Business succession planning with insurance

Once a business succession plan has been established, the next steps should include implementing complementary wealth management strategies, which will help to ensure the smooth transfer of your business.

Whether your business is transferred as a gift or sold to the family successors before you pass or after, insurance strategies are a cost-effective way to provide the required liquidity for a smooth transfer to cover the taxes payable by your successors, equalize the inheritance across your heirs, and potentially increase the legacy you leave.

Minimizing taxes payable by your successors

Just as life insurance is a valuable tool to cover taxes payable at death for an individual’s taxable investments, it can also be used to fund the tax liability at the business owner’s death. There are two primary ways to use life insurance to address these taxes:

Personally owned life insurance

As the business owner, your death would trigger a deemed disposition of your shares at the fair market value immediately before your death. This will create taxable capital gains on the growth of your company’s shares. The death benefit from a personally owned life insurance policy would be paid tax-free to your children, funding the tax liability they would face at the time. An advantage to your children being the named beneficiaries over the estate is that the death benefit is free of probate fees and delays and is not accessible by estate creditors’ claims.

Corporately owned life insurance

Another option to address taxes at death is to have the corporation named as the owner and beneficiary of the life insurance policy. You may find this a beneficial option as corporations generally have a lower income tax rate, and therefore, the after-tax cost of the insurance premiums is generally less than personally held insurance. At your death, your corporation would receive the life insurance proceeds. This will create the opportunity to pay a tax-free dividend to the shareholders, who can then use various methods to address the taxes.

Utilizing an estate freeze

Although this business succession strategy may be used to decrease taxes owned compared to waiting to exclusively pass on shares at death, it is a good idea to purchase enough insurance to cover the future tax liability, which your heirs will have to address. There are many options for how to structure the insurance policy’s ownership and address the taxes payable.

The proceeds from an insurance policy can also be used to keep the company going if, after your death, your beneficiaries decide that they do not want to continue with the business and choose to search for a buyer or if they wish to reorganize the management team.

Estate equalization

Not all of your children may be equally interested in carrying on the family business or have the skills necessary to manage the business. Life insurance can provide an equitable inheritance to those children who are not active in the business. If you are faced with either of these situations, likely, you will still want to treat your children fairly when it comes to leaving an inheritance.

Buy/sell agreement

Life insurance can be used as the funding vehicle for a buy/sell agreement. The plan proceeds would be paid to the business, thereby increasing the capital dividend account and allowing for tax-free capital dividends to be purchased by the surviving shareholders from the deceased shareholder.

Minors or uninterested heirs

To deal with minors or uninterested heirs, a life insurance trust can be established in your (the business owner’s) will. The trust would receive the proceeds of the plan, which in turn, could be used to buy the business interest from the estate. The trust would then administer the business interest for the benefit of the business successors. The estate would have adequate liquidity from the cash received to provide for your minor or uninterested heirs.

Retirement funding

A common concern for business owners is whether they will have enough money after the business transfer to provide for their retirement adequately. A split-dollar life insurance plan allows the business to own the death benefit and you, the retiring business owner, to own the cash value.

Maximizing the value of your estate

Corporate insured annuity strategy

Insurance can enhance the estate of business owners by reallocating a portion of your corporate fixed income assets into the corporate insured annuity strategy. This may increase your after-tax income while preserving the capital you have set aside for your estate. The strategy comprises two parts; the first involves purchasing a permanent life insurance policy, and the second involves liquidating your corporately held fixed income investments and purchasing an annuity with the proceeds. Upon purchasing the annuity, you give up all ownership of your funds in return for the guaranteed income stream. Unlike your fixed income assets, where all of the income you receive is taxable, an annuity payment is a blend of interest and a return of your original capital; as a result, on average, you pay less tax on the income you receive. The life insurance contract becomes payable upon the insured’s death; proceeds can flow through the capital dividend account as a tax-free dividend, with certain limitations, depending on its adjusted cost base.

Corporate estate reallocation strategy

Another insurance solution that may help maximize your estate is the corporate estate reallocation strategy. This strategy involves reallocating a portion of your company’s surplus cash into a life insurance policy which grows on a tax-deferred basis, and upon the death of the insured, proceeds are paid to your beneficiaries tax-free. Moving capital from a conservatively invested, tax-exposed environment to one that is tax-deferred may significantly increase the value of your estate, especially when those assets currently sit within a small business corporation or holding company.

source https://rosenbergdri.ca/business-succession-planning-with-insurance/