When thinking about your business assets, you might start with the obvious: the physical location of your business, the product or services you sell, and the tools and equipment you use. But there’s another asset class your business might be overlooking: life insurance. With Cash Value Life Insurance, you’re able to turn corporate dollars into a unique, valuable asset.
What is cash value in a life insurance contract?
Cash value in a life insurance policy, simply put, allows the policy to earn interest or other investment gains in a tax-exempt environment.
It might be unusual to consider life insurance an asset. But Patrick Devitt, founder and CEO of Generational Wealth Group, explains it plainly: “An asset is simply a thing of value to an individual or corporation,” he says. “And there is an expectation that the asset will have a future benefit of some sort. Cash Value Life Insurance is a perfect example of an asset: it increases in value for the contract owner and beneficiaries over time.”
Is the life insurance policy for me or my business?
The terms of the policy depend on your objectives, but a possible scenario is to have a corporate-owned policy. “A policy for a business owner is typically owned and paid for by the corporation,” Patrick says. “In that case, the beneficiary would be the business. When a business receives the death benefit a Capital Dividend Credit (CDA), in the equivalent amount is applied. The death benefit can then flow through the CDA to the shareholders and family members tax-free minus the Adjusted Cost Base.”
With your business as the owner of the policy, premium payments can now be made through the corporation. Those payments go toward:
The cost of insurance
Portfolio management fees
And broker commissions
While there are costs associated with Cash Value Life Insurance, the costs tend to represent roughly 20% of the growth in the contract. When compared to traditional investments paying between 26.5% to 53% in tax, the cost of Cash Value Life Insurance becomes very attractive as an asset.
Why use a Cash Value Life Insurance policy?
“Cash Value Life Insurance is tax-exempt,” Patrick says. “As cash value accumulates and grows within the contract, no taxes are paid on the growth.” Essentially, your life insurance policy can become an incredible investment vehicle for your business, allowing you to grow assets tax-free.
“Once a dividend is paid into the contract,” Patrick adds, “the cash value is guaranteed to never decrease, unlike traditional assets like market securities or real estate.”
And as an investment vehicle, for example, it’s possible to turn the small premiums into substantial gifts to foundations or charitable organizations. “Depending on the business objectives, this could result in tax savings during one’s life or at death on a terminal return,” Patrick says.
What happens when the policy is enacted?
It’s not pleasant to think about, but what happens with the policy when you die? With the owner naming the beneficiary, the benefit received comes with certain advantages.
“The death benefit is tax-free to a beneficiary and bypasses the estate,” Patrick explains. “Basically, it creates a liquidation event right at the time most needed.”
Or, if the policy is corporately owned, the death benefit flows through the corporation, creating a capital dividend credit. “This is then paid out of the corporation, tax-free to the named beneficiaries, when the adjusted cost base is equal to or less than the net cost of per insurance,” he says.
Your life insurance policy can also help with estate planning. Covering estate taxes will allow the family to keep assets intact as well as estate equalization considerations.
Can you access the Cash Value early?
Yes: as a contract owner, you can spend the cash value during your lifetime. Whatever you don’t spend will pass on to the next generation, tax-free. There are a few ways to access the cash value of your policy:
Policy loan: issued by the insurance provider, and won’t affect the growth of the cash value. Plus, loans equal to or less than the policy’s adjusted cost basis -- the cost of an insurance policy for tax purposes -- are not taxed.
Policy withdraw: policyholders can surrender part of the cash value of a policy. However, you may be taxed: if 40% of a policy’s cash value is tax-free, then typically only 40% of the withdrawal will be tax-free. More importantly, a withdrawal permanently modifies the insurance policy, reducing the death benefit by an amount equal to or greater than the amount withdrawn.
The most common among business owners is third-party loans: third-party lenders, like banks, issue this type of loan. Unlike policy loans, third-party loans do not create income, and typically do not affect the capital dividend account credit at death. That said, if a policy is used as collateral for a loan taken to earn taxable corporate income, the policyholder may be able to deduct the loan interest from the corporate income. You may also be able to deduct the lesser of premiums payable and the net cost of pure insurance. You should speak with your insurance professional before considering a third-party loan, as outcomes might differ.
Want to find out more about Cash Value Life Insurance? Generational Wealth Group can help you protect your family, wealth and business with smart planning that’s tailored to fit your needs.