1 business insurance part 2 insurance concepts for business owners jorge ramos, cfp,clu director of...

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Business Insurance

Part 2Insurance Concepts for

Business Owners

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

> Buy Sell

> Key Person

> Shared Ownership

> Executive Retirement Strategies

> IRS> IPP> RCA

Business Owner Insurance Concepts

1

Business Insurance

Part 1Working with Business

Owners

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

> Self Employed

> Partnerships

> Incorporated private business

> CCPC

> Publicly listed corporation

> Professional Corporations

Business Structures

> Incorporated Private business

> General corporate tax rates> 26% (11% Provincial, 15% Federal)> 25% (manufacturing, farming, mining)

> CCPC> 15.5% (4.5% Federal, 11% Provincial)> On first $500,000

> Publicly Traded companies

> Do not qualify as CCPC

Business Taxation 101

> First $750,000 of capital gains are tax-free

> Qualified small business shares> Qualified Farm property

> 50% of assets “actively” used in the business for the last 24 months

> 90% of assets “actively” used in the business at time of sale

> Shares owned by individual for last 24 months

Capital Gains Exemption

> CDA = Life insurance death benefit – ACB

> Life insurance death benefit> net of policy loans> not net of collateral loans> Applies to permanent and Term policies> Applies whether there is cash value or not

> Notes:> ACB usually goes to zero after 20+ years, cannot be negative> CDA has to be paid out equally to all shareholders of the same

class

Calculating CDA

> ACB – Adjusted Cost Basis> Ensures that corporate money gets taxed properly in

personal hands> The ACB of policy tracks the original premium paid by a

company for life insurance minus the NCPI

> Formula> Premiums Paid increase ACB> NCPI decreases ACB

ACB

> NCPI – Net Cost of Pure Insurance> Net amount at risk (NAAR) for the year multiplied by the

probability of death in that year, ie: similar to T1 rates> Based on 1975 Select and Ultimate mortality table> Costs for any benefits or riders removed> Removes any ratings on substandard risks

NCPI

> Problem:

> Potential death benefit shortfall created by CDA/ACB> Net death benefit may fall short of required amount

> Buy-sell

> Solution:

> Face plus fund plus ACB> Increases face amount so that CDA paid is equal to or

greater than original death benefit> Removes risk of the ACB tax grind on CDA> Removes risk of underinsuring the need

CDA Tax Trap

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Advantages of Corporate Owned Life Insurance

A PARTNER YOU CAN TRUST.

1

Disadvantages of Corporate Owned Life

Insurance

A PARTNER YOU CAN TRUST.

Thank You

Jorge Ramos, CFP, CLUDirector of Advanced Marketing

416-206-7050jorge.ramos@inalco.com

1

Business Insurance

Part 2Insurance Concepts for

Business Owners

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

> Buy Sell

> Key Person

> Shared Ownership

> Executive Retirement Strategies

> IRS> IPP> RCA

Business Owner Insurance Concepts

Buy Sell

> Establish Value of business

> Determine succession plan

> Estimate succession tax issues

> Recommend solutions

> Resolve issues

> Valuation Issues> Other Triggers

Buy-Sell Advisor Role

> Fixed Price

> Book Value

> Multiple of Book Value

> Capitalization of Earnings

> Independent Appraisal

Valuation Methods

> Accumulated Wealth

> Borrowed Funds

> Purchase over Time

> Sinking Fund

> Life Insurance

Buy-Sell Funding Options

> Death

> Disability

> Retirement

> Dissension

> Bankruptcy

> Marital Breakdown

Buy-Sell Triggers

> Personally owned

> Criss Cross

> Corporately owned

> Share Redemption> Promissory Note> Hybrid Method

Common Buy Sell Arrangements

> Set-up

> Personally owned policies> Partners own policies on each other> Premiums paid personally> Partners are each others beneficiaries> Premiums can be paid by company but treated as

taxable benefit

Personal Criss Cross Buy-Sell

ABC Inc.ABC Inc.

