Corporate estate transfer with cash withdrawal Patrick Cziolek, B Corporate estate transfer with cash withdrawal Patrick Cziolek, B.COM, CFP, CLU, TEP, CHS Regional Marketing Consultant, BC A long-term, tax-advantaged strategy for withdrawing cash from a corporation Information for advisors. This material is not intended for use with clients.

Client profile John is 45 years old, has a wife and 2 children Operates a successful dental practice Does not like paying taxes Does not like a lot of risk. He remembers 2008! Wants to maximize his estate Has no pension plan, but wants one Everyone is healthy, but has no life insurance You have gathered all necessary info from the client, analyzed it, developed a plan and are now in front of your client. What is your first move?

What happens during tax season for business owners? CASE STUDY What happens during tax season for business owners?

FOR CANADIAN CONTROLLED PRIVATE COMPANIES BC CORPORATE TAX RATES BC CORPORATE TAX RATES FOR CANADIAN CONTROLLED PRIVATE COMPANIES Type of Income 2017 2016 2015 2014 Active business income RATE Income up to $500,000 12.62 13% 13.5% Income in excess of $500,000 26% Investment income 49.67% 45.67% 44.67%

COMMON STRATEGY Assets Defer tax OPCO HOLDCO INVESTMENT

How much tax do you pay on the growth of your passive investment?

FOR CANADIAN CONTROLLED PRIVATE COMPANIES BC CORPORATE TAX RATES BC CORPORATE TAX RATES FOR CANADIAN CONTROLLED PRIVATE COMPANIES Type of Income 2017 2016 2015 2014 Active business income RATE Income up to $500,000 12.62 13% 13.5% Income in excess of $500,000 26% Investment income 49.67% 45.67% 44.67%

PASSIVE INVESTMENT EXAMPLE $500,000 INVESTED INITIALLY NET VALUE: NO TAX NET AFTER TAX VALUE: TAXED CUMMULATIVE POTENTIAL GROWTH LOST TO TAX 5 $ 579,637 $ 918,957 $ 106,791 10 $ 671,958 $ 1,050,742 $ 258,401 15 $ 778,984 $ 1,201,426 $ 469.408 20 $ 903,056 $ 1,373,720 $ 758,735 Initial Balance: $500,000 Investment growth rate: 3% Corporate tax rate: 49.67% Source: tax grind

PASSIVE INVESTMENT – AFTER TAX $500,000 INVESTED INITIALLY NET VALUE: NO TAX NET AFTER TAX VALUE: TAXED CUMMULATIVE POTENTIAL GROWTH LOST TO TAX 5 $ 579,637 $ 345,054 $ 234,583 10 $ 671,958 $ 384,615 $ 287,434 15 $ 778,984 $ 427,253 $ 351,730 20 $ 903,056 $ 473,209 $ 429,846 Initial Balance: $500,000 Investment growth rate: 3% Corporate tax rate: 49.67% Source: tax grind

TAX WORKSHEET

CORPORATE INVESTMENT – TRADITIONAL Policy year Age Cash invested/ premiums paid After tax cash flow to corporation After tax dividend to shareholder Shareholder net estate value IRR on death 5 $ 25,000 - $ 81,650 - 13.87% 10 $ 176,598 - 6.43% 15 $ 286,236 - 3.46% 20 $ 412,105 - 1.88% 21 66 $28,293 $ 16,803 $ 400,800 - 1.60% 30 75 $26,037 $ 15,463 $ 360,511 0.22% 50 95 $24,191 $ 14,367 $ 275,036 1.26% will benefit from a closer look at the capital dividend account. Non eligible dividend tax rate:40.61% Interest: 100%, Growth: 3% RDTOH: 30.67% Tax:49.67%

TAX ADVANTAGED LIFE INSURANCE Policy year Age Cash invested/ premiums paid After tax net of RDTOH partial surrender to Corporation After tax dividend to shareholder Net death benefit to shareholders estate IRR on death 5 $ 25,000 - $ 786,572 69.20% 10 $ 802,624 20.52% 15 $ 879,240 10.07% 20 $ 993,954 6.17% 21 66 $ 28,293 $ 16,803 $ 983,855 5.75% 30 75 $ 26,037 $ 15,463 $ 910,779 4.21% 50 95 $ 24,191 $ 14,367 $ 812,429 3.03% Dividend scale: 5.5%, Estate Achiever 20 pay, male 45, $25,000 premium

The strategy Cash Cash Other Equities Other Equities Insurance Instead of relying on investments alone, clients with excess money in their portfolio can reallocate a portion of their fixed-income investments into a participating life insurance policy. By reallocating a portion of the money that a client would typically use in fixed-income investments into a participating life insurance policy, they don’t have to incur any additional out-of-pocket expenses. Rather, they are further diversifying their portfolio, which means they may be better equipped to manage risk and enjoy guaranteed growth. Insurance Fixed income Fixed income

