81. Capital Dividend Account for Canadian Business Owners – Tax Free Legacy

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Understanding the advantage of the Capital Dividend account, otherwise known as the cda.

Talking about corporate owned life insurance, not only for the purposes of implementing the process of becoming your own banker, the infinite banking concept, but also to provide a corporate preferred retirement solution, among many other things. Welcome back to Wealth Without Bay street, joined of course by Mr. Richard Canfield. Hey, Rich, how's it going?

I'm doing good, man. I'm excited. Recently we did a release of a podcast and we did something unconventional from our normal style and we did something on showing some numbers, which is not what we would typically do, but just based on popular demand and stuff. There was some good commentary and things that came out of that. And so we thought today we would do something similar and we would walk through from a corporate standpoint, the power of life insurance being utilized by a corporation and the business owner at the end of life timeframe. But also, what are some of these unique advantages that just a lot of businesses have no idea exist and where in Canada at least, because we have this magical, powerful thing called the Capital Dividend account, a lot of people are unfamiliar with that and how it works. We're going to talk a little bit about that today because it is probably one of the hidden gems. It's one of the most powerful tax savings mechanisms available to the Canadian population for business owners. And so understanding what things can actually add value to that account and how that can be extracted is really critical. So we're going to talk through that a little bit today and we're going to use an example as we go through it. So if you're listening on the podcast, you're on your car or you're out for a run with your dog or something, you know, you may want to circle back after you're done and just make sure you head over to the YouTube channel wealth without Bay Street.com forward/YouTube. It'll take you right to the channel, make sure you subscribe there. But also you'll be able to watch this video after the fact and see what Jason's going to bring up on the screen. And I'll attempt to draw some chicken scratch notes on the, on the thing because Jason loves it when I do that. Right, Jay? I love that.

All right, let's Dive in man, let's have some fun. Okay, so here's the deal.

So we've got a 45 year old male because we're going to, we'll have some continuity here to the example and the life insured. So we have a 45 year old non smoking male, he's a corporate owner. And wouldn't you believe it when you look at the balance sheet, Every single item on the balance sheet has been addressed except for the most important one and that's the business owner. He doesn't show up anywhere on the corporate balance sheet. And so looking at this policy, so the corporate owner said, well, you know, my objective is to capitalize this policy and I want to do that for a 10 year period. Now, 10 years was just a number that the business owner picked arbitrarily. And we know that when we get to the 10th year, the business owner will still have the ability to contribute additional premium to the contract and can deposit premium all the way to age 100 if he chooses to do so. And says, look, when I retire, and if we just choose the stereotypical retirement age, I want to be able to net 70,000 bucks a year to maintain my contribution to the lifestyle that my spouse and I enjoy. And so I want that to be net of tax and I want that until age 90. Because we asked him, hey, back us up, when do you think you're going to die? And he said, well, why don't we pin it down at age 90? Okay, we'll kill you off at age 90 and let's see what the net effect of this whole arrangement is. Now we explained to him that this corporate owned policy, meaning the corporation owns it, the corporation is the beneficiary, the corporation is the premium pair. The corporation is taxed at a much lower rate than what the owner of the business is taxed at personally. And the anatomy of this contract is super important to understand that it is exempt from the passive investment income tax rules. So the surplus capital from the business that's going in to pay the premium, the daily cash value accumulation, there is zero taxation on the accrual of that cash value which is rising every single day without interruption. And the corporate owner immediately said, okay, well I understand that my capital has to reside somewhere. And we asked the question, what better place to have it reside than here? Well, let's test that and see if we're right, that it is the best place for that capital to reside. So what you can see here on the screen, Rich, I'll just blow this up a little Bit larger for people who are watching on the YouTubes is we've got $100,000 going into the policy.

In the form of premium for a 10 year period. So if we do the math on that, we've got $100,000 that's going to go in.

I'll just move my calculator here.

There we go.

So we have $100,000 over a 10 year period. So that's going to be $1 million going into the policy in the form of premium. Now, the corporation has total and absolute control over the use and liquidity of accumulating capital in the policy, no different than the person would have control of that if they owned it personally. The corporation can access policy loans for a wide variety of things. Equipment, technology, people, et cetera.

Anything that the business needs, they got to plug it back in to help it grow. And again, that's where the policy isn't there to be the investment for the corporation. The policy is there as a machine to help the corporation grow so that the business owner can increase revenues and profits along that period of time and beyond totally.

