Is Shared Critical Illness Insurance a Good Idea?

What You Need to Know Before Saying Yes

If you own a business in Canada, you’ve probably been approached about a Split Dollar Critical Illness (CI) Policy at some point. On the surface, it seems like an attractive way to get critical illness insurance while also extracting money from your corporation tax-free. Sounds like a win-win, right?

Not so fast.

While this strategy has been marketed as a way to optimize corporate funds and reduce taxes, the reality is more complicated. There are uncertainties surrounding how the CRA may treat these arrangements, potential tax implications, and concerns over conflicts of interest with commissions. If you’re considering this type of insurance in Toronto, you’ll want to proceed with caution.

Here’s what you need to know before making a decision.

How Does a Split Dollar Critical Illness Policy Work?

A Split Dollar CI policy is structured so that:

• The corporation pays for the critical illness insurance coverage.
• The shareholder (you) pays for the Return of Premium (ROP) rider—which means that if no claim is made, you could get your premiums refunded.
• If a claim is made, the insurance benefit is paid to the company tax-free.
• If no claim is made and the ROP kicks in, you personally receive the refunded premiums.

On paper, this setup sounds great. Either your company gets the insurance payout if you get sick, or you get your money back if you stay healthy. But the reality is much more nuanced, and that’s where the risks come in.

The Uncertainty Around CRA Taxation

One of the biggest concerns with this strategy is that the Income Tax Act does not explicitly outline how it should be taxed. This means the CRA could change its stance at any time, potentially leading to unexpected tax consequences.

For instance, if you were to sell your business and transfer ownership of the policy to yourself, this could trigger a taxable shareholder or employee benefit based on its fair market value. You might think you’re making a smart financial move, but it could result in a significant tax bill.

Even if you don’t sell your business, the CRA could determine that the structure of your critical illness insurance policy creates a taxable disposition. In other words, what was initially sold as a tax-free strategy might not be so tax-free after all.

If you plan to use the CI benefit personally, the funds must be paid out as a taxable dividend. Unlike life insurance, a CI payout does not credit the Capital Dividend Account. This means what initially seemed like a tax-free benefit could ultimately come with a hefty tax bill.

Is the Split Reasonable?

Another red flag is whether the split between corporate and personal contributions is actually reasonable. The CRA could challenge this if it seems disproportionate.

For example, if you purchase a Lifetime Coverage – 15 Pay Product with an ROP on Early Surrender, the CRA may see that as an unreasonable allocation. Some insurance carriers have tools to help determine a reasonable split, but not all brokers take the time to use them.

A good rule of thumb? Make sure your company’s portion of the total premiums is comparable to what it would pay for a simple term policy for the same coverage period. This can help reduce the risk of being hit with a shareholder benefit assessment.

The Problem with Corporate-Owned Critical Illness Benefits

Many business owners are drawn to corporate-owned critical illness insurance because the benefits are tax-free. But what happens when you actually need that money for personal use?

Here’s the catch: Unlike life insurance, a critical illness insurance payout does not create a credit to the Capital Dividend Account. That means if you want to access the money personally, you’ll have to pay yourself a taxable dividend—essentially negating the perceived tax benefits of this strategy.

At the end of the day, the CRA isn’t in the business of letting people extract money from their corporations tax-free. If something sounds too good to be true, it probably is.

Proceed with Caution—And With Your Tax Advisor

If you’re considering a Split Dollar CI policy, don’t rely solely on your insurance broker to guide you. It’s essential to involve your tax advisor or accountant in the conversation.

Some advisors sell these policies without properly disclosing the risks, and that’s a problem. The best brokers will work closely with your tax team to ensure proper documentation is in place, including:

• A formal shared ownership agreement, ideally drafted by a lawyer.
• An actuarial calculation to verify the split is reasonable.

Even with these safeguards, it’s impossible to predict how the CRA will interpret these policies in the future. And if things don’t go as planned, you could find yourself facing unexpected taxes or legal complications.

Final Thoughts: Is Critical Illness Insurance Worth It?

If a Split Dollar Critical Illness policy is structured properly and with full transparency, it can work. But given the uncertainties, it’s not something you should enter into lightly.

Would I recommend purchasing this type of insurance in Toronto just to avoid taxation? No. The risks outweigh the potential rewards, especially given the unpredictable nature of CRA rulings.

If you’re looking for a solid critical illness insurance strategy, there are safer and more straightforward ways to do it. Work with an advisor who prioritizes your best interests, not just their commissions. And most importantly, make sure your tax advisor is on board before making any commitments.

When it comes to insurance in Toronto, it pays to be cautious.