The key to tax-free investing for small business owners.

Are you an in­cor­po­rated en­tre­pre­neur?

Are you sav­ing for re­tire­ment?

Are you plan­ning on leav­ing a legacy for your chil­dren and grand­chil­dren?

Then keep read­ing, be­cause if you live in Canada, you’ve got a prob­lem:


Let’s fol­low the story of Tom and Tammy, a cou­ple that owns a suc­cess­ful, in­cor­po­rated, small busi­ness that is build­ing up ex­cess cash re­serves.

Tom and Tammy, both 40, non-smok­ers, and in good health, want to use these cash re­serves to:

  • Invest
  • Retire
  • Pass an es­tate on to their chil­dren

But, like any suc­cess­ful small busi­ness owner in Canada, they’re acutely aware of the ef­fect tax can have on their fi­nan­cial sit­u­a­tion.

Taxes are the num­ber 1 drain on their fi­nan­cial goals as a high-per­for­mance en­tre­pre­neur. In fact, they are po­ten­tially sub­ject to 6-LAYERS OF TAXATION.

  1. Tax on cor­po­rate prof­its at the small busi­ness de­duc­tion rate of 12.2% or the gen­eral rate of 26.5%
  2. Tax on re­tained earn­ings growth of up to 50.17%
  3. Additional tax via the loss of the small busi­ness de­duc­tion if cor­po­rate in­vest­ments gen­er­ate in­come more than $50,000 (you can thank Mr. Trudeau for this one)
  4. Personal tax on div­i­dends of up to 47.74%
  5. Capital Gains taxes on the value of their com­pany to their es­tate of up to 26.7%
  6. Dividend taxes for cor­po­rate ben­e­fi­cia­ries of up to 47.74%

This blog post will cover the fol­low­ing:

  • Why taxes are the #1 drain on a small busi­ness own­ers’ in­vest­ment and re­tire­ment plan
  • Why taxes can lead to a sub-par re­tire­ment and es­tate trans­fer
  • How to fix this with proper tax plan­ning

If you’re in­ter­ested, keep read­ing…

So, What Does This Actually Look Like?

Let’s keep this sim­ple, Tom and Tammy are a high-in­come earn­ing en­tre­pre­neurs pay­ing tax at the high­est mar­ginal bracket in Ontario. $1,000 of their in­vest­ment in­come will be taxed in the fol­low­ing man­ner:

They can lose the MAJORITY (53.53%) of their in­vest­ment re­turns to taxes alone!

Let’s put this into per­spec­tive. If they’re earn­ing $20,000 of in­ter­est in­come per year from age 40-65 they’ll be los­ing $10,706 PER YEAR to taxes.

But there’s more.

That $10,706, if in­vested an­nu­ally at a 6% re­turn on in­vest­ment would equal a lost in­vest­ment op­por­tu­nity of $587,379.

That’s like throw­ing money in the trash, and it’s what so many small busi­ness own­ers are do­ing year af­ter year af­ter year.

But It Doesn’t Have to Be Like That.

Tom and Tammy can al­lo­cate their cor­po­rate cash to dif­fer­ent as­set classes with dif­fer­ent tax treat­ments. The choice is im­por­tant as in­vest­ment in­come does­n’t just at­tract im­me­di­ate tax to their cor­po­ra­tion, it can also af­fect their cor­po­ra­tion’s ac­cess to the Small Business Deduction on ac­tive in­come (see tax layer 3 above), ef­fec­tively more than DOUBLING their com­pa­ny’s nor­mal tax rate.

So how do they de­cide?

Well, the ob­vi­ous choice is to min­i­mize tax­a­tion. But that’s not so sim­ple.

Capital gains at­tract the low­est amount of taxes when deal­ing with tra­di­tional in­vest­ments. But when in­vestors are seek­ing ONLY cap­i­tal gains they of­ten look ONLY to eq­ui­ties or com­pany stock. Many well-de­vel­oped com­pa­nies (think “blue-chip”) also pay div­i­dends, of­ten to the tune of 3-5% per year.

