By Andrew Fink and Michael Araujo

Advisors to small business owners understand that their clients have to be experts in many areas, from human resources and technology to strategy and accounting. And staying on top of the Canada Revenue Service (CRA) is practically a full-time job all on its own.

One of several issues for small businesses to keep an eye on is a smaller passive income limit. Small businesses need to keep their passive income to $50,000 or less if they plan to take advantage of the full $500,000 small business deduction limit. For those who go over, the limit will be reduced by $5 for every $1 of passive income over the maximum. Depending on their province, this could lead up to an additional $82,500 in tax on business income.

Savvy business owners will be looking for ways to stay below the threshold, even seeking out opportunities to invest in the business and, at the same time, achieve a financial return for their investment.

One unique strategy is for the small business owner to secure a permanent life insurance policy for themselves. The policy does more than provide death benefits for loved ones. It also builds equity and becomes a financial asset for the company. The savings component of the policy has a cash value; and the longer one pays into the policy, the larger the cash value. Small business owners can have their companies pay for the premiums of the policy. This allows them to use pretax dollars to fund the strategy. They can also draw against it to take out as a loan and even use it as collateral to build the business.

The best part is investing in a permanent life insurance policy provides a sort of safe haven. The CRA allows these policies – including the savings component – to live outside of traditional income tax rules.1 As long as the exempt rules are followed, a small business owner won’t have to pay capital gains, dividend, or income tax on this asset.

For many, purchasing a permanent life insurance policy can solve for a multitude of financial concerns, including:

  • Fund retirement. It’s very simple: The less money paid in taxes, the more there is to take and enjoy during retirement. Investing in a permanent life insurance policy shelters a certain amount of income during a time when it’s not needed so that it’s available later.
  • Provide solutions for tax liabilities. Financial planning for a small business can be confusing, but transitioning to qualified investments – such as a permanent life insurance policy – is one way to lessen a company’s tax burden.
  • Wealth preservation tool. If passive income exceeds the small business deduction threshold, a small business owner can wind up paying much higher taxes. Transferring assets into a policy like this can help maintain the deduction rate and save money.
  • Wealth transfer vehicle. There is no more efficient way to transfer wealth. Since all types of insurance policies are subject to beneficiary restrictions and regulations, the money transfers directly to heirs more favourably.
  • Estate equalization: Inheritance can be tricky for a small business owner, especially when only some of his or her children are interested in the business. This policy is one way to mitigate challenges and create equalization.

If done properly, this possibility is well worth exploring. Advisors should also have their small business clients consult with a tax professional before investing in a permanent life insurance policy as there will be tax implications if changes are made to it later. However, if maximum amounts are respected, the policy can be a worthwhile investment for any small business owner.

HUB International’s specialists in retirement and benefits strategies are available to consult with your organization on ways to enhance executive benefits.

1 Income Tax Act, Section 148