Insurance Understood: White elephant insurance

By Steve Meldrum on December 7, 2019.

steve@swellwealth.com

The Christmas season always brings with it a lot of get togethers with family, friends and coworkers. Often, there are gift exchanges and my favorite ones are “white elephant” exchanges. The idea is to bring a random gift to the party and then everyone takes a turn picking from the stack of gifts or taking a present from someone that has already opened their gift. If someone takes your gift then you can either choose another gift from the stack or take someone else’s. The spectrum of gifts usually varies quite a bit but there are usually a couple items that everyone wants to keep and some that nobody wants to keep.

The white elephant gift exchange got me thinking about transferring life insurance policies between a person and a corporation. I deal a lot with professionals and business owners and currently have four such transfer situations on the go. They can be treated very differently in the eyes of the tax man just like at a white elephant gift exchange.

First, I should explain some of the reasons why someone may want to transfer an insurance policy between a person and a corporation. One situation I have right now is a dentist who recently incorporated and wants to use corporate dollars to pay the insurance premiums since it is more cost effective that way. Another situation I have is where a group of businesses are restructuring and we need to move some policies between the corporations. A third reason may be if a corporation had a policy on a key person but that person is now retiring. Fourth, perhaps there was insurance on a shareholder but now the corporation is getting sold to a third party so the corporation no longer needs the coverage but the shareholder wants to keep it for personal planning.

Regardless of the reason, any time there is a transfer of ownership it is considered a disposition to the tax man – subsection 148(7) of the Income Tax Act. This section basically says that the proceeds of disposition are the greatest of the value (cash surrender value, net of policy loans), fair market value of consideration (what you paid), and adjusted cost basis (calculation provided by the insurance company). If the proceeds are greater than the ACB there is a policy gain. It is critical to realize that a policy gain is taxed as regular income.

When making such transfers there may also be a taxable shareholder or employee benefit to the extent that the fair market value of the policy exceeds what consideration was paid. Trust me, you do not want to have this type of benefit since it is fully taxable and there is no offsetting corporate deduction. You should pay fair market value for the policy. However, that is not easy to determine by yourself as it can be affected by such factors as the policy features, face value, conversion privileges, replacement value of it and especially the health or life expectancy of the insured person. I tend to recommend that an actuary do a valuation on the policy. This does have a cost but there is a lot of peace and protection with getting a certified number that can hold up in court whereas a guess or estimate will not. Additionally, the FMV of an insurance policy can affect the valuation of the shares of the company just the same as a piece of equipment can, which ultimately affects the sale price. So you do not want to miss accounting for the insurance.

There are some strategies to navigate through a transfer that can reduce tax consequences. Unfortunately, I cannot compress all of these details within this column. If you are looking to transfer an insurance policy into a corporation, between two corporations or out of one to a person I suggest you speak to an advisor with the chartered life underwriter designation to benefit from their expertise.

Steve Meldrum B.Mgt. CFP CLU is the founder of Swell Private Wealth Ltd. For over a decade he has specialized in helping individuals and businesses expand protect and perpetuate their wealth. For further information or tailored advice, contact him at 403-487-0490, steve@swellwealth.com or connect on social media.

9
-8