Saving Tax on Life Insurance Premiums

 Tax Treatment of Life Insurance Premiums

Normally, life insurance premiums are not deductible by individuals or corporations for tax purposes. However, there are a few exceptions which are discussed below.

Life Insurance Policy Used as Collateral for Loan

Life insurance premiums (or a portion of it) may be tax deductible if the policy is required as collateral security by a lender that is a restricted financial institution such as a chartered bank and the interest on the loan would normally be claimed as tax deduction.

Charitable Donation

If the life insurance policy is donated to a charity, the premiums paid by the individual or business in order to maintain the policy may be claimed for tax purposes. Individuals can claim a charitable donation tax credit (15% federal tax credit for first $200 and 29% federal tax credit for amount greater than $200) for the donation of the policy at its fair market value, as well as for premiums made after the policy had been donated.

Rather than receive tax credits for donations, businesses, can claim a deduction for the donation of the policy at its fair market value as well as for the premiums paid after the donation.

Group Term Life Insurance

If a business provides life insurance coverage for its employees, the corporation can claim a deduction for the premiums made. The premiums would then be taxable to the employees, and must be included in their income as a taxable benefit.

Ownership of Life Insurance Policy via Corporation

A life insurance policy can be owned by an individual or through a corporation. If a corporation is named as the beneficiary of a life insurance policy, it will make premium payments with after-tax corporate and receive insurance proceeds after the death of the insured individual. The insured individual is generally the shareholder of the corporation while the corporation is the beneficiary and policy owner.

Many choose to own insurance policy using a corporation as it is a less expensive method of funding the insurance premiums. As premiums are paid with after-tax dollars and the corporate tax rate is lower, it is generally a better strategy to use the corporation to own the insurance and policy fund the premiums.

A great advantage of owning life insurance via corporation is that insurance proceeds can be paid out tax-free as capital dividends through the company’s capital dividend account (CDA).

What are segregated funds and how are they taxed?

A segregated fund is an investment similar to a mutual fund. The securities held in this investment fund range from stocks, bonds, or other assets. The securities are held within an insurance contract and are subject to extra wealth protection.

Lifetime income benefit option

The investor will receive a lifetime income benefit option. This will enable the retiree to better plan for retirement since he/she will know the amount of funds to be received. This will also protect the investor against risk of inflation or market volatility.

Guaranteed maturity date

The investor will also have a guaranteed maturity date which will enable individuals to better plan their retirement.

Designation of beneficiaries

Individuals may also designate beneficiaries through a segregated fund.

For tax purposes, the securities within a segregated fund retain their character. The investments are subject to the same income tax and capital gains tax requirements as they would had they been invested without the insurance contract.

What is key man insurance and do I need this?

A key man is an individual in the business without whom the business may incur severe losses and may not continue as a going concern. As such, it may be beneficial for the company to invest in key man insurance which is life/disability insurance and is intended to protect the company in the event of this individual’s death or disability. Since the company may not survive without this key employee or individual, companies will usually invest in key man insurance to protect them from losses that may result in the event of the passing of a key employee such as the CEO or president.

In the event of their death, the beneficiary will receive a death benefit to compensate him/her for the lost revenues or inefficiencies as a result of this key man’s death (this benefit will be tax-free). Since the insurance is needed for business purposes, the company may deduct it as a business expense for tax purposes.

Why do business partners obtain life insurance on each other?

In most businesses with multiple partners, the success and future growth lies in the hands of all the business owners and partners since they have knowledge of the business and are key drivers of the day to day operations. It is intuitive that the death or injury of the business partner will negatively impact the profitability of the business. Hence, it is beneficial for a business to obtain life insurance. In the event of death of a key personnel member, the other business partner will receive a death benefit.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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