The Ultimate Beneficiary
Corporate Owned Life Insurance: The Beneficiary vs. The Ultimate Beneficiary
As you know we are big fans of life insurance, when used in the right place at the right time. It has many benefits which we have written about in the past. One of these benefits is the additional creditor protection, which can be a game changer in this litigious society we live in. When a policy is owned personally, and when the beneficiary is a “preferred beneficiary” (includes spouse, child, grandchild or parents) or an “irrevocable beneficiary” is named, creditors are hard pressed to seize the death benefit or the cash value. However, if the policy is owned by your private corporation the same cannot be said. The purpose of today’s blog is to talk about corporate owned life insurance and consider ways to protect it.
If one were to dust off one’s corporate owned life insurance contract you would likely see that the owner and beneficiary of the contract is your private corporation. Why…..because of tax law rules dealing with taxable benefits and a tax rule that allows for the tax-free payment of a particular dividend to the shareholders of the corporation. But in most cases who is the real “Ultimate Beneficiary “of this corporate owned policy? Typically, it is the family shareholders. Why? Because the death benefit usually 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. Furthermore, and more importantly, the corporate owned life insurance is also a very valuable asset of the “ultimate “beneficiary, the family shareholders. 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 or the death benefit? Not that likely but it is not zero. Is 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 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.
The other question to consider is …could one recover if still alive? Does one have the time, energy and ability to do so? Also it is highly unlikely that one could replace the lost insurance contract. Firstly it would be more expensive, and might be impossible to get if ones insurability had changed.
The good news is that there are steps you can take to protect the ultimate beneficiary of your corporate owned life insurance, your family. If you have questions and /or would like to hear more about this strategy please reach out to the team at Family Wealth Coach. Look forward to hearing from you.
(Many thanks to Paul Jacobson, Q.C.)