There are many reasons why an individual might purchase a life insurance policy - and owning life insurance is fundamental to a stable financial plan - but are you holding your policy in the most tax efficient manner?

Many professionals are not aware that a professional corporation can be the beneficiary and owner of a life insurance policy; this could be a significant advantage in your favour since your professional corporation is afforded a much lower tax rate on its income than you are personally. The lower tax rate means less gross income is required when the premiums are paid by your professional corporation. This can be best illustrated through the following example:

Suppose Joanne's monthly life insurance premiums are $500 and she pays income tax at the highest marginal tax rate. If she owns the policy personally, she will have to earn $991 in order to have sufficient "after-tax dollars" to cover the monthly premium. By comparison, if the life insurance policy is owned by her professional corporation and the corporation pays the monthly premiums, the corporation will only have to earn $592 to pay the monthly premium. By having the corporation own the life insurance policy and pay the premiums, Joanne will have an extra $4,800 of cash in her professional corporation each year.

If a corporation owns a life insurance policy and the insured individual dies, the life insurance proceeds paid are received tax-free by the corporation. These funds are then treated as part of a special account that can be paid out to a shareholder of the corporation tax-free.

If you currently own a life insurance policy, consideration should be given to transferring the ownership to your professional corporation and making it the beneficiary. Although the additional cash that may be realized on a corporate-owned life insurance policy is appealing, there are some traps that must be considered before the policy is transferred.

Potential Tax Liability on the Transfer of Your Life Insurance to Your Corporation

The transfer of your life insurance policy to your professional corporation is considered a disposition and could be subject to income tax. If the cash surrender value (CSV) exceeds the adjusted cost base of your life insurance policy, you are required to pay tax on the difference. Term life insurance policies do not have a CSV, and therefore, would not trigger any tax on a transfer. However, permanent, universal life or whole life insurance policies often do have a CSV and therefore may result in a tax liability. Likewise, a future transfer of the policy out of the corporation could also result in tax consequences. Your insurance broker will be able to provide you with the CSV and adjusted cost base of your insurance policy.

Lack of Creditor Protection

Where the life insurance policy is owned by a corporation, the policy's CSV is susceptible to any claims made by a creditor of the corporation. For example, if the professional and his or her professional corporation are sued and there is not sufficient professional liability insurance to cover the claim, the creditor may be able to encroach on the assets of the professional corporation, including the CSV of the life insurance policy. Again, there is no concern if the policy is a term life insurance policy since these policies do not have a CSV.

Potential Loss of Capital Gains Exemption

In some instances, health care professionals who incorporate are eventually able to sell the shares of their professional corporation (generally, not applicable to medical professionals such as doctors). On the sale of the professional corporation's shares, shareholders are currently able to shelter currently up to $813,600 of gains by utilizing the individual's lifetime capital gains exemption. If this is applicable to you, you should be careful what type of life insurance policy you transfer to your professional corporation. Transferring a term life insurance policy to your professional corporation will not pose any concern; however, a permanent, universal life or whole life insurance policy, which builds up its CSV over time within the professional corporation, may prevent the shareholders of the corporation from utilizing their capital gains exemptions on an eventual sale.

There are many factors to be considered when deciding if transferring your life insurance policy to your professional corporation is right for you.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.