BB50%50%

BB50%50%

AA50%50%

Personal Criss Cross Buy-Sell

A owns policy on B

A pays premium on B

A is beneficiary on B

B owns policy on A

B pays premium on A

B is beneficiary on A

> Death of a Shareholder

1. Shares of deceased transfer to estate/heirs

2. Death benefit paid to surviving partner

3. Funds used to buy shares from deceased shareholder estate/heirs

4. Surviving partners end up with more shares

Personal Criss Cross Buy-Sell

> Premiums paid out of after-tax personal funds or paid corporately but as a taxable benefit

> Can create inequities in premium payments

> Complicated if more than 2 partners

Personal Criss Cross Disadvantages

Personal Criss Cross with 5 partners

4 policies8 policies20 policies

> Set-up

> Company buys insurance on partners lives> Company pays for premiums> Company is beneficiary of all policies

Corporate Share Redemption Buy-Sell

Death of a Shareholder

1. Shares of deceased transfer to estate/heirs

2. Death benefit paid to Corporation

3. Corporation redeems deceased shares with death benefit proceeds

4. Corporation cancels deceased partners shares

5. Surviving partners shares increase in value proportionate to cancelled shares

Corporate Share Redemption Buy-Sell

> Set-up

> Company buys insurance on partners lives> Company pays for premiums> Company is beneficiary of all policies

Corporate Promissory Note Buy-Sell

Death of a Shareholder

1. Shares of deceased transfer to estate/heirs

2. Surviving Partner buys shares with Promissory note

3. Death benefit paid to Corporation

4. Corp. issues a tax-free dividend to surviving partner

5. Surviving partner uses funds to retire promissory note

6. Surviving partner receives shares from deceased partners estate

Corporate Promissory Note Buy-Sell

> Generally cheaper to use corporate funds

> Premium inequities removed

> No T4A’s for partners

> Creation of CDA

> Watch out for the ACB

Corporate Buy-Sell Advantages

> No tax deduction for premiums

> Policy is asset of company

> Subject to creditors> Affects balance sheet> May affect CGE of company

> Fund value considered a passive asset

> Stop-loss rules may apply

> Changing policy from corporate to personal

> Taxable disposition could apply

Corporate Buy-Sell Disadvantages

> Allows parties involved to choose best methodology

> Promissory Note> Share Redemption> Hybrid> or take advantage of new laws in place at time

Optimization Clause

Key Person

> Establish the need for key person

> Determine the value of key person

> Recommend Solutions

Key Person Insurance Advisor Role

> Replace the loss of a key person:

> Owner/partner> Executives> Key sales people> Employees with highly specialized knowledge

Key Person Insurance

For three 40 year- olds the chance of one of them being disabled before

age 65 – about 90%

Chance of losing a 40 year-old to a long-term disability of 3 months or more

before the age of 65 – about 60%

Key Person Risks

> Multiple of salary

> Debt retirement

> Replacement costs

> Lost profits and increased expenses> creditors may reduce or withdraw credit

> may lose customers

> may lose other employees

Value of a Key Person

> Same as Buy Sell

> Insurance

> Life Insurance> Disability> Critical Illness

Funding Solutions

> Corporate owned and funded

> Company is beneficiary> Premiums are not tax deductible

> Creates liquidity for company

> Can create benefits for key person’s family

> Shared ownership

Key Person Insurance

Shared Ownership

> Corporate Key-person/Buy-sell insurance required

> Corporation has cash not required for growth of business

> Shareholder wants to move corporate cash into personal hands

> Shareholder seeking retirement funding arrangement

> Shared cost strongly favours the shareholder

Shared Ownership

• Sole Shareholder, age 50 NS

• Corporation has a justification for $1Million corporate owned insurance.

• Corporation has excess cash not • necessary for growth

• Shareholder wants to maximize

retirement income tax-efficiently.

Shared Ownership Case Study

Face Amount paid to theCorporation (CDA Credit)

Corporation pays fair valuefor the assigned Face Amount

Shareholder Purchases Policy

Genesis UL

FaceAmount

plusFUND

Shareholder assigns

‘Face Amount’to Corporation

‘Fund Value’ paid to

shareholder’sbeneficiary

Shareholder Dies

• Survey the T100 market for a rate to use (Shareholder plans to stay in business beyond normal retirement age)

• Calculate the present value of T100 premium from now to life expectancy (approx. age 85 for a M50NS)

• Spread the Net Present Value out over the 10 year premium payment period

Corporations share

Executive Retirement

Adequate Pension

“a normal level of benefits would be the same benefits provided under a registered pension plan without regard to the Revenue Canada maximum. This would be 2% x years of service x final average earnings or about 70% of pre-retirement income for an employee with 35 years of service.”