Now, this can be at­trac­tive in some cases, but as they build their cor­po­rate port­fo­lio up, these div­i­dends, in com­bi­na­tion with other in­vest­ment re­turns, can quickly lead to a tax sit­u­a­tion that spi­rals out of con­trol.

Let’s Cut Out the Tax Using Life Insurance.

Life Insurance?!?!

Stay with me.

Remember those 6 lay­ers of tax above? Well, we can ef­fec­tively cut out lay­ers 2-6 with proper tax plan­ning.

  1. Tax on cor­po­rate prof­its at the small busi­ness de­duc­tion rate of 12.2% or the gen­eral rate of 26.5%
  2. Tax on re­tained earn­ings growth of up to 50.17%
  3. Additional tax via the loss of the small busi­ness de­duc­tion if cor­po­rate in­vest­ments gen­er­ate in­come more than $50,000 (you can thank Mr. Trudeau for this one)
  4. Personal tax on div­i­dends of up to 47.74%
  5. Capital Gains taxes on the value of their com­pany to their es­tate of up to 26.7%
  6. Dividend taxes for cor­po­rate ben­e­fi­cia­ries of up to 47.74%


A pri­vate cor­po­ra­tion that owns, pays for, and is the ben­e­fi­ciary of a tax-ex­empt life in­sur­ance pol­icy can use the funds it ac­cu­mu­lates in that pol­icy to achieve a va­ri­ety of fi­nan­cial ob­jec­tives:

  1. Tax-free sav­ings and growth
  2. Tax-free ac­cess to the pro­ceeds for owner-man­ager re­tire­ment
  3. Tax-free death ben­e­fits for es­tate trans­fer

The Accumulation Phase:

Tom and Tammy’s pri­vate cor­po­ra­tion can pur­chase a life in­sur­ance pol­icy on their lives. Over time, they will trans­fer the cor­po­ra­tion’s sur­plus cash sav­ings into the pol­icy where it can grow on a tax-ad­van­taged ba­sis.

This is achieved by pur­chas­ing a PERMANENT life in­sur­ance pol­icy. More on that later.

Ideally, they’ll want to en­sure the pol­icy is max­i­mally funded to ac­cu­mu­late ex­cess funds whilst main­tain­ing the tax-ex­empt sta­tus of the pol­icy.

These tax-ad­van­taged funds can con­tinue to grow on an an­nual ba­sis and will be avail­able to them in the fu­ture to help sup­ple­ment their re­tire­ment with a tax-free cash flow in ad­di­tion to a tax-free es­tate ben­e­fit.

The Access Phase:

When Tom and Tammy want to ac­cess the funds ac­cu­mu­lated in their pol­icy, they can as­sign the pol­icy to a bank as col­lat­eral for a loan or line of credit.

Most fi­nan­cial in­sti­tu­tions will al­low them to ac­cess up to 90% of the pol­i­cy’s cash value.

Accessing these funds is TAX-FREE, as cur­rent leg­is­la­tion does not tax loans in Canada.

In most cases, the lend­ing in­sti­tu­tion does not re­quire them to re­pay the loan in their life­time, and in­ter­est can be struc­tured to be paid or com­pounded and added to the loan prin­ci­ple.

The loans can be struc­tured in two ways:

  1. Corporate bor­row­ings (to fund op­er­a­tions)
  2. Shareholder bor­row­ings (to fund re­tire­ment)

What About Their Estate?

Don’t worry, I did­n’t for­get about their es­tate.

Most suc­cess­ful en­tre­pre­neurs build up large nest eggs in their cor­po­ra­tions. These funds can serve dif­fer­ent pur­poses:

  1. Funding busi­ness growth
  2. Funding owner re­tire­ment
  3. Funding a legacy to pass on to own­er’s chil­dren

The pri­mary pur­pose of life in­sur­ance is to pay out at death. And when done cor­rectly this can be very tax ef­fi­cient.

