January 14, 2009, 6:00 am

How To Withdraw Money From Your Holding Without Paying Taxes – The Split Dollar Strategy

by: The Financial Blogger    Category: Financial Planning,Types of Financial Products
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Who likes to pay taxes? I don’t! Actually, most people don’t like to pay taxes ;-) This is probably why we see so many people trying to legally decrease the amount written on the government’s cheque at the end of the year! One way to reduce your taxation rate is to earn income via a corporation or a holding. In most countries, INC structures pay fewer taxes than an individual with the same level of income.



However, it technically comes down to the same thing once it is time to withdraw money from the company… until you know about the split dollar strategy.

The thing is when you withdraw money from a corporation or a holding; it is taxable as income (additional to your current revenue) at your marginal tax rate. Therefore, unless you are retired and live off your company’s dividend, you will pay your share of taxes.

But, there is good news for those who want to benefit from the fruit of their labour while they are still working and earning money. The good news is called the split dollar strategy.This method requires cash flow within the company (you need water to drink, don’t you?) and that the company’s owner is healthy (huh?!?).

So here how the split dollar strategy works:

#1 you take a critical illness insurance contract on the company owners with premiums paid by the company.

#2 you take an option in the critical illness to get full reimbursement of the premiums if the individual doest not have a critical illness after 15 years.

#3 you name the individual (not the company) as the beneficiary or the premiums reimbursement.

#4 in 15 years, you will receive a nice cheque from the insurance company in your name that is not taxable.

Isn’t this too cool to be true? Not really. However, there are some things to know about the split dollar strategy:

#1 the insurance premiums require stead cash flow to be taken out of the company

#2 if you stop the strategy half way, the benefit won’t be that great (full reimbursement option seems to be only available after 15 years).

#3 if you ask for a premium reimbursement prior to the end of the contract, penalties occur.

#4 you will personally get taxed on the “benefit” received from your company in regards to the premium reimbursement option. However, the taxation is minor compared to a regular tax rate.

#5 this insurance is not to be considered as insurance by itself but as a tax saving tool. If you require critical illness insurance, you should do it separately as this contract is meant to be terminated in 15 years.

I’ll run some calculation and come back with a complete example of the split dollar strategy later on.

Disclaimer: I am not telling you to do the split dollar strategy and I am not selling insurance. Please contact a professional in order to determine if this strategy is applicable in your situation.

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Comments

Sounds very similar to the Return of Premium rider on some Life Insurance policies. Probably costs a bit more. That being said, the reason for the money coming back tax free is because the money was ALREADY taxed going into the policy.

Richard,
the premium is tax deductible for the company, therefore not paid with after tax dollar. The benefit receiving the premium is taxed in the end of the company owner. However, the tax rate in Canada is very minimal.

As I said, I’ll come back with real calculation to show you the magic behind the split dollar strategy. However, I have no clue if it works in USA…

As I said, it sounded similar. The way your suggesting sounds like how we down here can use LTC as a business expense (tax write off) to the owner/spouse as well as employees.

As for benefits, well, they get paid directly so they should not be (I’m not a tax guy by any stretch) taxable to the beneficiary, but to the recipients. However, returning of premium down here is just that, a return of premium paid.

I’ll double check to see if it gets returned tax free (I believe it does) since insurance premiums can be tax deducted and still come back tax free for some strange reason.

[...] The Financial Blogger presents How To Withdraw Money From Your Holding Without Paying Taxes – The Split Dollar Strategy [...]

[...] few days ago, I explained the split dollar strategy and give an example of this tax strategy showing how critical illness insurance can help you out [...]