It is common business practice for a company to use corporate owned life insurance in several situations. This article will identify those situations and discuss appropriate amounts of coverage for each of them.
The corporation should own and be the beneficiary of sufficient life insurance on each of the partners in order to meet its obligations to re-purchase or redeem the shares of the deceased shareholder from his or her estate. The Shareholders’ Agreement usually has a method of valuing the shares and this is the appropriate amount for which the shareholder should be insured.
The amount of life insurance coverage that the company would take on that key person is usually determined by an estimate as to how much the company would suffer financially if the key employee were to die. Sometimes this can be an arbitrary number, although the insurance company requires justification for any amount of coverage they would issue for this purpose. In other situations, an analysis is undertaken to estimate the loss to share value due to the death of the employee. A company may want to insure such an individual to provide sufficient funds to attract, train and employ a replacement. Usually, this number would include two years salary in addition to acquisition and training costs.
There are some tax advantages for corporations to insure their shareholders to secure debt as well. If the bank requires the life insurance as a condition of the loan (or provides a letter to that effect), a portion of the premium may be tax deductible to the corporation. In order to obtain this deduction the transaction must meet specific criteria as stated in the Income Tax Act. Upon the death of the shareholder, there is another benefit which could accrue to the benefit of the surviving shareholders. Even though the entire proceeds of the life insurance are used to retire the loan, there could be a contribution to what is known as the Capital Dividend Account for an amount up to the insurance proceeds which are used to repay the loan. Capital Dividends can then be paid tax free to the surviving shareholders. In effect, this means that future corporate earnings, retained earnings, or other cash assets can be paid tax free to the shareholders.
The amount of the life insurance required for this use could be equal to the amount of bank or other debt the company has incurred.
These are the main uses of corporate owned life insurance. Other corporate uses for life insurance exist in more sophisticated arrangements. For example, some corporations use life insurance as part of a charitable giving strategy. We can assist you in determining where the needs for life insurance exist in your corporation and how to establish the appropriate amount. Please call us should you wish to investigate the prudent business practice of corporately owned life insurance.
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