What should an incorporated dentist know about retained earnings and whole life insurance?

What is a dental professional corporation in Canada?

A dental professional corporation is a corporation authorized to provide dental services under the rules of its province and its dental regulator.

Incorporation changes the legal and tax structure through which a dentist practises. It does not change the dentist's professional obligations to patients, and it does not mean that any corporation can provide dental services. The corporation needs the registrations, permits and continuing compliance required where the dentist practises.

Share ownership deserves attention before any insurance or financing decision. Each province and its dental regulator set rules about who may hold shares, which classes of shares they may hold and who may direct the corporation. These rules differ from one province to another and change from time to time. In Ontario, the Royal College of Dental Surgeons of Ontario (RCDSO) issues the certificate of authorization for a professional corporation. In Quebec, the Ordre des dentistes du Québec (ODQ) sets the declarations required of dentists who practise through a company. In British Columbia, the regulatory role once held by the College of Dental Surgeons of British Columbia (CDSBC) now sits with the College of Oral Health Professionals. Dentists elsewhere should check their own provincial regulator, and everywhere the current rules should be confirmed by a lawyer.

The practical question is whether the corporation can retain money after meeting its obligations. Practice revenue first has to cover staff, premises, supplies, debt service, taxes and the dentist's chosen compensation. Incorporation may, however, leave money inside the corporation for equipment, improvements, expansion or future contingencies.

That is why the discussion should start with a practice financing plan rather than a policy illustration. Who will need the money? When? Can the corporation afford to set some aside for years without weakening its operating reserve? Those answers determine whether a long-term insurance contract is worth considering at all. The wider sequence of a dental career, from associate years to retirement, is set out in financing a dental career, and the purchase year itself in buying a dental practice.

Why do retained earnings build up in a dentist's corporation?

Retained earnings build when the corporation keeps part of its after-tax profits instead of distributing all available money to shareholders.

A dentist may leave funds in the corporation to replace equipment, prepare for a lease renewal, hire staff or explore a second location. Some funds may simply be waiting until the owner decides how and when to take compensation. These are different purposes. Money needed soon for payroll or a fit-out should not be treated the same way as money that can remain committed for many years, and the equipment replacement cycle gives the first group a predictable rhythm.

Retained earnings are an accounting measure, not a separate pile of cash. A corporation can report retained earnings while its resources are tied up in receivables, equipment or other assets. Its accountant can help distinguish the amount shown on the financial statements from cash actually available for a new commitment.

The financing idea known as The Infinite Banking Concept®, described by Nelson Nash in Becoming Your Own Banker® (2000), starts with a broader observation: a family's need for financing can be greater than its need for life insurance protection. It is first a concept about financing: the policy is a tool, and financing is the purpose. A purchase financed through an outside lender has an interest cost. A purchase paid entirely in cash uses money that could otherwise have remained available and earned something elsewhere. The same choice appears in a dental practice when it buys a chair, renovates rooms or opens another location.

The aim is to think like a lender toward your own family and, in this setting, toward the practice: plan future purchases, set terms for restoring the funds used and protect the capacity to finance the next need. Over years, a household may seek to rely less on commercial lenders for ordinary purchases, remembering that a policy loan is itself a loan from the insurer, with interest. Canadian Wealth Creation Centre Inc., the firm that provides the service and publishes the educational website IBC Financial, calls that long-term goal Infinite Financial Sovereignty® (a registered trademark of Jose Salloum). It is a goal, not a promised result. A dental corporation may still need outside credit, especially for large or time-sensitive projects.

Retaining money also has a tax cost and an opportunity cost. An accountant should compare keeping funds in the corporation with paying compensation, reducing debt, maintaining liquid reserves and other uses before any policy is proposed.

How can passive income affect a dentist's small business deduction?

Federal rules can reduce a corporation's small business deduction when it and its associated corporations earn enough passive income, but the calculation concerns income, not simply the balance of retained earnings.

Under subsection 125(2) of the Income Tax Act, the business limit for the small business deduction is $500,000, and associated corporations share a single limit. Subsection 125(5.1) then reduces that limit by $5 for each $1 of adjusted aggregate investment income above $50,000, measured across the corporation and its associated corporations for the taxation years that ended in the preceding calendar year. At $150,000 of such income the business limit reaches nil. A reduced business limit means that less of a corporation's qualifying active business income receives the small business deduction. The calculation has its own definitions and exclusions, so it is not a test based on the size of a savings account; the rule is described in more detail in retained earnings and the passive income rule.