The strategy Cash Cash Other Equities Other Equities Insurance Instead of relying on investments alone, clients with excess money in their portfolio can reallocate a portion of their fixed-income investments into a participating life insurance policy. By reallocating a portion of the money that a client would typically use in fixed-income investments into a participating life insurance policy, they don’t have to incur any additional out-of-pocket expenses. Rather, they are further diversifying their portfolio, which means they may be better equipped to manage risk and enjoy guaranteed growth. Insurance Fixed income Fixed income

SUMMARY OF RESULTS – COMPARISON AGE 95 TRADITIONAL INSURANCE INSURANCE ADVANTAGE Cumulative cash invested or premiums $ 500,000 Result if cash is accessed Cumulative net cash flow to shareholder $ 453,360 $ Net benefit at death to corporation $ 185,137 $ 812,429 $ 627,292 Credit to capital dividend account Net benefit to shareholder’s estate $ 109,953 $ 702,476 Internal rate of return 0.43% 2.77% 2.34% Result if cash not accessed Estate Benefit 699,186 1,836,885 $1,137,699

CAPITAL DIVIDEND ACCOUNT (CDA) When a corporation owns a life insurance policy and names itself as the beneficiary, this opens up new opportunities to use the corporation’s capital dividend account (CDA). In this life insurance strategy, the corporation (as beneficiary) receives the death benefit tax-free.The corporation can distribute the net death benefit received and any other funds to the extent of the credit to the CDA, to heirs or the estate as shareholders tax-free. Notional account Tracks tax-free amounts received by private corporation, resident in Canada Ensure integration of taxes payable by a corporation and its shareholders Passes tax-free amounts to shareholders, such as life insurance death benefit (less its adjusted cost basis) The capital dividend account (CDA) has several benefits you should consider when you buy life insurance and name your private corporation as the beneficiary. These include: Life insurance proceeds from the death benefit Tax-free capital dividends, up to the balance in the CDA, may be paid to surviving shareholders or the estate, to provide money for succession or taxation issues. CDA is only available to private corporations. Corporations don’t have to pay a capital dividend immediately after the corporation receives the death benefit proceeds. The CDA balance remains until capital dividends are elected. This allows corporations to pay a capital dividend when it’s most advantageous for shareholders. However, it is possible future capital losses that ocurr in the corporation can reduce the CDA balance. Because payment of a capital dividend is elective, it requires attention to detail and knowledge of tax legislation. Your accountant should be involved in the election process. For more information on the CDA, refer to the Income Tax Act, subsection 83(2).

Capital dividend account Winding Up Dividend No Insurance With Insurance Winding Up Dividend 900,000 Tax Payable 300,000 Net to Estate 600,000

PREMIUM BENEFIT OF CORPORATE OWNED POLICY Annual insurance premium $ 25,000 Corporate tax rate 13% Personal tax rate 47.7% Premiums paid in corporation on corporate owned policy Gross revenue required in corporation $ 28,736 Corporate income tax ($ 3,736) Net after tax – pay premium Premiums paid personally via salary increase from corporation Gross revenue required in corporation, paid out in salary $ 47,801 Tax on salary ($ 22,801) Net after tax to individual - pay premium

ADVANTAGES AND DISADVANTAGES OF CORPORATE OWNED LIFE INSURANCE

ARTICLE FROM CA MAGAZINE

TARGET MARKET Business owner Age 45-50 Has excess cash in retained earnings Is looking to enhance estate Is looking to supplement retirement income

The Corporate Estate Transfer Strategy What are the benefits? Tax-advantaged asset accumulation during lifetime Access to assets accumulated during lifetime Conversion of taxable retained earnings into tax-free capital dividends following death Significantly enhanced after-tax estate values for heirs Permanent life insurance coverage In addition to having permanent insurance coverage, this strategy is primarily intended to: Permit tax-advantaged asset accumulation – acts as a form of tax-shelter from the perspective of the policyowner - the growth in policy cash values is not subject to policyowner taxation. Create a capital dividend account in the corporation from the life insurance proceeds which can be used to fund tax-free capital dividends to the shareholders. Net effect is greater asset values (depending on returns, of course) and a significantly greater net estate value for spouse or other heirs.

The Corporate Estate Transfer Strategy How does it work? Corporation acquires an exempt life insurance policy Corporation is owner, premium-payer and beneficiary of the policy TODAY These slides walk through the steps. Step 1 – the corporation acquires an exempt life insurance policy (whole life or universal life).

