You’re a successful business owner. You also know that you have to invest your after-tax profits so they don’t get eaten away by inflation, but with so many different choices, which investment option should you choose?
Business owners should be taking advantage of tax-sheltered life insurance strategies, but most of the time, they don’t have enough information to even consider this possibility.
What Is Participating (Par) Whole Life Insurance?
Par Whole Life Insurance is a permanent life insurance solution that accumulates cash value over time in a tax deferred contract. In other words, it will protect the owner in case the life insured passes away, and it is like a high-powered savings account that attracts no tax. If a corporation is the owner of the policy, then the life insured is typically the owner of the corporation.
Before we get into the five reasons to invest in Par Whole Life insurance, let’s share a fictitious example based on real business cases:
Justin and Jewel
Justin and Jewel are a married couple in their 40s who have built a successful chain of clothing stores. They would like to build a significant retirement income using their retained earnings. They don’t like risk and don’t want to lose any of their hard-earned capital. They are also in good health and want to retire in 25 years. The annual revenue for their business is $2.5 million, and they want to invest $100,000 per year from their retained earnings.
When we first met, I asked them several questions, including:
- How long do they expect to be in business?
- Do they expect to sell the business? If so, when?
- Do they have a Holding Company?
- What are their annual retained earnings (after-tax profit)?
- Do they expect this amount to remain consistent now that they have an established business?
- When do they expect to retire?
- What retirement income would work for them?
- Do they wish to leave a legacy to children, church or charity?
The answers to these questions helped us to formulate the correct corporate strategy using Par Whole Life Insurance.
5 Reasons Why Your Business Should Invest in Par Whole Life Insurance
Reason #1 – Key Employee/Shareholder Protection
Their company owns the policy and receives the tax-free death benefit. They are the insured (key persons). To shelter the amount of money required ($50,000 annually for each of them), we will need to have policies large enough to accommodate those deposits. This is usually not a problem, and certainly not for Justin and Jewel.
Here’s an example:
Reason #2 – Low-Risk Annual Dividends
Every year, the policy will receive a dividend that will accumulate in the cash value account. Also, the contract is set up to compound the dividends over time. This will maximize the amount of cash in the policy. Even when the deposits are no longer required, the dividends will continue to be paid, and the cash value will continue to grow. This cash is not taxed if it stays inside the policy contract.
Reason #3 – Tax Deferred Investment Growth
Life insurance policies are tax deferred. This means the growth of the cash value account attracts no attributable tax as long as the funds remain in the contract. In other words, we can avoid the high taxation on investment income inside our corporation. The dividends are vested (guaranteed) upon payment, so there is no way for the cash account to lose money. It can never go backward.
The only variable is the dividend rate and whether the board of directors of the insurance company will pay in any given year. Historically, they rarely miss a dividend payment. Canada Life started their Par Whole Life policy in 1847 and has never missed a dividend. Nor has Equitable Life, whose illustrations are being used for our case study. Forester Financial, who began in 1839, missed a payment in 1917 (due to the Spanish Flu) and since the insurance company manages all aspects of the Par Fund and the investments, it can be considered a “sleep at night” investment. The only need for review is the annual dividend statement.
Reason #4 – Tax-Free Retirement Income
Now we come to the stage that everyone is interested in – retirement income. When was the last time someone told you that you could produce an income stream using life insurance? It is not a common strategy for most investment advisors. In the corporation, the Par Policy is considered an asset. In fact, that is exactly how banks treat a paid-up policy with cash values. At age 65, Justin and Jewel’s policy values will look something like this:
They can take the policy to their banker and ask for a loan against the Cash Value. The bank will lend up to 90% of the value with some minor underwriting and up to 100% if they have other income available. They could also ask the bank simply to lend them an annual loan to maximize their income over a set time period – 20 years, as an example. For Justin and Jewel, it would look like this:
Assume they live to age 85, they will be able to access an annual tax-free loan in the sum of:
And if they pass at age 85, there will still be money left over for their beneficiaries.
If they tried to achieve the same income with a non-registered investment inside the corporation returning 4% interest per year (if they can find a safe investment that will pay that kind of interest), Justin would run out of cash at age 72 and Jewel would deplete her savings at age 74. Their beneficiaries would be out of luck.
Even if they took a greater risk and invested in a Balanced Portfolio, returning 6% annually, they would still run out of income at age 84, and their estate would receive nothing.
Reason #5 – Tax-Free Estate Transfer
As we have already mentioned, even if Justin and Jewel use the Cash Value as collateral for a tax-free income stream loan from a bank, if they expire before the age of 100, there will still be some death benefit available for their loved ones. In the example above (pass at age 85), they would have had their dream retirement, and their beneficiaries would still receive $1,997,143 from Justin’s policy and $2,221,844 from Jewel’s policy.
But what if they never used the policy for retirement and instead just used it to transfer wealth? If they passed at age 85, the benefit paid to the corporation would be much greater: $6,893,203.00 from Justin’s policy and $7,479,079.00 from Jewel’s policy.
Most of the money can be transferred to shareholders (spouse, children, partner, family) tax-free depending on the key person’s age at death. This is one of the easiest and safest ways to transfer wealth.
Note: The above example is based on Equitable Life Illustrations (dated March 31, 2022) using today’s dividend rate, a bank loan rate of 4.5%, and corporate tax of 46.67% on passive income, maximizing the annualized loan. The complete illustrations are available upon request and contain all disclosures and legal provisos.
For every business owner, the key things you need to remember about a Par Whole Life Insurance policy are:
- it protects the company should a key employee/shareholder die unexpectedly;
- it has specific guarantees, including maintaining a consistent cost of insurance, which means you’ll always know what your premiums will be;
- it pays an annual dividend that compounds over time paid out from the investment fund of the insurance company;
- cash accumulates ‘tax deferred’ inside the contract, which means no tax must be paid on the accumulated dividends if the cash remains inside the policy;
- it pays a tax-free benefit, which means the insurance proceeds to the beneficiary are not taxed; and
- it is considered an asset and can be used as collateral for a tax-free loan for any purpose (e.g., retirement income).
With all these benefits, it can be considered an excellent protection product with a sleep at night investment component coupled with tax-free opportunities for retirement as well as legacy planning efficiencies.
The explanations and examples herein are for illustration purposes only and should not be employed without the advice of a qualified professional life advisor in conjunction with legal and accounting advice.