And then if we get through to retirement, and we can see that by utilizing this policy as the vehicle that's going to provide capital to the business owner in retirement. So from age 65 all the way through to age 89, so for a 25 year period, the corporate owner is going to be able to access a gross amount of $105,000. This is just a level maximum amount for a period of 25 years. So if we do the math on that and Rich, you've got it there. So $105,000 times $25,000. So that's $2,625,000. Now, the corporate owner can access the capital in one of two ways. The first way is corporate borrowing. So what that means is that the policy itself is going to be pledged as collateral to a commercial bank. The commercial bank is going to lend up to a minimum, pardon me, of 90% of the total cash value of the policy. The commercial bank knows that the life insurance company itself is the entity that's contractually guaranteeing the collateral for the loan. And so if we follow the money, $105,000 comes from the bank, not from the life insurance company. That money flows into the corporation. If the corporate owner, as a shareholder of the business wants to access that money, then the corporate owner can take that money out and receive that as a taxable dividend. So if we presume that the tax rate's going to be again we're not chartered accountants here. But if it was 30%, then he's going to achieve his objective. Because after tax, after that dividend, if we take 105,000.

Less 30%.

He'S got $73,500. So he's achieved his objective. And if he can spend that over a 25 year period.

He gets the same amount each year. That's $1,837,000,000. Now, Richard, my question to you and to our listeners and viewers is.

Who paid the premium?

Well, the business paid the premium.

And who's spending the money?

The business owner is spending the money.

When the business owner dies, who is going to receive the net death benefit proceeds?

So the way that that works is that the corporation, who's the owner of the policy, often it's a holding company, in most a lot of circumstances will receive that net tax free death benefit. Now what Jason's alluding to is that any remaining shareholder of the corporation will be able to withdraw that on a tax free basis. And that's what we're going to kind of get into and dive into next year, which is our main topic of conversation today.

Yes, let's get to the capital dividend account. So we're doing pretty good so far, right? The corporate owner has achieved their objective.

The source of retirement income is not tied to the performance of a stock market, to an economy, to real estate cycle, to government intervention. Tax rates could go up and what the impact that that will have is what the after tax amount will be. If the corporate owner is accessing this through corporate borrowing, if the corporate owner says, well, I don't want to go that route, I want to go the shareholder borrowing route. What the corporate owner needs to do is pay the corporation what's called a guarantee fee. And that guarantee fee can be on average about 1.5%. But let's estimate it on the high side. Let's say it's 2%. So what that would mean is that in the first year, if the corporate owner accessed 105,000, the corporate owner would have to pay the corporation a guarantee fee of $2,100. That's a lot less than the taxes on a dividend. And the Corporation receives that $2,100 as revenue. It's taxable revenue. So the shareholder may decide to do that. However, the shareholder must have enough collateral so that if the shareholder passed away, the corporation can get the assignment on the policy released from the commercial bank so that the death benefit in its entirety can be paid into the corporation and then the corporation can in turn pay the bank the loan balance that's outstanding. If that doesn't occur and it's set up improperly, then the entire amount that the shareholder accessed using this shareholder guarantee fee method is going to be added to their terminal tax return as income.

Which defeated the entire purpose, basically, of getting started in the first place. So what Jason just identified is extremely important because we see this very often where there's a lot of active promotion of this shareholder guarantee fee situation out in the marketplace right now. But there's not a lot of conversation about what happens if it goes sideways or what the shareholder needs to do. And now that's all fine and dandy if you're talking about that, you know, at age 45. But then when you go 20 years later, 25 years later, you're going to implement this program and you forget, because I don't know about anyone listening to this session today, but is there a chance that you maybe forgot something that you learned 20 years ago? Right. It happens. It's called life. It gets in the way sometimes. And so you may not remember that ultra specific, very critical detail that could have a massive monstrous tax impact to you and your family. So very, very important, understand that although there's these two options, one of these is making sure that you're kind of, I guess, playing at the safe route. You're not tempting fate with what's going to happen on the background. And the other one requires more effort, more preparation, and more assets set aside in the realm to make sure that you can actually get the result that you're looking to achieve totally.

And it's really important that there's proper planning done so that if the shareholder says, well, you know, I'm going to go the shareholder borrowing route, well, then there is very specific proper planning that needs to be put into place. The arrangement has to be made in advance with the lender so that all parties to the, to the agreement understand what's going to happen when the shareholder dies. Because you do not want that sequence of steps to happen incorrectly. Now, if we go back to the corporate borrowing route, which, as Richard said, that's the simple method, that's the easy route. Well, let's calculate what's happened here, because assuming that this corporate owner died at age 90, his death gave rise to what's called the capital dividend account. Now, this is a notional account, and this account is created and credited, and the amount that it's credited with in this case is the total death benefit of the insurance policy, which is $6,844,669.

That is the amount that is credited to the CDA balance. Now, it's not an actual amount of cash that's in the corporation, but here is the advantage. Let's determine the loan balance to the bank. When the shareholder died, it was $5,261,913.

Because the borrower did not repay anything, including interest, until death.

So we take 6.844 million.

684-4669, we subtract 5261913. So the net death benefit proceeds are $1,582,000,000.

