Universal life (UL) insurance can benefit Clients in many situations. But a key “sweet spot” is its use within a private corporation, where it can help solve many issues. That includes minimizing taxes at death, preserving and improving liquidity for the business, and providing tax-preferred asset growth along the way.
Here are five questions that top advisors often consider as they help business owner Clients assess their UL decisions.
1. Where does the yearly renewable term (YRT) advantage lie?
The advantage of YRT cost of insurance is that premiums are low in the early years of a policy. This allows Clients to fund their policy early and represents an excellent growth opportunity for policy values. A UL policy with YRT cost of insurance therefore offers a great place to hold and grow retained earnings within an incorporated business.
For corporate Clients, there are different YRT curves to illustrate. Examples are YRT to age 70 or 85, or even YRT to age 100. Advisors will often look at the length of the payment period. Longer payment periods mean a lower cost of insurance in the early years. That gives Clients more room to fund the policy.
2. What does the Adjusted Cost Basis (ACB) pattern really tell us?
In general, the ACB of a policy rises in the early years of a policy. Then ACB declines slowly to zero in the later years.
Consider when a UL policy is held within a beneficiary corporation and the insured dies. The excess of the death benefit over the policy’s ACB is credited to the corporation’s capital dividend account (CDA). This allows the corporation’s shareholders to receive the insurance proceeds as a tax-free capital dividend. Unfortunately, the higher the ACB (typically in those early years), the lower the amount credited to the CDA, and the lower the tax-free capital dividends.
It’s important to evaluate the ACB of a policy against predicted payments – both of premiums and into the UL investment account – which affect its structure. Knowing what Clients will pay into their policy effectively sets their ACB curve. However, top advisors also pay attention to YRT pricing. Typically, when pricing is lower, a Client can reduce their ACB quicker, even when making payments in excess of the required premiums.
3. How should the policy fund be used?
One of the key benefits of UL policies is the ability to make payments beyond the required premiums. Such payments both cover the cost of the insurance and grow a cash value within the policy. Clients can then invest that cash value in any investment options their policy offers.
One goal of these payments is for Clients to accumulate enough assets within the policy to pay the subsequent premiums for the rest of their life. That means this strategy works best with a lower YRT cost of insurance, which typically gives Clients more room to make payments into their investment account.
However, there are cases where Clients won’t want to increase the cash value of their policy. For example, they may need to minimize the value of corporate assets not used to produce active business income. Specifically, they want to ensure that their corporation’s shares remain qualified small business corporation (QSBC) shares. That way, they’ll remain eligible for the lifetime capital gains tax exemption.
In such cases, businesses may want a UL policy that’s intentionally funded to have a minimal cash value. That way, they can maintain their investable corporate assets elsewhere, preserving the QSBC status of their corporation’s shares. In such cases, a level cost of insurance can be a better option, as it avoids the higher rates that come in the later years of YRT.
4. How does the illustration fit within business planning strategies?
Clients will have specific business planning strategies in mind. Advisors experienced in UL ensure their choice of illustrations is consistent with those strategies.
For many businesses, the long-term viability of a policy is top of mind. The need to cover taxes at death is often a priority. Illustrations in which the UL investment option provides a guaranteed minimum rate of return helps show Clients there are ways to manage long-term viability, including the volatility of investments and the risk of underfunding.
5. When do investment account options matter?
UL policies offer a variety of investment account options to help Clients diversify and manage volatility within their portfolio. Overall, choice is good. Clients can choose the account options that meet their performance expectations, time horizon and the level of risk.
However, with a choice of investment options comes the need for active management. Rebalancing is required to keep target allocations in check. As a Client’s needs or risk tolerance changes, so too must the investment mix.
For UL polices held in a private corporation, active management may be more burden than benefit. Long-term viability of the policy is a primary goal, and the need for a “set-and-forget” style of investment option can be greater. These types of options are similar to what can be found with a par account. They provide a single diversified offering with access to a variety of asset types and a guaranteed level of income.
The UL solution – a worthy consideration for private corporations
Each year, corporations in Canada pay millions of dollars into UL policies. Clearly, business owners and advisors are tapping into the long-term benefits of corporate-owned UL policies.
With these top questions in mind, the UL policies for your Clients will go beyond a simple expense for insurance protection. They become a corporate asset that can yield valuable benefits over time.