Using life insurance to leave your kids an inheritance
Q. My wife and I are both 57 years old. I have a business in Ontario, from which I earn $260,000 a year, and my wife makes $40,000 at her job. We have maxed out our RRSP contributions and we will soon do the same with our TFSAs. We are not big spenders and I want to leave our kids some money. On the advice of my accountant, I set up a holding company so I can pay myself a salary of $150,000 and I put the rest of my annual income in the holding company. Someone has suggested that a life insurance policy in my holding company would be a good investment. Is that a good idea?
–Aaron and Cynthia
A. At your stage of the game, life insurance is all about tax. So you may want to know more about an insurance concept often referred to as the “corporate insured retirement plan” which is all about reducing tax and maximizing the transfer value of your wealth to your children.
The basic concept is to buy a permanent insurance policy (not a term policy) in your corporation. Then, like a reverse mortgage, borrow against the policy’s cash value and pay yourself a taxable dividend from your corporation. When you pass away, the loan is paid off with the tax-free life insurance death benefit and the remaining insurance is paid out of your corporation to your children (shareholders) tax-free.
This concept is best suited to conservative or moderate-risk investors who have maximized their Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs). This strategy will likely not appeal to an aggressive investor who plans to hold only non-dividend paying stocks in their portfolio throughout their lifetime.
To really understand how this works and visualize the benefits, you need to understand the tax behind the strategy.
In Ontario, anyone earning $260,000 will pay about $100,000 in tax, leaving them with $160,000.
With your corporation, you can decide on the amount you want to pay yourself and the amount you would like to leave in your corporation.
In your case, if you pay yourself a salary of $150,000, you will pay tax of $45,413, leaving you with $104,587.
Now here is the important part: What happens to the $110,000 ($260,00 – $150,000) you’re leaving in the holding company?
In Ontario, the small business tax rate is 12.2%, so on $110,000, your company will only pay tax of $13,420, leaving you with $96,580 to invest.