However, their surviving shareholders can extract $6,844,000,000 in asset value from the corporation in the form of tax free capital dividends. So irregardless, and I know that's not proper grammar or vernacular, but regardless of the fact that there was a loan balance that had to be paid back to the commercial bank, the capital dividend account is credited with the entire death benefit amount. Now, if the shareholder had died in the earlier years of the policy, the capital dividend account credit would not be the entire death benefit amount. The formula is simple. It is the total death benefit minus the adjusted cost basis of the policy. That's the credit to the capital dividend account. Well, in this case, the adjusted cost basis at this age is zero. And so the entire death benefit amount gets credited. I cannot emphasize highlight this advantage enough because if there's other assets in the corporation that the surviving shareholders want to get out in the most tax advantaged way, then exercising the capital dividend account credit is the way to do it. So let's summarize what's happened here with this corporate owner. $1 million went in. So that's the amount in. The corporate owner utilized the dividend route and spent $1,837,500 in retirement. The corporation paid the premium. The corporation owned the policy, the shareholders spent the money.

So we put $1 million in, we spent $1,000,837,000,000 at death. The corporation got back everything that it put in plus $582,756 more. And the surviving shareholders had a capital dividend account balance credit of $6,844,669. My question to anyone watching or listening to this, Is there anything stupid about doing that?

That is a good question. And I'm going to take a minute to expand on this a little bit and just provide some context. So I'm drawing some of the quality Richard Canfield little houses on the screen here that many of my clients are familiar with. So just imag it simple. Let's assume that this business owner had been using capital as business was growing and stuff to start accumulating other assets in his holding company. He's buying investment real estate or apartment buildings or some type of asset. I just keep it with real estate because that's common. Most people are pretty familiar with that. So if he's got these other assets and there's a bunch of them there and they're rental properties. Now, the remaining shareholders, typically the spouse, maybe the kids, the adult children at this point, they're shareholders of a certain class of shares. So they're able to extract money out of this capital dividend account. Well, maybe they don't want to be in the business of owning rental properties and they're done with that. So they go and start selling off these properties. They take those net proceeds after they pay whatever capital gain is associated with them in the corporation. They have a lump sum amount of capital and they could just continue doing that until they've eroded this capital dividend account and they can withdraw that money tax free. So any other asset that's available to be extracted out of that corporation now or in the future, because you don't lose that capital dividend as long as that corporation lives. And it exists that the value of that capital dividend account is there to be extracted. And that is a massive opportunity for families to be able to cascade wealth and to be able to basically stick their nose up at the cra around how much tax they're going to pay over a lifespan.

In addition to that too, Richard, the shareholders, through a unanimous shareholder agreement, can define how the capital dividend account credit is to be utilized. So if you just leave it open ended, then there's no criteria in place then that could create obviously some issues with their surviving shareholders where one says, listen, we want to get everything out of the business, let's do this, let's exercise this capital dividend account credit. And the other shareholder says, well no, wait a second, we want to hang on to some of these passive income generating assets.

Again, the parties to this need to be first and foremost, you have to have an advisor who thoroughly understands how to structure this properly. So working with a life license advisor who has experience, a chartered life underwriter, somebody who has demonstrated experience with this, you need to involve your accountant. And if your accountant does not have a high degree of knowledge of this tool, of this unilateral binding contract and how it can be accessed and the capital dividend account and all of these things, then all the more reason why you should have an experienced advisor who can consult with your accountant and bring him or her up to speed on all of the attributes of this amazing tool. Thirdly, an estate planning attorney would be very important to have engaged to make sure that there's proper shareholder agreements in place, that there is a clear understanding among the shareholders as to why this is being put into place, how it's going to be utilized, et cetera. And if there are no other shareholders, then making sure that the surviving family is aware of what's been put into place and why. Because when the corporate owner passes away, his spouse is going to continue coming to the very same place that they relied upon for income, and that is the company. And whomever's going to take over the business may not want to be in business with the spouse of the deceased corporate owner. And so lots of proper planning needs to happen and the right professionals have to be engaged in that planning process. And we have all of those professionals on our team that we bring to bear to do this. And we are extremely good at it. And so for any corporate owner who's listening and you're considering implementing this process, you may choose not to do that with us, but just make sure that you work with a group of professionals who are thoroughly, thoroughly familiar with it, because there are more intricacies here that, you know, we don't have time in this episode to dive into. But this is just an incredible advantage because you can clearly engineer the outcome. You can engineer exactly what the corporate owner is looking for.

