Key Person Life Insurance vs Critical Illness Insurance: A Guide for Canadian Small Business Owners

Key person life insurance is the life policy which the business owns on a crucial employee or the owner. The beneficiary is the company and the premiums paid are paid by the company. In the event of the death of the key person, the business gets a benefit of death. 

Key benefits:

• Death protection – The insured is paid a lump-sum following his/her death to the business, and that sum could be used towards recruiting, training or revenue loss.
• Financial stability – The payout provides the company with time and funding to make the adjustments that will reassure creditors and partners. In its absence, the loss of a key individual could be a catalyst to lost sales, churn, or loan requests, affecting it catastrophically.
• Tax efficiency –The death benefit is tax-free to the corporation. In a Canadian company which is privately owned, the amount above the adjusted cost base of the policy could be transferred to the Capital Dividend Account and the shareholders or family (as needed or planned) would be allowed to have that amount tax free as a dividend.

• Economical –The premiums tend to be low in comparison with the coverage.  The young and health reduce the premiums. To cover key people, most businesses purchase term life that is much cheaper than permanent life insurance.

Critical-illness  insurance is a living benefit insurance. Instead of waiting to die, it provides a lump sum upon the diagnosis of the insured with a covered serious illness in Canada (cancer, heart attack, and stroke). CI is not provided as monthly income as in the case of disability insurance, but as a one-time cash amount that can be used in any way by the policy owner or business as it is required.

Key Benefits:

• Living benefit -The insurance provides a lump sum that is usually delivered approximately 30 days following diagnosis when a covered illness arises. The payment is done whilst the individual is alive and can heal.
• Tax-free – CI payout is normally tax-free to the business in CRA regulations and thus the full amount can be utilized in recovery. None of the shareholder withdrawals is taxable as a Capital Dividend Account credit, unlike a life policy; however such a withdrawal can be taxed as dividends.
• Peace of mind -The policy helps alleviate financial pressure in case of a sickness and the policy helps pay the treatment or accommodation bills therefore the business is able to concentrate on recovering rather than worrying on the cash flow.

Key Differences at a Glance

In life insurance owned by a corporation, the company receives payment upon death, which is referred to as a trigger event. Critical-illness insurance Triggers the payment in case the insured is found to have a covered disease and survives after the waiting period.

• Benefit type – Life insurance is provided with a death benefit upon death; the CI insurance is provided with a living benefit upon diagnosis.
• Use of funds – Both policies pay tax-free lump sum to the firm. The key person can also be replaced, or a lost profit covered or even the debts paid with life insurance proceeds. CI proceeds normally pay medical expenses, wages or other overheads as the insured recuperates.
• Tax treatment – Business premiums as to either policy are not tax-deductible. Both payouts are tax‑free to the corporation. A life-insurance death benefit is the only one which establishes Capital Dividend Account credit of tax-free shareholder payouts; a CI payout does not provide CDA room.

Cost – Depending on the insured age, health and amount of the coverage, the premiums differ. Key-person term life insurance is most often less expensive than a whole-life plan. Claiming is more probable in CI insurance, so it is generally more costly than a comparable policy in life.

Many businesses cannot make a choice between the two as it is either or. It is based on the risk you are covering against death, serious illness or both. Here are some scenarios:

Key person life insurance is required in case of the demise of a leader or specialist that would paralyze the company. As an example, a single-owner business or a small firm that has one key person might require life coverage to ensure that the company has funds in case such an individual suddenly dies. The payout may finance a buy out or guarantee to pay outstanding debts.

The critical illness insurance is necessary when an illness is very serious and it will cause a hindrance in the operations even when the individual is alive. In case one of the partners or managers becomes ill with cancer or heart attack, CI funds are able to continue paying salaries and bills during their recovery. CI would also be helpful to key individuals with a rich medical history of screening or the presence of illness in their families.

Both combined: There are a number of businesses that prefer to have both covers. Life insurance covers the worst-case scenario of the death, whereas CI insurance covers major health occurrences. An example of a professional practice that has several partners is one that may fund a buy-sell, by life insurance on death, and CI insures a buy-sell or loan repayment in case one of the partners becomes ill. Wiseconomy Wealth Solutions tends to assist clients to look into their continuity plans and put together both types of insurance in a fashion that benefits them.

The Right Choice To Make When Doing Business.

Every business is different. The decision will be influenced by factors like the size of the company, the type of ownership structure, the amount of debt incurred by the company and the health history of the key persons. In most cases, the most optimal solution is a compromise. 

We are Wiseconomy Wealth Solutions and we assist owners of small businesses in a comparison of scenarios. We consider the cash flow, pending loans and the succession requirements. In most instances, the business ventures find themselves purchasing both critical illness insurance and key person life insurance on the same personalities to be on the safe side. Other people can give a priority on one of the two such as a retiree may consider CI cover to secure his retirement savings in case of illness whereas a young growing business may consider life insurance to secure loans and growth capital.

The critical illness insurance and the key person life insurance have different roles, yet they are complementary. The life insurance provides insurance against financial shock of the death of a key person whereas critical illness insurances provide insurance against financial shock of a serious illness in the event that the person survives. Each of them can be important to make sure your Canadian business will withstand sudden storms without debilitating debt or the loss of clients.