In 2017, radical changes to the Income Tax Act targeted business owners who dared to accumulate wealth inside their corporations.
The Problem: Passive Income Pitfalls
As a successful business owner, your corporation generates retained earnings—after-tax profits that you don’t need to cover your day-to-day expenses. Naturally, you want to invest those funds for future growth. But if you invest inside the corporation, you’re in for a rude awakening. The CRA has a special term for this type of investment: “Passive Income.” And guess what? They hate it.
In Alberta, passive income is taxed at a brutal 46.67% (over 50% elsewhere in Canada). Worse yet, if your corporation earns more than $50,000 per year in passive income, you start losing your Small Business Tax Exemption at a rate of $5 for every $1 over the limit. By the time you hit $150,000 in passive income, you’re paying the full 23% corporate tax rate—no more tax breaks for you!
So how can you invest your hard-earned profits without incurring sky-high taxes?
The Unexpected Solution: Participating Whole Life Insurance
Yes, you read that right. One of the oldest financial products in the world is now a game-changer for incorporated professionals and business owners. Here’s how it works:
A participating whole life policy (Par Whole Life) is purchased by your corporation to insure a key person—typically yourself, a partner, or a key employee. The corporation is both the policy owner and beneficiary. While the policy provides financial protection in case of death, it also accumulates cash value over time, and here’s the magic: Life insurance policies in Canada are tax-exempt—meaning the cash value grows without annual taxation.
How to Access the Money
Of course, investing is pointless if you can’t eventually access your funds. But withdrawing directly from the policy would trigger taxes, so try something clever instead.
Rather than withdrawing funds, borrow against the policy. Banks happily offer lines of credit using the policy as collateral. And because a loan isn’t taxable, you can enjoy your money tax-free. Even better, the loan never needs to be repaid during your lifetime. When you eventually pass away, the bank collects what’s owed from the insurance payout, and the remaining funds go to your corporation (and then to your heirs) tax-free.
The Bottom Line
With this strategy, you can:
- Protect your corporation against the untimely death of a key person
- Avoid taxes on investment growth
- Preserve your Small Business Tax Exemption
- Enjoy a tax-free retirement income
- Leave a tax-free inheritance
If you’re an incorporated business owner and tired of CRA dipping into your profits, it’s time to explore this strategy. But don’t go it alone—consult with a financial specialist who understands how to make this work for your specific situation.
After all, paying taxes is inevitable—but overpaying them is entirely optional.
Real-World Numbers:
The Dentist’s Advantage
Let’s say a 40-year-old female dentist (non-smoker) invests $50,000 per year of retained earnings into a Par Whole Life policy to be paid up in 20 years.
Here’s what happens:
- By age 65, she has $2,038,623 in tax-free cash value and a $4,031,579 death benefit
- By age 85, her cash value grows to $6,338,066 with a $7,794,873 death benefit
- She can take a tax-free annual retirement income of $158,180 per year from age 65-85
If your business is not as big as the example, perhaps you have a small boutique hair salon and you only have $10,000 per year in retained earnings.
It really does not matter what your excess earnings are, you can shelter them using this strategy, simply envision 1/5th the numbers.
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