Business Owners: Have You Considered Split Dollar Critical Illness?

Split dollar critical illness

Split Dollar or Shared Ownership refers to a concept where more than one party owns an interest in an insurance policy.  The most common of these arrangements is where the corporation is the owner and beneficiary of the death benefit and the shareholder and an employee owns the cash value of the policy.

What is Split Dollar Critical Illness?

Recently there has been growing interest in applying this strategy to a Critical Illness policy.  The concept is referred to as Shared Ownership or Split Dollar Critical Illness.   Although the CI policy does not have cash value, there is usually an option to have a Return of premium (ROP) in the following situations:

  • Upon death – If the insured dies without having submitted a claim for critical illness the premiums paid are refunded;
  • Upon termination – If the policy reaches its termination age without a claim being made, the premiums paid are refunded;
  • Upon surrender – If the policy is surrendered without a claim, premiums paid are refunded.

Who Should Consider Split Dollar Critical Illness?

Anyone who owns shares in a corporation and wishes to protect that corporation against loss if one of the shareholders or other key employee is diagnosed with a critical illness.

How does Split Dollar Critical Illness Work?

A Shared Ownership Agreement is drafted documenting:

  • That the corporation will own, pay for and be the beneficiary of the CI coverage on the key shareholder or employee;
  • That the shareholder will own and pay for the Return of Premium option upon the surrender of the policy.

Who Benefits from a Split Dollar Critical Illness Policy?

Under this arrangement the company is protected against loss but should no critical illness occur the shareholder/employee will receive a financial benefit as the premiums paid will be refunded.   Provided this is set up properly, the shareholder or business owner could receive the premium in a tax-preferred way.

Case Study

Barry applies for $500,000 of critical illness coverage with a return of premium benefit upon surrender.  His company  drafts a Letter of Direction and/or Shared Ownership Agreement, which stipulates that the corporation owns and is the beneficiary of the $500,000 CI benefit while Barry owns and pays for the Return of Premium benefit.

Premium Structure

• The total annual premium for the policy is $ 9,131.

• The Corporation pays the cost of insurance $7,003

• Barry personally pays the ROP benefit of $2,128

How does Barry Benefit?

Twenty years later, when Barry turns 60, he determines that the CI coverage is no longer required. His company cancels the policy and Barry exercises his return of premium option.  Barry receives a cheque from the insurance company for $182,628 Tax Free.

This represents an after tax rate of return on Barry’s annual ROP premium ($2,128) of 12.5% compound interest.

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Is this an important planning strategy?

Consider this*,

  • One in three Canadians will develop life threatening cancer;
  • Half of all heart attack victims are under the age of 65;
  • Each year 50,000 Canadians suffer a stroke with 75% of all victims being left with a disability.

The Split Dollar Critical Illness Strategy can result in significant financial benefits for the individual shareholder while the Corporation enjoys the protection of its key employees against loss from a critical illness.

Call me if you would like to explore whether this strategy will benefit you and your company.

For Barry’s case study, Industrial Alliance’s Transition Critical Illness product with Flexible Return of Premium was illustrated. Of course, results will depend on age and amount plus product features will be vary by company.

Chris Coulter is the Founder and President of The Finish Line Group.  He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms. 

Chris’ passion for what he does evolved from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth.  Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.

 

6 Comments on “Business Owners: Have You Considered Split Dollar Critical Illness?”

  1. Hi there,
    I’m researching this strategy. I’m wondering about this statement in your article:
    “Twenty years later, when Barry turns 60, he determines that the CI coverage is no longer required. His company cancels the policy and Barry exercises his return of premium option. Barry receives a cheque from the insurance company for $182,628 Tax Free.”
    Are you sure that the ROP check is a tax free? Will it be treated as “investment income” since there is a gain involved? Haven’t been able to find the answer to that question anywhere. thanks

    1. Hi Jamie,
      Thanks for your comment. You’re correct in that it’s not straightforward. CRA has not given a definitive direction on this however, fair and reasonable is the principle that needs to be applied here. As an example, take a 40 year old male, non smoker who takes out a $100,000 Critical Illness policy with the ROP rider. On a T75 CI policy, the CI portion is $1,217/year (61.3%) and the ROP portion is $768/year (38.7%). If the business pays the CI, which incidentally is paid out in business after-tax dollars and the business owners pays the ROP in personal after-tax dollars, is this fair and reasonable? Many would argue it is because the business owner doesn’t see any upside if he/she does make a claim. In fact, to get any of the CI money into his/her hands, it has to be in personal after-tax dollars.

      Conversely, if someone takes out a T100 CI with ROP policy and Quick pays it in 10 years, is that fair and reasonable? The Quick Pay CI costs $3,476 (91.6%) and the business owner’s portion of the ROP is $316 (8.4%). CRA may look at this in a skeptical manner. The later scenario is what the CRA is likely going to dispute.

      Although neither scenario is cut and dry in the eyes of CRA, the former scenario paints a much more fair and reasonable argument. Some insurance companies believe so strongly in this that they are willing to put forth legal representation for any client’s case that is scrutinized by CRA. I guess that’s the insurance industry’s way of putting their money where their mouth is.

      I hope this helps. CC

  2. Hi, It sounds good strategy. But do corp and shareholder need a contract about this arrangement and does it have to be done through Lawyer.
    Please Advise

    1. Hi Mangal
      Yes contract between shareholder and corp is advised. There are some pretty good templates that have been drafted by insurance companies who sponsor these policies.
      If I can be of assistance or furnish a sample template please reach out to me.

      Chris

  3. Hello,

    Can the campany transfer ownership to the employee or shareholder once he/she retiered? Any extra tax consideration? If the ee is 65 and they got a T75 for example.

    1. Hi Paolo,

      Great question. In a split ownership scenario the company pays the critical illness portion and the employee pays the return of premium. Because CRA hasn’t made a definitive decision on the split dollar CI strategy being fair and reasonable is the safe response. Although some insurance carriers will vigourously fight CRA if they challenge it, nothing is set in stone. Careful consideration is to be taken with your Financial Advisor and Accountant when weighing if this is the right strategy for you and how aggressive you should be.

      If the CI is transferred to an employee or shareholder, the employee or shareholder would assume paying both portions of the premium and the beneficiary would change to the individual from the corporation

      Let me circle back after consulting with a senior legal expert

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