When evaluating corporately held life insurance policies, many focus solely on the death benefit and premium schedule. However, two policies with identical premiums and death benefits can result in vastly different net value to your estate. The key difference lies in how each policy impacts the Capital Dividend Account (CDA) and the portion of proceeds that can be distributed tax-free.

The Impact of Policy Structure on CDA

A common tax planning strategy in Canada is to hold life insurance policies within a holding company (Holdco). This approach provides a significant advantage: premiums can be paid with corporate after-tax funds rather than personal funds, creating tax efficiency in premium costs. When a life insurance policy is held by a Holdco, the proceeds received on death are eligible for CDA credit, allowing for tax-free distribution to shareholders.

The CDA is a notional account used by Canadian private corporations to distribute certain amounts tax-free, including life insurance proceeds. With an exempt life insurance policy, the amount credited to the CDA is not the full death benefit but the death benefit minus the adjusted cost base (ACB) of the policy. The ACB reflects the total premiums paid into the policy minus the cumulative cost of insurance. A lower ACB means more of the death benefit is eligible for CDA credit and can be distributed tax-free, while a higher ACB reduces the amount eligible for tax-free distribution.

While the full death benefit is paid to the corporation tax-free, only the amount up to the CDA can be distributed tax-free. Any remaining portion of the death benefit must typically be distributed as a taxable dividend, reducing the overall value of the policy payout to the estate.

Even if two policies have the same death benefit and premium schedule, the internal structure of each—how premiums are allocated between insurance costs and savings/cash value—affects the CDA credit. Structuring a policy with the goal of maximizing the CDA is often overlooked but should be a key element of the planning process.

Note: Only certain corporations are eligible for the CDA. According to Canadian tax law, the corporation must be a private corporation under subsection 89(1) of the Income Tax Act, and it is required that the corporation electing for the CDA be the direct beneficiary of the life insurance policy. Additionally, capital dividends from the CDA are not tax-effective for non-resident shareholders. Speak to your tax advisor for details on how this applies to you.

Key Considerations for Evaluating Life Insurance Policies

When evaluating a corporately held life insurance policy, insist that your broker provides a clear table of ACB and CDA values for each policy year. Additionally, request that they apply the applicable dividend tax rate to the portion of the death benefit not attributed to the CDA dividend. This will provide a clearer picture of the net-to-estate value of the policy in any given year. Understanding this will allow you to estimate how much of the insurance proceeds will actually reach your family and whether an adjustment is needed for any shortfall due to taxes on the dividend.

By using a Holdco to plan your estate in a tax-favored way, it’s crucial to consider the net-to-estate value of your life insurance policy. The true value of a policy goes beyond just the death benefit and premium schedule. By understanding how the policy pricing impacts the CDA, you can optimize the tax-free proceeds available to your estate. Insisting on detailed CDA calculations from your broker will provide better insight into how much of the insurance benefit will reach your family, helping you avoid unexpected liquidity shortfalls.