Think ‘when,’ not ‘if’

With the right approach, small-business owners can benefit by preparing for the worst.

A few years ago, a co-worker of ours suffered a heart attack. He was lucky; he had emergency surgery and made a complete recovery. However, he was off work for several months and the company had to hire additional staff while he recovered. The company’s group insurance policy provided him with income benefits, but his ability to obtain future
critical illness insurance had been severely compromised, especially for an individual
under 50.
About a year later, he decided he needed a change and left our company. He was a great asset, and in our business, our people are our assets. Our firm has more than 190 employees in four offices across Canada, so finding a replacement within our pool of employees
was relatively easy; small-business owners
don’t have the same luxury.
How would your company manage without you over the next 12 to 24 months if you suffered a critical illness like a heart attack, stroke, or cancer? Who would manage day-to-day operations? Would you need to sell assets to keep the business whole? Would you need to hire a replacement while you recuperate? How would this affect your customer base, your creditors, and your family?
Keep in mind that four in 10 people will be diagnosed with cancer and one in four will suffer from heart disease. Today, 95 per cent of people survive their first heart attack. But will your finances survive a health setback?
A business solution exists for these health risks, and it benefits both the company and the business owner. The Executive Health Savings Plan (EHSP) has been designed to pay a lump sum to your corporation if you suffer a critical illness over the life of the policy. As an added incentive, should you not suffer a critical illness beyond a stated minimum time period, all premiums will be returned to the business owner personally as a tax-free benefit.
It’s highly recommended that you seek legal and accounting advice for your individual situation. It will protect you and your corporation by ensuring the effectiveness of the allocation of benefits from a legal and tax perspective.
{advertisement} As an example, let’s say a 45-year-old owner/shareholder of an active corporation enters into a contract to purchase $500,000 in critical illness insurance. A pre-arranged shared ownership agreement is crucial — it will outline the details of the parties involved in the insurance contract. (We strongly recommend the use of a lawyer for this part of the business solution.)
Generally, under the terms of the agreement, the company will pay the costs of insurance while the business owner/employee pays the costs of the return of premium benefit. This is a win-win scenario in that it pays both ways. If the business owner suffers an illness, the corporation receives a tax-free, lump-sum benefit to offset financial losses and secure creditors, and in turn the owner receives financial liquidity while he/she recovers.
For example, the business owner calculates that the business will require $300,000 to survive and an additional $200,000 to maintain salary continuance or dividend distributions to the owner while he or she recovers. This also creates instant liquidity to offset additional health-care costs and flexibility should the owner decide to sell the business and retire.
In this example, the business would pay a premium of approximately $8,500 per year while the owner/key employee would pay $4,900 for the return of premium rider or a combined total of $13,400 per year. Business owners need to realize that the premiums paid to the insurance company are not a tax-deductible expense. However, any benefits paid out as a result of an illness claim are paid to the corporation tax-free.
While this sum might sound onerous, it is crucial to realize that if no claims are made after a stated number of years (usually a minimum of 15), then the corporation can, at its option, choose to cancel the policy and pay the full return of both premiums to the owner/key employee as a tax-free benefit. That benefit return works out to $201,000. The owner/key employee has paid $4,900 for 15 years or $73,500 with after-tax dollars; that works out to a gross internal rate of return of 12 per cent. So under these circumstances, the business owner has effectively removed 15 years of $8,500 payments or $127,500 from the corporation tax-free.
While we are not accountants, we understand from materials supplied to us from insurance companies that, under section 148 of the Income Tax Act, these critical-illness policies are considered accident and sickness policies. At this time, the act has no specific provisions concerning the taxation of benefits or the refund of premiums. Therefore, the benefits received by the company under a critical-illness insurance policy, or the refund of premiums, are not taxable benefits as long as all conditions satisfy the Canada Revenue Agency.
To avoid pitfalls, it’s crucial to consult a qualified insurance adviser when structuring a critical-illness plan. For example, should the corporation pay the return of premium portion of the cost of insurance, it could constitute a taxable benefit to the employee/owner in each of the years that the policy remains in force.
In summary, business owners need to understand the importance of critical-illness insurance. Too many overlook the need for protecting their most important asset: the business owner himself/herself. In many cases, it’s not a question of, “if the owner contracts an illness, will that prevent him or her from earning an income from the business?” It’s a question of when it does happen, is the owner protected with the proper insurance?
We urge you to investigate the EHSP. It’s an effective solution for business owners.
Steve Bokor and Ian Clark are insurance advisers with PI Financial Services Corp.