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What is corporate-owned life insurance (COLI)? – Updated 2024

SUMMARY

A business can own a life insurance policy as a way to ensure the continued viability and profitability of their business, while benefiting from the policy’s unique tax treatment. Life insurance is an effective tax and estate planning tool, especially for business owners. They can use it to protect their families, safeguard their personal and business assets, and support business continuity.

IN THIS ARTICLE

Life insurance can offer unique benefits to business owners and high-net-worth individuals. Alongside the traditional death benefit provided through a life insurance policy, permanent life insurance policies can be used to cover high tax bills, to secure a business loan, to help effectively plan an estate, and more.

In this article, we discuss what corporate-owned life insurance is and the many different ways it can benefit business owners and high-net-worth individuals in Canada.

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What is corporate-owned life insurance?

Corporate-owned life insurance (COLI) is a life insurance policy that is owned by a business or corporation rather than an individual. In this setup:

  • The business owns the life insurance policy
  • The covered person is a key person, such as an owner, shareholder, or vital employee
  • Insurance premiums are paid with the company’s after-tax dollars, helping to maximize tax efficiency
  • The business is the beneficiary, so the death benefit payout is made to the company — not the covered person
  • In Canada, most COLI policies are permanent life insurance, a type of coverage that lasts permanently, builds cash value over time, and can pay out dividends

Corporate-owned life insurance is also called business life insurance or business-owned life insurance. Companies are allowed to own an insurance policy on an employee or key person once they have insurable interest.

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What are the advantages of corporate ownership of a life insurance policy?

A corporate-owned life insurance policy has several advantages:

  • Reduced tax cost — Paying premiums through a business allows for the use of after-tax dollars generated by the business
  • Equitable distribution of premiums — When a business pays for premiums for multiple people, the cost is more equally distributed than it would have been if each covered person individually paid for a policy
  • Easier management — A business can centrally manage policies on multiple individual or shareholders, making it easy to pay premiums, use cash values, verify status, or even file claims
  • Creditor protection — The life insurance proceeds on a business-owned policy are generally protected from the creditors of an individual shareholder
  • Tax-preferred cash value accumulation — The cash surrender value of a COLI policy is treated as a business asset and not taxed until the policy is cashed in or the values are withdrawn. This helps businesses diversify their asset mix and gain tax advantages
  • Tax-free death benefit — Death benefit proceeds received by a company can be paid out as dividends to the deceased’s estate or other beneficiaries as capital dividends

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How can life insurance policy be used for your business?

There are multiple ways a business owner can leverage life insurance in Canada to ensure their business will continue after you pass away:

  1. Key person insurance
  2. Buy-sell agreements
  3. Estate equalization
  4. Life insurance collateral assignment

1 Key person insurance

Key person insurance allows a business to protect against losses they may face when a key employee passes away. It’s a cost-effective way to help ensure business continuity in the fact of specific risk.

  • The policy is owned and paid for by your business
  • It covers the life of an individual deemed critically important to the company’s operations
  • Proceeds from the death benefit can be used for various business needs

2 Buy/sell agreements

A buy-sell agreement is a contract that stipulates how the shares of a deceased business owner or partner may be purchased. Canadian business owners can use the proceeds from a life insurance policy to fund a buy-sell agreement.

  • A death benefit helps prevent business partners from having to use personal funds or business assets to buy back shares
  • Having enough funding available ensures the business will continue

3 Estate equalization/Estate planning

Estate equalization is a specific estate planning strategy that arranges for fair transfer of assets to one or more beneficiaries or shareholders. It’s especially useful for business owners who have some beneficiaries who are interested in inheriting their business, and others who are not.

  • Family members with an interest in the estate inherit the family business or family assets
  • Other family members receive an equivalent cash value to the estate using the tax-free proceeds of a life insurance policy

4 Life insurance collateral assignment

Business owners can also use the cash value from permanent life policies as collateral in multiple ways. You can get a policy loan from your policy’s cash value or use the policy as collateral to secure funding from a bank, lender, or other financial institution.

  • There may be restrictions on how much your cash value has to grow before you can borrow
  • If you fail to repay the loan, and the collateral of the cash value has to be used, then the interest and the loan amount can cut into the policy’s death benefit

Learn more about using life insurance as collateral in Canada

What’s the biggest risk of business-owned life insurance?

The biggest risk of business-owned life insurance occurs when a business ends up with a significant tax liability. This can happen if a shareholder passes away without a spouse to rollover their shares.

  • When this happens, the deceased shareholder is deemed to have disposed of their shares at something called Fair Market Value (FMV)
  • The cash surrender value (CSV) on the shareholder’s policy is included when computing the FMV of the shares
  • When a business owns an insurance policy with a high CSV, the FMV of the shares of the deceased shareholder is also high
  • As a result, the deceased shareholder will be subject to a large capital gain on death, and also a major tax liability

However, this tax liability can be avoided with something called insurance tracking shares.

What are insurance tracking shares?

Insurance tracking shares are a special kind of share issued to the heirs of an estate — this is usually the business owner’s child. It tracks the cash value of a COLI policy, but does NOT grant the shareholder (i.e. the deceased owner’s child) entitlement to dividends, proceeds on the sale of the business, or voting rights.

Learn more about corporate-owned life insurance in Canada

PolicyAdvisor’s licensed insurance experts can help you better understand what insurance products may be best for your situation and business. Book some time with us and see how you can use insurance to best plan for the future of your business, your estate, and your family’s future.

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KEY TAKEAWAYS

  • Business owners can use whole life insurance as a source of liquidity to achieve diverse estate planning goals
  • A business owner may purchase life insurance personally or through his corporation
  • A corporation may purchase life insurance policies to facilitate key man insurance, buy-sell agreements, or estate equalization
  • While there are several benefits and flexible planning opportunities, there are also a number of additional complexities to consider for corporate-owned life insurance

By Jason Reynold Goveas
Senior Insurance Advisor, LLQP
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