Yeah. And a couple of quick things before we tie this off here that I want to just leave everybody with. So again, we got 6.8 in this capital account. Incredible. We actually received $1,058,000,000 in tax free capital, which can immediately be extracted tax free by the shareholders out of that capital dividend account. But we want to get off the page and get people thinking beyond what the numbers are. So I just circled the 105,000 of borrowing to the corporation. Yes, the shareholder can take that out as a shareholder dividend. But what if they just want to keep growing the business? What if they, rather than taking that as an income, they want to continue growing income producing assets. So every year that shareholder could take 105 and go buy another property for 20% down or whatever that could be, you know, or every couple, two to three years, maybe they had enough that they could go buy a 12 unit or 15 unit apartment building or whatever they want to do or another business, a franchise operation so they can use that capital inside of the corporation to. And they could have been doing that from day one by the way. Not just on the back end. They could have been doing that the entire timeframe to augment the asset base that that corporation has available for to grow it production. And then the actual income they might be able to receive if they wanted 74,000 might be well greater than that because of everything else. They had a lifespan, amount, access of capital to put to work to the advantage of growth. And with a wealth mindset. And so the, all the numbers on the page are all, are all fine and dandy, but you got to get off the page and you got to start using our brain here, the squishy mash and mass between your ears to start thinking about what can you utilize capital for over that entire timeframe. Where else might you deploy it to go to work, to add financial benefit into your family's life?

I love that. And it's important to remember too that just because the owner is the corporation and the premium payer is the corporation, the anatomy of this contract is the same. We have contractually guaranteed daily cash value accumulation that must match the total death benefit by age 100 of the life that is insured. The corporation is paying zero tax on that accrual of cash value.

They're saving tax from passive income rules quite possibly because of the money that they're working with in their corporation.

Right. And dependent upon the size of your business and the amount of revenue that, that you generate and the assets that are in the corporation. The passive investment income tax rule conversation may just be a moot point altogether, but we can't discount it at an early stage in a business because our presumption is that the business is going to continue growing and expanding. And in addition to that, the corporation has total control over accessing policy loans. The corporation controls the repayment schedule of those loans. We have clients with corporations where they're buying fleet vehicles, they're buying equipment, all of these things where the accountant says this is brilliant because the corporation now has total control over their cash flow management. And they don't have to build up a sinking fund in some commercial bank account to go buy the stuff they need. They can take advantage of borrowing against the accumulating value on a tax free basis inside of the policy. And the advantages are just really limitless.

Especially for businesses that have really long lead times on receivables, like something 120 day periods where they're just like, they've got sunk cost and staff wages into a project and they're waiting for this huge check to finally arrive by some provider, a government or a large oil company or something, and they're just waiting there for this influx of capital.

Here's the truth. Your money must reside somewhere.

Your company's money must reside somewhere. And so when we talk about, we hear the term retained earnings. Well, if you're flowing all of the corporate money through someone else's bank, who's retaining those earnings, it isn't the corporation, it's the bank that the corporation does business with. And if the corporation takes on debt, then the debt that the corporation takes on is someone else's passive income.

Because every payment that the corporation is making is contributing to someone else's passive income. And if the corporation is in a position of total and absolute control and there's no stock market volatility, there's no government intervention, there's no lengthy nosy credit applications with bank loan officers, when the corporate owner knows that they have a vision, they want to grow the business, but they don't want to get into an arm wrestling match with a banker who knows nothing about their business but yet wants to have this corporate owner jump through all the hoops, go through all the gatekeepers and toll takers and get paperwork and get abused along the way. And most importantly, not one corporate owner has ever sat down with us and said, you know, rather than create more jobs and grow a business, I'd rather pay more tax.

Not one. And so if we can be flowing capital through this wonderful, I assume that.

Person'S out there somewhere.

Wonderful tool. Think about it. Nobody talks to the corporate owner about being the most important asset on the balance sheet. Everything else is insured. The buildings, the equipment, key people. But the corporate owner himself or herself isn't insured. So this is just another added benefit. There's a death benefit thrown in for good measure. Isn't that good?

And we're solving huge problems, you know, problems for pennies a piece. You know, that's really what insurance does for a lot of times. It's you pay, you pay pennies, you get access to dollars. And a lot of times people just don't. They're just not aware, they're just not sure how you can use them while you're alive. The words life insurance enter into a person's brain and it becomes like a poison because they've heard bad things or they think it's only good for when you're dead. That is just not the case. If it's built the right way, it's for living, not for dying.

That's awesome. On that note, thank you to all of our viewers for your feedback about the numbers. I know a lot of you love to see numbers. We try to cater to the right brain and left brain. So thank you all for your feedback. We hope you enjoyed this one as well. I got to hop onto a live LinkedIn interview now. So with that, just look over here. You're going to see some other videos to continue your journey of learning. Really appreciate you tuning in to another episode of Wealth Without Bay Street. Richard, it's always a pleasure. We're going to do way more of these because obviously our audience is hungry for it. And I'll see you in just a short while. We've got some more guests to interview today, but thank you again everybody. Make the rest of your day great and we'll see you on the next episode.

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