If Tom and Tammy used the pol­i­cy’s cash value to ob­tain a re­tire­ment loan, then at death the in­sur­ance pol­icy death ben­e­fit is used to pay off the loan, with any ex­cess go­ing to the cor­po­ra­tion.

Under cur­rent in­come tax leg­is­la­tion, the cor­po­ra­tion’s Capital Dividend Account (CDA) is cred­ited with the full amount of the death ben­e­fit less the pol­i­cy’s Adjusted Cost Basis (ACB). A por­tion of the death ben­e­fit will be used to pay off the loan (if taken). The CDA can be paid out to share­hold­ers TAX-FREE.

This fa­vor­able tax treat­ment re­mains, even though a por­tion of the death ben­e­fit pro­ceeds were paid to the bank to re­tire the loan, be­cause the cor­po­ra­tion did not re­lin­quish own­er­ship of the pol­icy.

The pro­ceeds of the pol­icy can then be used to:

  1. Pay their fi­nal es­tate taxes
  2. Make a legacy-defin­ing do­na­tion to a char­ity
  3. Equalize their es­tate among var­i­ous ben­e­fi­cia­ries

So, How Does Life Insurance Double Up as an Investment??

If you’ve made it this far then let’s do a quick re­cap:

  • Investing in­side Tom and Tammy’s cor­po­ra­tion can trig­ger up to 6 lay­ers of tax
  • Investing in a cor­po­rate owned life in­sur­ance pol­icy can cut up to 5 of those lay­ers out
  • Corporate owned life in­sur­ance can be used to achieve a va­ri­ety of fi­nan­cial goals:
    • Tax free sav­ings and growth
    • Tax free ac­cess to funds for re­tire­ment or busi­ness ex­pan­sion
    • Tax free trans­fers of wealth to the next gen­er­a­tion

But how does this work?

Remember be­fore when I men­tioned PERMANENT life in­sur­ance?

Life in­sur­ance comes in many forms, but to keep it sim­ple it re­ally falls un­der two cat­e­gories:

  1. Term life in­sur­ance
  2. Permanent life in­sur­ance

Do You Want to Lease or Own Your Car?

When you walk into a new car deal­er­ship you have two ba­sic choices if you want to drive off in a shiny new ve­hi­cle: Lease or Buy.

If you lease, you’re get­ting use of that car for a set term and a set monthly price. At the end of the term, you must hand that car back. Ultimately, you took out a long-term rental con­tract, you don’t own it.

Now, if you buy the car, that’s go­ing to cost you a lot more up front but, you own the car for­ever.

It’s the same thing with life in­sur­ance.

Most peo­ple are fa­mil­iar with term life in­sur­ance. Term in­sur­ance is great for cov­er­ing the risk of early death. Basically, you pay a flat monthly pre­mium for a flat cov­er­age (death ben­e­fit), over a pre-de­fined pe­riod (say 10 or 20 years).

At the end of the term the in­sur­ance pol­icy is done. If you did­n’t die, your ben­e­fi­cia­ries get noth­ing.

Term life in­sur­ance serves its pur­pose: a cheap way to mit­i­gate the fi­nan­cial risk of an early death for the peo­ple who de­pend on you.

Permanent life in­sur­ance is like buy­ing a car; you own the pol­icy for life. The pol­icy will have monthly or an­nual pre­mi­ums, just like a term pol­icy. These pre­mi­ums may be payable for set terms (i.e., 10 or 20 years), or can be set as “life-pay”, mean­ing that you have the op­tion to pay into the pol­icy every year for the rest of your life.

Permanent in­sur­ance is a great tax and fi­nan­cial plan­ning tool, es­pe­cially for own­ers of pri­vate cor­po­ra­tions.

Permanent Life Insurance Doubles-Up as a Tax Efficient Investment Vehicle.

Permanent in­sur­ance can also dou­ble up as a very tax ef­fi­cient in­vest­ment ve­hi­cle. This is achieved by build­ing up the pol­i­cy’s “Cash Surrender Value” or “CSV” for short.