The Corporate Estate Transfer Strategy How does it work? Premiums are funded from excess corporate cash flow or by transferring existing capital into the policy Increases in cash values are not subject to policyowner taxation ACCUMULATION Step 2. The corporation funds the premium deposits. The growth in policy values is tax-sheltered.

The Corporate Estate Transfer Strategy How does it work? Policy cash values can be accessed to supplement retirement income, if desired Withdraw from policy Policy loans collateral assignment to third party lender for loans Tax implications vary between alternatives ACCESS The policyowner may decide to access the policy values, for example, for retirement, business expansion, etc. 3 methods of accessing cash values: Cash surrender – prorata taxation of accrued policy gain Policy loan – proceeds in excess of policy ACB taxed as policy gain Leverage – collateral assignment of policy by corporation (or possibly by shareholder) for a bank loan or line of credit – advances are not taxable so this is a more efficient method of accessing policy values in many cases – however, there are financing charges The key point is that the funds inside the insurance policy are accessible if needed.

Accessing cash value Can be a one-time or series of cash withdrawals to: Supplement retirement income Create another tax-advantaged account Use for unexpected life events Alternative to accessing income from corporate assets Accessing cash value can be a one-time withdrawal, or a series of cash withdrawals. Withdrawing cash value may reduce the total death benefit while maintaining the initial base life insurance coverage amount. Let’s compare partial surrenders/cash withdrawals and policy loans, as each one works differently. If a client borrows against or withdraws money from the policy, it may reduce the policy’s cash value and death benefit and may be subject to tax.

The Corporate Estate Transfer Strategy How does it work? Insurance death benefit is paid tax-free to corporation Excess of death benefit over policy ACB credited to capital dividend account of corporation (CDA) Corporation can distribute tax-free dividends to shareholders to extent of balance in CDA ESTATE Insurance proceeds are received by a corporation on a tax free basis. The portion of the policy proceeds that constitutes adjusted cost basis is received tax-free as part of the death benefit, however the ACB portion does not form part of the CDA. The CDA portion of the proceeds can be paid out to the shareholders on a tax-free basis. The ACB portion of the proceeds would be paid out on a taxable basis. The cash value portion of life insurance is included in the share value of a corporation for purposes of valuation of those shares immediately before death. Therefore the CSV is included in the share price for calculating any capital gain on the death of the shareholder.

CONCOURSE

CONCOURSE

Excel Spreadsheet

TAX GRIND CALCULATOR

Dividend scale interest rate Low volatility Current DSIR 5.5% rate for 2017 Historical performance for periods ending 2016 7.0% 10-year average, since 2006-2015 7.8% 20-year average, since 1996-2015 8.9% 30-year average, since 1986-2015 8.9% 60-year average, since 1956-2015 1.9% 30-year standard deviation, since 1987 The investment component of policyowner dividends is based on the dividend scale interest rate. The dividend scale interest rate reflects the return on the assets backing the participating account liabilities. It does not include assets backing the participating account surplus. As this slide shows, the dividend scale interest rate for 2013 2014 is 6.50 per cent. Note the historically low volatility level, as measured by the 30-year standard deviation. From 1983 1984 – 2012 2013, it’s only 1.8 per cent. (Note to presenter:) This historical information matches the last printed version of this information. What this means . . . For clients, this means they are purchasing something with a solid investment component and low volatility It’s important to understand the dividend scale interest rate is only one factor that contributes to the performance of your client’s policy. The policy’s cash value also reflects other factors, such as type of product, product features, premium-paying period, issue age, rating, dividend option, and others.

Where policy owner dividends come from Facts Where policy owner dividends come from Key messages: It’s important to distinguish between two different types of performance within participating accounts.   Investments (circled in red) -- Investments held in the participating account achieve returns. The returns from the assets backing the participating account’s liabilities are reflected in the dividend scale interest rate. They are brought into the dividend scale interest rate over a period of time. This “smoothing” helps reduce volatility. Other factors (circled in blue) -- the dividend scale interest rate is used to calculate the investment component of the dividend scale. Other factors also affect the dividend scale. These include mortality, expenses and taxation and others. The main takeaway here is that the participating account performance, reflected in the dividend scale interest rate, is just one of many factors that contribute to the overall performance and stability of policyowner dividends.

Bond laddering strategy

REVIEW STRATEGY REPORT

Important notes An exempt life insurance policy is defined in regulations 306 and 307 of the Income Tax Act (ITA). Generally, the ITA provides that the cash value accumulation is exempt from annual accrual taxation, provided certain conditions, as set out in the regulation, are met. Illustration examples: Examples provided are not complete without the Canada Life illustration, including the cover page, reduced example and product features pages, all having the same date. Read each page carefully, as they contain important information about the policy. Dividends are not guaranteed and vary up or down from those illustrated, depending on future dividend scales.

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