Who is the beneficiary of your corporate owned life insurance? A rather simple question but one that is often misunderstood.
If one were to dust off one’s corporate owned life insurance contract you would see that the owner and beneficiary of the contract is your corporation. Why? Because of tax law rules dealing with taxable benefits and that allow for the tax-free payment of a dividend of the death benefit to the shareholders of the corporation.
On the other hand, who is the ultimate beneficiary of the corporate owned life insurance? The family. Why? Because the death benefit would not remain in the corporation but would be paid out to the family shareholders as a tax-free dividend. The corporation is merely a conduit for the family for the receipt of the death benefit.
So far so good; however, there is a problem – often an understated problem. That corporate owned life insurance contract is an asset of the corporation, often a very valuable asset of the corporation, that is subject to the claims of the corporation’s unsecured creditors. This would not be the case if the life insurance contract was personally owned with a family member of the life insured named a beneficiary of the death benefit.
Furthermore, and more importantly, the corporate owned life insurance is also a very valuable asset of the ultimate beneficiary: the family. It is designed, on the death of a loved one, to create financial liquidity for their exclusive use and benefit.
So, what is the likelihood of the unsecured creditors successively suing the corporation, getting a judgement and collecting on that judgement, which could include the surrender of the corporate owned life insurance? Scooping up the cash value of the policy? Not that likely but it is not zero.
Is not the better question to ask, what would be the consequences to the ultimate beneficiary, the family, if the corporation lost the life insurance to an unsecured creditor? The answer depends in large part to what the family was going to use that death benefit for. Payment of death taxes, payment of other family debts, supplemental retirement funds for the surviving spouse, estate equalization for the children, buying out a business partner, etc.
It is actually rather easy to quantify the consequence. If there is no death benefit, then the replacement of those funds must come from other sources: cash on hand, the sale of the family recreation property, the sale of a stock portfolio, etc. If there is a cash shortfall, the replacement of a $1.0 million death benefit could require the sale of as much as $2.0 million of assets, depending on asset mix, the tax treatment of the sale of those assets and tax rates. Ouch!
The other question to consider is could I recover if I am still alive? Do I have the time, energy and ability to do so? Definitely, you will not be able to replace the lost insurance contract with the exact same contract. It will be fundamentally different and more expensive. Why? You are older and mortality costs are higher due to your age. In addition, have you had a health event? Cancer, a heart attack, diabetes, etc. If so, the likelihood of getting a new life insurance contract is very remote, probably impossible. Ouch!
Is there any good news to consider out of all of this? Yes, you are now informed and can now take positive steps to protect the ultimate beneficiary of your corporate owned life insurance: your family. A worthy exercise indeed!
About the Author
R. Paul Jacobson, QC is a senior member of the Alberta Bar with a referral-only, Calgary practice concentrating on “bespoke preservation planning™”.