Let’s say Tom and Tammy’s cor­po­ra­tion takes out a Participating Whole Life pol­icy on their lives. They’ll have to make an an­nual pre­mium pay­ment, say $50,000 per year. A por­tion of these pre­mi­ums cover var­i­ous cost:

  • Mortality costs (i.e., pay­ing out death ben­e­fits)
  • Selling costs
  • Underwriting poli­cies
  • Administration costs
  • Taxes
  • Investigating claims

The re­main­der goes to boost the pol­icy re­serves.

When par­tic­i­pat­ing poli­cies gen­er­ate ex­cess rev­enues, the in­sur­ance com­pany will use some of this ex­cess to keep their pol­icy re­serves at lev­els re­quired by their provin­cial reg­u­la­tors. However, some or all of these ex­cess rev­enues may not be needed. That’s when they will make dis­tri­b­u­tions to pol­i­cy­hold­ers as pol­icy DIVIDENDS.

These pol­icy div­i­dends can be cashed out or, if not needed im­me­di­ately, can be used in a tax ef­fi­cient man­ner to pur­chase paid-up ad­di­tions (PUA).

Over time, the pre­mi­ums add up, the div­i­dends add up, and you can po­ten­tially build up a very large cash value in the pol­icy.

And that’s the se­cret, build­ing up the cash value.

Once Tom and Tammy built up a sig­nif­i­cant cash value, they have sev­eral op­tions to drawn on that value to:

  • Make a large pur­chase in re­tire­ment (i.e., a va­ca­tion home in the South)
  • Create a tax ef­fi­cient in­come stream in re­tire­ment
  • Make a tax ef­fi­cient gift to their chil­dren to get them go­ing in life

So Where Do These Excess Revenues Come From?

When Tom and Tammy pay their an­nual pre­mi­ums, they are used to pay cur­rent pol­icy ex­penses. The re­main­der goes into a large in­vest­ment ac­count that all pol­i­cy­hold­ers par­tic­i­pate in.

This ac­count is man­aged by pro­fes­sional man­agers and is highly reg­u­lated. A typ­i­cal ac­count will hold a mul­ti­tude of as­sets and may look sim­i­lar to this:

Predictable Returns Through Institutional Smoothing

The most im­por­tant fac­tor af­fect­ing the long-term per­for­mance of a par­tic­i­pat­ing per­ma­nent life in­sur­ance pol­icy are in­vest­ment re­turns. Certain as­sets such as eq­ui­ties can po­ten­tially lead to large in­vest­ment gains, how­ever, they can also lead to sig­nif­i­cant tem­po­rary losses.

If a sig­nif­i­cant in­vest­ment loss is im­me­di­ately fol­lowed by the death of a life in­sured this can lead a lower death ben­e­fit.

Not good.

Nobody un­der­stands this risk more than an in­sur­ance com­pany, and that’s why they main­tain a con­ser­v­a­tive ap­proach to man­ag­ing the port­fo­lio of the par­tic­i­pat­ing ac­count.

This con­ser­v­a­tive ap­proach has his­tor­i­cally led to a div­i­dend scale in­ter­est rate that is smoothed to re­duce the im­pact of short-term mar­ket volatil­ity, lead­ing to a less bumpy ride over time.

See the chart be­low for par­tic­i­pat­ing ac­count div­i­dends from 2005 to 2021 in­clu­sive (in com­par­i­son to the av­er­age prime lend­ing rate):

As you can see, even dur­ing chal­leng­ing eco­nomic times such as the great re­ces­sion of 2008-2009 when the Toronto Stock Exchange Composite Index dropped by al­most 50% in value, the ma­jor in­sur­ance com­pa­nies were able to main­tain a smooth and con­sis­tent div­i­dend rate in their par­tic­i­pat­ing ac­counts.

It’s also im­por­tant to note that div­i­dends are vested once they are paid, at that point they be­long to the pol­icy owner, there are no neg­a­tive po­si­tions.

