilities, surplus cash flow or investments arising from an operating company (Opco).
Excess funds are transferred to the holding company from the Opco to maintain the Opco’s small business status and a lower tax rate.
Personal tax rates apply to taxable dividend distributions.
Why use holding companies?Why use holding companies?
Holding company considerationsHolding company considerations
Funds held within Holdcos and management companies are taxed at the top rate.
Funds withdrawn from a corporation are taxed according to the method they are distributed.
Capital gain tax liability will exist at the death of shareholder.
Passive assetsPassive assets
CORPORATION $1,000,000 passive assets
CORPORATION $1,000,000 passive assets
TAXABLE DIVIDENDSDIVIDEND - $1,000,000
TAX at 33% 330,000
NET $670,000
SHAREHOLDER
The The Corporate insured annuityCorporate insured annuity strategystrategyHow it works: Purchase a non-prescribed life annuity contract with a portion or
all of the passive assets to provide tax-preferred income for life.
Fund a permanent life insurance policy with a portion of the additional cash flow generated by the annuity.
Use the tax-free death benefit proceeds to replace, in whole or in part, the capital originally intended for heirs.
Take advantage of the capital dividend account (CDA) to provide further enhancements to your estate.
Clients should ensure they can obtain life insurance before purchasing the annuity. Only private corporations are eligible for the CDA.
How it worksHow it works
Life annuity contractLife annuity contract
Corporation purchases a non-prescribed annuity Annuity provides regular payments for life Annuitant is shareholder Taxable portion of payments decrease over time
Eligible productsEligible productsPermanent life insurance
- Term to 100, non-participating whole life insurance- Universal life insurance (minimum funded)
Options for retirement incomeRefundable dividend tax-on-hand (RDTOH) is available only if a corporation is a private corporation at the time the dividend is paid. RDTOH is accumulated in respect of Canadian and foreign investment income, if the corporation is a Canadian-controlled private corporation when income is earnedCorporation can distribute these funds by
- paying salary and/or- paying a taxable dividend
Distributing excess funds from a Distributing excess funds from a corporationcorporation
Comparing distribution methodsComparing distribution methods Example of comparing dividend or salary distributions
(without Corporate insured annuity strategy)Private corporation residing in Canada has a GIC portfolio worth $800,000.
AssumptionsGIC interest rate = 5 per cent.Corporate tax rate on investment income = 49.79 per cent.Personal dividend tax rate = 31.34 per cent.Personal income tax rate = 46.41 per cent.Shareholder does not require distributed cash to live on, but still wants to annually remove after-tax income from the corporation.
Dividend versus SalaryDividend versus Salary Distributed as salary
Distributed as taxable dividend
Interest income ($800,000 x 5%) $40,000 $40,000
Salary1 $40,000 $0
Taxable income $0 $40,000
Corporate taxes payable before dividend2 $0 $19,916
Net cash flow to corporation $0 $20,084
RDTOH recovery3 - $10,042
Taxable dividend issued to shareholder $30, 126
Dividend received from corporation $30,126
Salary income $40,000
Taxes payable by shareholder $18,560 $9,453
Personal after-tax cash flow $21,440 $20,685
1. Tax-deductible to the corporation.2. Based on assumed corporate tax rate of 49.79 per cent noted above. Includes a RDTOH balance generated on taxable income, before dividend, of $10,668 (26 2/3 per cent of $40,000). 3. The amount of the taxable dividend issued to the shareholder is limited to the amount of funds within the corporation. Here, there are no other available sources of income or cash. The full RDTOH balance cannot immediately be refunded to the corporation. It has a remaining RDTOH balance of $626 after taxable dividends are paid.
Comparing distribution methods Comparing distribution methods
Comparing distribution methodsComparing distribution methods
Client profileClient profileJoe Martin is a major shareholder of A1 Holdings Inc., a
CCPC.- Joe, male , age 70, non smoker
Joe is looking at retiring and wants to ensure that sound estate and financial planning solutions are in place to:- maximize after-tax estate values- supplement his retirement income
The situationThe situation
Joe works with his financial advisor John Thomas and determines:- he has $800,000 surplus capital in A1 Holdings Inc.- the surplus capital is invested in GICs
Joe believes that this investment approach is the only solution to maximize after-tax estate values while supplementing his retirement income.
But…Further discussions with John have determined that there are
alternative options available to him.
Male, age 70 Non smoker, standard risk Annual premium for Dynaterm 100, $800,000 face
amount Corporate tax rate 49.79 per cent Personal tax rate 46.40 per cent Non-prescribed annuity, single life, zero guarantee period
with an underlying interest rate of 5 per cent
Key assumptionsKey assumptions
Insurance solutionInsurance solution
The Corporate insured annuity strategy
– Ascertain insurability.
– Corporation uses capital to purchase a life annuity with a lump sum payment of $800,000.
– Receive tax-preferred income.
– Use excess income from the annuity to purchase a Term to 100 permanent life insurance policy.
– Death benefit is paid to A1 Holdings tax-free.
Corporate insured annuityCorporate insured annuity versus an versus an alternative investmentalternative investment
