Rubach Wealth Blog

Waking up to tax-efficient estate planning

March 21, 2017

We get it: if we try to tell you about the merits of the capital dividend account, you’ll likely be asleep or hitting “close” before we can start our second sentence.

So instead, let’s talk about sheltering your investments from taxes. Let’s talk about building your personal estate with money taxed at a corporate tax rate (15–25%) rather than your personal tax rate (possibly as high as 53%). Let’s talk about building a bigger, better financial future for your family.

Still with us? Good! Let’s jump in.

Waking up to tax-efficient estate planning - 2017.03.21

Freeing the trapped surplus in professional corporations

Professional corporations are common among lawyers, accountants, doctors, dentists and others offering professional services.

What’s also common is this conundrum: if business is booming and you pay yourself too much out of your corporation, you’re going to be hit with a hefty tax bill at your high personal tax rate. If you leave the extra money in your business, it will be subjected to the lower corporate tax rate, but it will also be “trapped” within the corporation and unavailable for personal use.

So, how can you free this trapped surplus in a tax-efficient manner? The surprising answer is via life insurance.

Life insurance premiums are paid with after-tax dollars. While this is something you cannot change, you do have a choice in deciding which after-tax dollars to use. If you take out a life insurance policy on yourself via your corporation (with the corporation as the owner and beneficiary), you can pay the premiums with income taxed at the corporate tax rate rather than income taxed at your higher personal tax rate. This allows you to pay less for a life insurance policy that will ultimately pay out the same death benefit that it would have paid out had you purchased the policy personally.

Example:
Life insurance premiumPre-tax dollars required assuming personal marginal tax rate of 53%Pre-tax dollars required assuming corporate marginal tax rate of 16%
$1,000$2,128$1,163

 

Accessing your money in a tax-free manner

So we’ve established that you can pay less for a life insurance policy (when taking into account premiums + income tax costs) by purchasing it through your corporation. However, isn’t this money still trapped in your company? How do you get it out?

Remember the capital dividend account we mentioned just before you nearly dozed off? Even if you have no interest in all of its complexities and inner workings, you should know this: it can be used to transfer money received by your corporation from specific sources on a tax-free basis to you or your family members, as long as you are Canadian residents. 

One of those specific sources is the death benefit from life insurance policies for which the corporation is the beneficiary. This means that if your corporation holds a life insurance policy on your life, after you die the death benefit will be paid out to your corporation and the amount of the death benefit (less the adjusted cost basis, or ACB) will be credited to the capital dividend account. From there, it can be paid out tax free to your estate or directly to your family members.

Making smart decisions for your financial future

At Rubach Wealth, we get that your interest in learning the intricacies of insurance is probably close to nil. However, we also recognize that you have a strong personal interest in managing your money in the most tax-efficient manner possible for the benefit of you and your family.

If you’d like to find out more about putting trapped funds within your corporation to efficient use via life insurance, we invite you to contact us for a chat. We may end up talking about insurance, but we promise to keep you awake with good coffee and a discussion about opportunities for building a brighter financial future for your family.

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