CCRA roundtable discussion (1998)

RRSP Limits

Max. Contribution Max. Income

> 2012 $22,970 $127,611

> 2013 $23,820 $132,333

> 2014 $24,270 $134,833

Executive Retirement Strategies

> IRS/IRP

> IPP

> RCA

Insured Retirement

The concept in 4 steps:

Corporate IRS

Step 1: Implementation

1. The company is owner and beneficiary of the contract

2. Premiums are paid by the company from the excess retained earnings

3. Insurance premiums are not tax deductible

Corporate IRS

Corporate IRS

• Minimum of 10 to 15 years

• Contract options

• deposit level

• number of accumulation years

• date retirement income begins

Step 2: Accumulation period

Step 3: Payout at retirement

Corporate IRS

Two possibilities

• Loan by the company

• Re-lend to individual

• Dividend

• Loan by the shareholder

• Guarantee Fee

Death benefit

Step 4: Death and repayment

CDACDA

Heirs

Repay loans and

Balance retained by

heirs

Non-taxable CDA dividends

CDACDA = Death = Death

benefit Less benefit Less ACBACB

ACB ACB credits credits

Retained Retained earningsearnings

Regular taxable dividend

Corporate IRS

Individual Pension Plan

Individual Pension Plan

> Registered pension plan

> Increases contribution room beyond RRSP limit

> Defined benefit

> Employer funded

> Tax deductible contributions

> Creditor Protected

> Reduces RRSP Room through pension adjustment

RRSP vs. IPP

IA IPP Support

> Prep and quote plan

> Initial actuarial valuation and on-going monitoring

> Past service calculation

> Register plan with CRA

> Annual statements

> Pension adjustment calculation

> For Quotes: Paul.Vanderkolff@inalco.com

RCA’s

> Defined benefit pension plan

> Tax deductible contributions

> More room than IPP

> Creditor protected

> Does not affect personal RRSP room

> Alternative to “Bonus down” strategy

> Removes capital from balance sheet

> Often used as Golden handcuffs

Retirement Compensation Arrangements

RCA Mechanics – Non Insurance

OPCOOPCO

RCARCATRUSTTRUST

Refundable Refundable Tax Tax

AccountAccount

RCA RCA INVESTMENTINVESTMENT

ACCOUNTACCOUNT

tax deductibletax deductible

contributionscontributions

50%50% 50%50%

50% of realized growth50% of realized growth

RCA Mechanics – using Universal Life

OPCOOPCO

RCARCATRUSTTRUST

Refundable Refundable Tax Tax

AccountAccount

RCA RCA INVESTMENTINVESTMENT

ACCOUNTACCOUNT

tax deductibletax deductible

contributionscontributions

50%50% 50%50%

50% of realized growth50% of realized growth

RCA Mechanics upon Retirement

RCARCATRUSTTRUST

$2$2 $1$1

TaxableTaxableIncomeIncome

RCA RCA INVESTMENTINVESTMENT

ACCOUNTACCOUNT

Refundable Refundable Tax Tax

AccountAccount

PensionerPensioner

$3$3

RCA Example

• Male

• Non-Smoker

• 45 years of age

• earns $200,000

• RRSP of $200,000

• Max. RRSP contrib.

• 35 yrs of service at retirement

• retires at 65

RRSP Retirement Income (assuming 5.5% ROR from age 65 to age 82) =

$95,632 annual income

Expected Pension (indexing 5% to age 65, 70% of final 5 year average) =

$321,647 annual income

RRSPRRSP

RCARCA

RCA Disadvantages

> 50% of contributions go to CRA RTA account

> No growth on these funds

> 50% of growth goes to CRA RTA

> Can require large top-up deposits by Corp. if interest rates decline as it is a defined benefit plan

RCA Advantages

1

Business Insurance

Part 2Insurance Concepts for

Business Owners

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

> Buy Sell

> Criss Cross vs. Share Repurchase

> Key Person

> Shared ownership policies

> Executive Retirement strategies

> IRS> IPP> RCA

Business Owner Insurance Concepts

1

Business Insurance

Part 3 Servicing Corporate Owned

Insurance Policies

Jorge Ramos, CFP ,CLUDirector of Advanced Marketing

A PARTNER YOU CAN TRUST.

Thank You

Jorge Ramos, CFP, CLUDirector of Advanced Marketing

416-206-7050jorge.ramos@inalco.com