Can corporate investments match the after-tax benefits of corporate life insurance?

Clients with excess corporate capital often ask a familiar question: Should I invest inside the corporation, or use permanent life insurance to build my legacy?

At first glance, this appears to be a comparison of expected returns. In reality, it’s a much broader planning question  – one that centers on after-tax outcomes at death, not just accumulation during life.

For advisors, the challenge is helping clients understand that how wealth is transferred can matter as much as how it’s grown.

Post-mortem planning without life insurance

Without life insurance, clients and their tax accountants typically rely on two common post-mortem planning strategies:

1. 164(6) Loss-carryback planning

Effectively, this strategy extracts corporate assets at dividend tax rates upon final passing.

2. Pipeline planning

This strategy extracts corporate assets at capital gains rates upon final passing, which may yield a better outcome despite its more convoluted nature.

While effective, both approaches will result in a meaningful tax cost at death.

Post-mortem planning with life insurance

3. The 50 per cent solution

When corporate life insurance is introduced, different planning opportunities emerge. Namely, the 50 per cent solution is a strategy that involves working around the stop-loss rules in section 112 of the Income Tax Act to maximize the value of the tax-free capital dividend account (CDA) created via life insurance proceeds. In turn, tax costs at death can be substantially reduced, or eliminated.

On the surface, the life insurance solution looks compelling, but one must also account for the cost of the vehicle.

The ultimate showdown: Corporate Investments vs. Corporate Life Insurance

Several assumptions will be applied to test the output as follows:

• A, 60, Mrs. A, 60, each own 50 per cent of the shares of a Canadian Controlled Private Corporation.
• Final passing occurs in 34 years at age 94 (Mrs. A). (Per Statistics Canada and Canadian mortality tables, there is a 50–60% chance one reaches age 94.)
• An estate freeze has been implemented and the projected value of the frozen preferred shares on final passing is $4M.
• Their corporation generates excess after-tax cashflow of $47.1K annually.
• The goal: Maximize their after-tax estate value using excess annual cash flow.

Investing assumptions include:

• Their risk profile is growth/moderate aggressive.
• Annual cash flow of $47.1K is invested as follows:
  • 80 per cent in equities with annual returns of 6.4 per cent*with minimal tax drag.
  • 20 per cent in fixed income with annual returns of 3.2 per cent*.
  • All after-tax income is reinvested.
• Pipeline planning will be deployed on final passing, combined with loss-carryback planning to the extent that the combination is optimal. Assume no advisor fees or professional fees.

*Non-eligible dividend rates (highest bracket) are applied where relevant in showdown.

Permanent life insurance assumptions:

• A Joint Last to Die Manulife Participating Whole Life Policy on a Male, age 60, Non-smoker and Female, age 60, non-smoker.
• Initial coverage of $741K with total annual deposits of $47.1K (premiums of $18.3K + additional deposits of $28,8K) for their lifetime. No early premium offset.
• Current dividend scale with dividends purchasing paid up additional insurance.

Conclusion

Keep in mind that this is a very long-term projection, and many factors may shift considerably over the course of time to yield an alternative result, with timing of final passing being a highly unpredictable factor.

The bottom line is that CDA generated by life insurance proceeds provides substantial tax benefits that may be difficult to match, especially when the client is not an aggressive investor.

While it’s not unreasonable to contemplate that an aggressive investor could match the outcome in this case, consider that advisor fees, professional fees (via pipeline planning) and higher tax drag on the corporate investment alternative will not impact the life insurance solution.

Ultimately, corporate life insurance should be viewed as an integrated planning strategy that compliments corporate investing and estate planning. Where clients prioritize low volatility and tax efficiency, corporate life insurance can be a powerful tool. With this option, advisors have a unique opportunity to shift the client discussion from “Where to invest” to “How to transfer wealth.”