Shared Ownership Critical Illness Insurance
Overview
The idea behind using the shared ownership critical illness plan can vary depending on your goals, but is mostly used for two reasons.
1) Protect the business operations if the owner or key employee were to be diagnosed with a critical illness
2) Potentially provide a method of transferring cash from the corporation to the individual tax free
Effectively what we are doing is putting a critical illness insurance policy on an individual who is important to the business. The reason this is called “shared ownership” is because the corporation pays part of the insurance premium and the remaining portion is paid personally.
This strategy can be implemented at any age but it generally works best if the insured person is 55 years of age or younger.
Now before going any further, I want to mention that in order for this strategy to be effective it needs to be enacted with a long-term view in mind. Generally, the minimum time frame is 15 years. You’ll learn why further on.
If this time frame works and the concept interests you, read on.
What is Critical Illness Insurance?
Let’s first take a look at what a critical illness policy actually insures. Depending on the insurance company we use, the coverage is for 23-26 illnesses plus some additional partial payout conditions. Below is a picture of what one company covers as an example. Most insurance providers cover very similar things plus or minus one or two but the main conditions are cancer, stroke and heart attack.
Like any insurance product you pay your premiums monthly or annually and have an insurance benefit associated. For example, a person may pay $4000 per year to have $200,000 of critical illness insurance. Of course, the premiums required depend on many underwriting factors including age and health.
If the insured person is diagnosed with a covered condition, the insurance company will pay out the benefit, tax free, as a one-time lump sum payment. At that point the insured person can use the proceeds however they wish, and the policy is terminated.
Optional Benefits
Within a critical illness policy, regardless if it is shared ownership or not, the policy owner can add on optional riders for additional premiums. Below are the most common options available. This is important to note as some are needed to set up a shared ownership plan.
Return of Premiums on Death (ROPD): This option is generally low cost, fairly simple, and common to include. If the insured person passes away while the policy is in force a designated beneficiary will receive 100% of all premiums paid by the owner refunded to them, tax free.
Return of Premium on Cancellation (ROPC): this option is similar to the ROPD option above although it generally costs more. This option allows the policy owner to cancel their plan, after a certain period of time has passed, and receive 100% of their premiums paid, back to themselves tax free. When this option is included it guarantees that the policy owner will either receive the insurance benefit or 100% of their money back (again provided the required amount of time has passed.)
Additional Covered Illness: This option is just as it sounds. On some plans you can add the option to include another set of illnesses that would trigger a payout of the insurance benefit. This option is more common when parents place CI insurance on their children as they can be specific to children’s illnesses.
How to Set up a Shared Ownership Plan
Now that we’ve covered the basics on critical illness insurance plans, we’ll go through how to set up a shared ownership plan type. A shared ownership plan can only be accomplished by having a corporation and including the ROPC option. ROPD is not required but for the cost is generally a good addition.
Essentially all that takes place is the premium related to the ROPC option is broken out separate from the rest of the policy. This ROPC specific portion is paid by the policy owner at the personal level (no corporate dollars fund this portion). The rest of the premiums are then paid by the corporation using their after-tax dollars.
There are different ROPC time periods available from 10 years all the way to age 75. Multiple factors including price, time frame and flexibility required go into to choosing which option is best. However, it is important to note that in order to get the full 100% of premiums refunded the policy must remain in force with premiums paid for the entire length the ROPC option states.
How the Plan Works
Once the plan is in force there are two options for how it will proceed.
1) The insured person is diagnosed with a covered illness and the insurance benefit is paid out or
2) The policy is cancelled
Here is how the plan works if the 1st option occurs (diagnosed with covered illness and benefit is paid):
To avoid triggering taxable benefits with the CRA, the corporation must be the beneficiary of the policy because it is the one paying for that portion of the premium. Therefore, if the benefit is to be paid it will go to the corporation tax-free.
At that point the corporation can do what it wants with the funds by holding them or distributing them to shareholders. If the proceeds are distributed, they would be treated the same as any other payment to shareholders and trigger taxes owing on the personal level (either as income or dividend depending on how they were paid).
Here is what happens if the 2nd option occurs (policy is cancelled):
Assuming the full ROPC time period has passed, this option results in 100% of premiums paid (both by the corporation and individual) being refunded. Since the ROPC option is owned at the personal level the individual receives 100% of these premiums to their personal account tax-free.
That includes the portions paid by the corporation.
If you want to see an illustration of this it is included in the Appendix on page 6.
Why Implement a Shared Ownership Plan?
Shared ownership plans help to ensure that a company receives liquid cash in the event that an owner or key employee is diagnosed with a serious medical condition. Often these conditions will require time away from work or have high costs associated with treatment and a critical illness plan helps to limit the impact of those two things on the business.
By structuring the insurance as shared ownership a person generally has two favorable outcomes. The corporation receives the insurance benefit amount. Or the individual receives all of the premiums back personally. In doing so, they move money out of the corporation to themselves personally without triggering personal income tax.
Although it requires a longer-term commitment, shared ownership critical illness insurance is a product that offers more than insurance alone.
If you want to explore planning opportunities like shared ownership CI, send me a message using the link below.
https://www.mcwealth.ca/contact
