Page 22 - Newcom

Putting needs ahead of solutions
Clients wary of an insurance sales pitch will be won over by an advisor who comprehen- sively identifies needs instead of diving in headfirst with solutions.
When addressing liquidity, rather than assume a business-owner client requires insurance, “I start with a question,” says Peter Wouters, director of tax, retirement and estate planning services at Empire Life Insurance Co. in Toronto. Does the client have a plan for the business if a certain shareholder dies? If the
client wants to buy out the shareholder, where will the money come from? Would removing money from the business cause undue strain? Could the client get a loan with an appropriate interest rate and payment schedule, and what would the tax implications be? (Loan payments are non-deductible to the business.)
Beginning the conversation with questions is “disarming,” Wouters says, and demon- strates that the advisor is a problem-solver rather than a salesperson.
Liquidity at death
to fund capital gains tax
When a business owner dies, their estate will owe capital gains taxes on the deemed disposition of their shares in the firm — and that cost could be significant. Life insurance could cover the liability.
For example, David says, “If you own a lot of real estate with huge embedded capital gains, you have a liquidity problem” that insurance can solve. She notes that a quick sale of the business to a third party may not be feasible, depending on market conditions.
For a married couple with a non-profes- sional corporation, the tax act allows shares to be rolled over tax-free to the spouse after the other spouse dies. As a result, David suggests a joint last-to-die policy, with premiums typ- ically payable until the second spouse’s death. With such a policy, “I’ve dropped the risk to the insurance company by almost 50%,” she says. “As a result, they’ve dropped the cost of permanent insurance to my clients by almost 50%.” Clients often assume insurance will be too expensive, she says.
Be aware, however, that if the couple divor- ces, it’s difficult to unwind a joint last-to-die policy. “If they get a divorce, you don’t get the tax-free rollover of the shares,” Zlotnik says. The joint coverage would need to be replaced with individual coverage, which could present a challenge if one of the spouses is uninsurable at the time of divorce. Thus, Zlot- nik suggests the couple have both individual term and joint last-to-die permanent policies.
If the owners plan to sell the business, term insurance would suffice.
Key person coverage
Insurance advi­ sors can edge out the competition by understanding available products, whether universal or whole life, and how those serve clients. “Be the guy who knows more than your next­door neigh­ bour,” says Cindy David, president of Cindy David Financial Group in Vancouver. That way, you can explain to clients the pros and cons of what’s avail­ able, and let them choose, she says.
If the retained earnings are meant to fund the owner’s retirement, and passive income levels have reached a concerning level, an option is to “reposition that money into a specially designed life insurance policy where you can tax-shelter the growth,” Wouters says — a.k.a. an exempt policy. (This planning requires that retained earnings aren’t notional and instead are readily available as investible cash, he says.)
Where the business owner will pay retained earnings to benefici- aries, and passive income levels are concerning, those earnings can be repositioned to an exempt policy, with the proceeds paying out tax-free to the corporation. Then those proceeds can be paid to the shareholders out of the CDA, Wouters says. (If passive income levels aren’t a concern and money deposited in the policy isn’t more than what’s needed to cover premiums, there should be no exempt concerns because there’s no overfunding or large cash accumulation.)
If the business owner lives long enough for the policy’s adjusted cost basis to reach zero, David notes, the CDA would be credited for the full proceeds, which could then be distributed as tax-free capital dividends.
By buying life insurance by using retained earnings, the client avoids paying the top marginal tax rate on passive income as well as the clawback of the SBD. “That combination is very compelling” and can be highlighted to clients, Wouters says.
If such an insurance policy isn’t purchased, clients subject to a
full clawback of the SBD may have to take on significant risk in an investment portfolio held by the corporation to get results compar- able to the performance of a life insurance policy — certainly regard- ing estate values and, potentially, cash values, Wouters says.
Furthermore, every year that earnings can be repositioned to the exempt policy instead of invested inside the corporation, the client continues to avoid or reduce the SBD clawback (depending on passive income levels). The client thus avoids a minimum 50% tax increase on active income — a benefit that’s often understated or missed, Wouters says. In Ontario, for example, the client with an exempt policy pays 12.2% instead of 18.5%.
A particular policy’s cash surrender value must also be considered. A high cash surrender value has potentially
Another situation in which insurance cover-
age is needed occurs when one of the share-
holders is the firm’s rainmaker. “If something
happens to the key person, all of a sudden I’ve
got a strain on my income-producing capabil-
ities, and I need to go hire someone to replace them,” Campagna says. This could include a finder’s fee or large signing bonus, he says.
In a corporation with multiple active shareholders and employees, Wouters suggests business owners consider the five most important tasks that impact the business daily, as well as who performs them. That assessment may reveal that cash would be required to offset losses in the immediate aftermath of a key person’s death, he says, in addition to covering hiring costs.
Depending on the person’s importance to the business, a policy payout is typically five to 10 times the person’s compensation, Zlotnik says. For a relatively young person, term insurance of 10 or 20 years may be ideal, he says; for an older person, a yearly renewal term or 10-year term policy may work better.
Passive income considerations
Life insurance can also shelter a business owner’s investment income — an important consideration because passive income inside a cor- poration is taxed at the top marginal rate. Furthermore, access to the small-business deduction (SBD) drops by $5 for every $1 of passive income above $50,000, and is eliminated at $150,000 of passive income. (For example, a business with an investment portfolio of $3 million earning 5% would lose access to the SBD.)
If a business owner has a lot of retained earnings in a taxable investment portfolio, find out why, Wouters says. For example, a retail business could have plans to establish more stores.
Capital dividends are paid tax­free from a corpora­ tion’s capital divi­ dend account. The notional account is credited with the difference between the total sum insured and the adjusted cost basis of the policy.
negative implications if the business owner wants to eventually sell the business. “If you have too much in passive assets — whether that’s cash surrender value of a life insurance policy or an investment portfolio — that can impact your ability to claim the capital gains exemption in the future,” Campagna says.
A cash surrender value that’s too high could cause the corporation’s shares to run afoul of the tax rules for qualified small-busi- ness corporation shares, thus negating eligi- bility for the capital gains exemption. That’s because a small-business corporation must use 90% or more of the fair market value of its assets to carry on an active business (among other requirements).
Not only would the policy impair the
22 Investment Executive’s Insurance Guide 2020