If you knew you could pay dividends out of your company that were tax free, wouldn’t you arrange your balance sheet in such a way to take advantage of that? Sure you would.

The Income Tax Act makes provision for “capital dividends” which in essence are dividends that can be paid directly to shareholders free of tax. However, there are only a limited number of transactions that create an opportunity for the corporation to declare a capital dividend. One of those is the receipt of life insurance proceeds upon the death of a shareholder.

As insurance advisors, sometimes we hear business owners say they are aren’t interested in insurance because there is enough liquidity around to pay tax liabilities or buy out shareholders upon a death. They believe they are “self insuring”.

The term “self insuring”, however, can be very misleading. It is a belief that money in the bank is at least as good as, if not better, than money that comes from an insurance payout. The fallacy of this conviction is that the money they consider to be “self insurance” can’t get out to shareholders on a tax free basis…life insurance proceeds can.

So, here is an ideal solution. Take some of the “self insurance account” and put it into an account that has an insurance contract attached to it. Then, when that account gets paid out it will receive “capital dividend” treatment and be paid tax free to the shareholders.

Now that is truly “self insuring” when a business owner take their taxable account and turns it into a non-taxable capital dividend account.