So how does this play out over time?

Let’s re­cap:

  • Tom and Tammy are suc­cess­ful small busi­ness own­ers, both 40, non-smok­ers, in good health
  • They are look­ing for a tax-ef­fi­cient way to use their cor­po­rate sav­ings to:
    • Grow tax free
    • Retire tax free
    • Pass an es­tate to their chil­dren tax free
  • They find a so­lu­tion: Corporate owned life in­sur­ance

Tom and Tammy worked out their bud­get and de­cided they could eas­ily com­mit $50,000 per year of their an­nual cor­po­rate sur­plus to this strat­egy. Below is an out­line of what the strat­egy looks like:

At the top is a tra­di­tional, tax­able cor­po­rate fixed-in­come port­fo­lio.

At the bot­tom is the tax-free, in­sured so­lu­tion.

The fol­low­ing chart gives much more de­tail. In sum­mary:

  • Tom and Tammy pay pre­mi­ums of $50,000 per year from age 40 to age 65
  • At age 65 the pol­icy pre­mi­ums are off­set by an­nual div­i­dends
  • Tom and Tammy be­gin bor­row­ing $155,256, TAX FREE, every year un­til their pro­jected sec­ond death at age 90
    • Note: Under this plan, the cou­ple never re­pays the loan or in­ter­est dur­ing their life­time
  • At sec­ond death, age 90, the cou­ple is pro­jected to ob­tain a net death ben­e­fit (after pay­ing off the en­tire ac­crued loan and in­ter­est) of $2,269,293

When com­pared to the “traditional”, tax­able, fixed-in­come port­fo­lio, you can see how pro­found of an ef­fect tax has on the out­come.

For ex­am­ple, the tra­di­tional port­fo­lio is pro­jected to de­plete to zero by the cou­ple’s age 71, whereas the more tax ef­fi­cient so­lu­tion is pro­jected to last a life­time and then some. Focus on the “strategy ad­van­tage” columns to see the dif­fer­ence.

Now, this pro­jec­tion is based on sev­eral as­sump­tions about the cou­ple’s health, main­te­nance of the cur­rent pol­icy div­i­dend rate, cur­rent tax rates etc. etc. Small changes in as­sump­tions can lead to big dif­fer­ences in out­comes.

That’s why it’s im­por­tant to see this type of so­lu­tion as one of many pos­si­ble tools in your fi­nan­cial plan­ning tool­box. It’s not a panacea that solves every­one’s prob­lems and DIVERSIFICATION of in­vest­ments is still an im­por­tant con­cept to fol­low in any fi­nan­cial plan (more on this in an­other blog post).

But this ex­am­ple does high­light the im­por­tance of tax and es­tate plan­ning when it comes to per­sonal fi­nan­cial plan­ning for small busi­ness own­ers.

Nick Lanaro CPA, CPA and small busi­ness owner

As a CPA I know the value of proper tax and es­tate plan­ning. This is why I specif­i­cally en­gaged Fabio to lead my fam­i­ly’s es­tate tax plan. Fabio acted as the quar­ter­back, co­or­di­nat­ing his team of lawyers, in­sur­ance ad­vi­sors, and his own in­ter­nal tax team. We had full con­fi­dence in him, and his team and they re­ally de­liv­ered. I highly rec­om­mend Fabio and his team and have been re­fer­ring my own fam­ily and friends to him for years.

At the Campanella Group we help clients like the Tom and Tammy every day. We are ded­i­cated to help­ing our clients forge the best fi­nan­cial path for their fam­i­lies.

Are you ready to take a step for­ward and se­cure a lu­cra­tive fi­nan­cial fu­ture for your­self and your fam­ily? We are al­ways ready to speak to am­bi­tious en­tre­pre­neurs and in­vestors look­ing for an edge.

Feel free to con­tact us for a zero-cost, 30-minute, on­line meet­ing where we can get to know you and de­ter­mine if we can help you pave a path to fi­nan­cial suc­cess.