Split-Dollar Critical Illness Insurance for Business Owner/Operators

No Lose – All Win strategy for risk management and income/tax planning

Did you know there is a way to protect your business from financial loss if you became critically ill and create a tax efficient way to get money out of your business at the same time. Imagine being insured from financial loss if you had a heart attack, stroke, got diagnosed with cancer, etc. and at the same time you are building up a savings account that allows you to extract money from your business – TAX FREE!

If you are an owner of a private Canadian Controlled Private Corporation (CCPC), this article is for you!

There is a way that you can have your cake and eat it too. This win-win strategy works best for owner/operators of their business who would suffer financial loss (or ruin) if they were to have a critical illness that kept them away from work. The insurance allows you to protect your business (which in effect is you).

This critical illness strategy (called split-dollar or shared ownership) also allows you to have a 100% return of ALL premiums paid in – TAX FREE – to the business owner after 15 years if there was no diagnosis of a critical illness. So, if you stay healthy you get back all the premiums tax free. This is an excellent way to extract a large amount of capital from your business into your hands without paying taxes, and represents a very health internal rate of return (IRR).

How a Split-Dollar Critical Illness Insurance Strategy Works

The term “split dollar” refers to dividing up ownership and the premium payments of an insurance policy. There are two sides to the critical illness insurance plan: the actual insurance protection and the return of premium.

The company pays for the insurance

The corporation will pay for the insurance portion of the critical illness policy, and will thereby be the beneficiary of the policy if you were to have a critical illness. Only the cost of the insurance is paid by the company and they are only entitled to an insurance claim for a critical illness.

The owner pays personally for the return of premium

The business owner (you) pays for the return of premium rider that is attached to the policy. Since they are not paying for the insurance protection, they will not be entitled to a claim for a critical illness – that belongs to the company. They will be 100% entitled to the return of premium portion of the policy. After 15 years the owner is fully vested in the return of premium and will be paid out ALL premiums that have gone into the policy – both their own return of premium portion and the company’s insurance cost portion – TAX FREE!

Only one benefit can be paid out – not both

Either the critical illness benefit OR the return of premium benefit will be paid out on this policy – not both. This is why the split-dollar critical illness insurance strategy works so well for owner/operators of Canadian Controlled Private Corporations (CCPCs). The owner(s) is(are) the company and the insurance claim will directly benefit them by protecting the company. If they don’t have a critical illness claim then they get paid out personally and tax free.

Example of Split-Dollar Critical Illness Insurance at work

Life Guard Insurance has a client, Joe Owner, and he owns a Canadian Controlled Private Corporation (CCPC) called Your Company. Joe is 45 years old and decides to buy a split-dollar critical illness insurance policy for $250,000 of coverage.

The company pays for the cost of insurance – $3,185 per year.

Joe pays for the Return of Premium benefit – $2,400 per year.

If Joe is diagnosed with a critical illness then the company will be paid $250,000 tax free as an insurance benefit.

If nothing happens to Joe, he will personally be able to cash in his Return of Premium benefit after 15 years. This will give him $83,775 of tax free cash for a personal investment of $36,000 (his portion of the premium over 15 years). This represents a guaranteed rate of return of 9.99%.

Setting up a Split-Dollar Critical Illness Insurance plan

The first thing you will need is a legal agreement between the business and the employee/owner. This is an agreement to share ownership in the policy and is fundamental to the plan working. Without the legal agreement in place the life insurance company will probably not even issue the policy.

Here is an example of a Critical Illness Shared Ownership Agreement

Secondly, you must have two separate premium withdrawals – one from the business account and the other from the personal account of the owner. Sun Life Financial is able to set up this kind of dual payment system, either as an annual payment or as a monthly pre-authorized chequing plan.

Thirdly, you cannot tax deduct any of the premiums – either the business’s portion or the owner’s portion. In order for the benefits to be paid out tax free the premiums must come from after tax dollars.

Fourthly, there are a few tax considerations you need to be aware of to make sure the return of premium benefit is paid out tax free to the owner. Most importantly the return or premium cannot exceed the total premiums paid, the cancellation of the policy must be mutually agreed upon by both parties (easy to do if you own the company), and cancellation of the policy cannot be deemed to impoverish the company under the Canada Revenue Agency’s guidelines. Here are two reference documents that speak to the tax implications of this strategy:

• Help your business owner clients keep their best people: Share ownership with Sun Life Critical Illness Insurance
• Critical Illness Insurance: Health and welfare trusts and other concepts by Sun Life Financial

Split-Dollar Critical Illness can be used for multiple owners and/or key employees

This strategy can be shared with a multiple ownership team of a company where all owners are key employees and the insurance is valuable for the company. It can also be used to provide additional benefits to key employees and retain them with a windfall benefit payable after 15 years. So long as the critical illness insurance benefit for the company is legitimate (the company would suffer a financial loss if the owner or employee became critically ill) and the owner/employee agrees to share ownership and costs of the policy, the strategy will work.

Life Guard Insurance recommends using Sun Life Financial for this strategy

Sun Life Financial has the best track record in setting up these shared ownership or split-dollar critical illness insurance policies. They have a critical illness policy with a guaranteed return of premium after only 15 years, which works very well for this strategy. Sun Life is also the only company we know of that can properly set up a monthly shared pre-authorized chequing plan (PAC) between a company and an employee/owner.

We are confident in recommending Sun Life Financial for this strategy as they have the administrative expertise to help make the tax free return of premium payment work for owners/employees.

Other useful reference material

• Share ownership of Critical Illness Insurance reference paper
• Shared ownership of critical illness insurance strategy brochure from Sun Life Financial
• Sun Life Share Ownership Critical Illness Insurance example illustration (for example above of Joe Owner and Your Company)

Life Guard Insurance can design Split-Dollar Critical Illness Insurance

At Life Guard Insurance we have experienced and knowledgeable life insurance brokers across Canada who can help you design and implement a split-dollar critical illness insurance plan. Contact us today to find out if this insurance strategy is right for you.

The article was written by +Mitch Reynolds. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about split-dollar critical illness insurance would also be very much appreciated.

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