A dental corporation might earn interest, dividends or other income on assets held outside its clinical operations. Its accountant must determine what counts in the statutory measure, whether another corporation is associated with it, and whether the corporation otherwise qualifies for the deduction. Provincial tax treatment also matters. Simply moving retained cash into a different asset does not make the passive income rule disappear.

This is where a participating whole life policy may enter the discussion. When a life insurance policy continues to meet the exempt policy test under section 306 of the Income Tax Regulations, amounts accumulating within the contract are generally treated differently from income earned each year in a taxable corporate account. That does not mean premiums are deductible, that the policy creates a guaranteed tax saving, or that every later withdrawal or loan is tax-free. A policy that fails the exempt test, or a transaction that causes a taxable policy gain, changes the analysis. Amounts in respect of a life insurance policy that are included in the corporation's income, such as the part of a policy loan above the adjusted cost basis, count in adjusted aggregate investment income for that year (subsection 125(7) of the Income Tax Act) and can reduce the following year's business limit.

The reason to raise the issue is to ask a focused question, not to assume an answer: how would this particular contract and its intended use be treated in the corporation's tax filings and in its passive income calculation? Ask the accountant to compare projected policy transactions with the corporation's existing assets and expected needs. A physician's corporation faces the same questions, discussed in incorporated physicians and retained earnings.

How could a participating whole life policy help finance dental equipment?

A corporation with a suitably funded policy may later obtain a policy loan from the insurer and use the proceeds for a practice expense, subject to the contract and the available loan value.

Participating whole life insurance combines a death benefit with cash values set out in the contract. It is an insurance contract, not an investment. A Canadian participating policy may also receive dividends, but dividends are never guaranteed. If declared, they are applied under the dividend option chosen in the contract, often to buy paid-up additions, and the dividend scale interest rate an insurer publishes is not the rate at which the policy's cash value grows. The guaranteed values, possible dividends, premiums and loan provisions should each be read separately. The contract continues to be administered under its terms while a loan is outstanding; the loan does not create a second pool of money beside the policy.

A policy loan is an advance from the insurer, secured by the policy's cash value. The corporation, as policyowner, requests it under the contract's provisions. It is requested from the insurer rather than approved like commercial credit, but the insurer confirms the amount available under the contract and its rules, and an assignee's consent may be needed. The owner plans repayments within the contract's terms, but interest is owed to the insurer whether or not the corporation follows that plan.

The proceeds might help pay for equipment, leasehold improvements or work associated with a second location. That possibility is most useful when the need occurs after the policy has had time to develop accessible value, which is why capitalization comes before use. It takes years and steady funding to build a useful financing capacity. It is therefore a poor substitute for cash that a practice may need shortly after opening.

Illustrative example only, with no dollar amounts: suppose a corporation, after reviewing its contract, requests a policy loan equal to the price of a new piece of equipment, and the amount is well within the loan value the insurer would permit. The corporation budgets to repay the principal in three equal yearly instalments, each one third of the amount advanced. If every instalment is paid on time and the interest is paid as it is charged, the amount advanced is repaid by the end of the third year. Interest charged by the insurer is additional and is deliberately not estimated here; unpaid interest may be added to the loan under the contract's terms, and three payments of the original amount would then leave a balance. Ask the insurer for a schedule showing each payment, the interest and the closing balance. The example does not project policy values, tax treatment or approval for any other form of credit.

A loan is not automatically tax-free. In Canada, a policy loan is a disposition under section 148 of the Income Tax Act: the amount above the policy's adjusted cost basis immediately before the loan is included in income. If a policy loan caused an income inclusion, a later repayment of that loan can be deductible under paragraph 60(s) of the Income Tax Act, within its limits. Ask the insurer for the policy's current adjusted cost basis, and have the corporation's accountant review it and the likely tax result before a loan request. Whether any loan interest is deductible is a separate question for the same accountant, not something to assume.

Can a corporate-owned policy secure a loan from an outside lender?

A corporation may offer its policy as collateral for a conventional loan, but the outside lender decides whether to lend, how much to advance and on what terms.

This is distinct from a policy loan. With a collateral loan, an outside lender advances the money under a credit agreement, and the policy helps secure the debt. The lender may examine the practice's finances, ask for other security, impose covenants and decline the application. The policy does not replace credit approval or promise access to a stated amount.

A collateral arrangement can be considered when a project needs more financing or different terms than a policy loan from the insurer can provide. A dentist looking at a second location, for example, should compare the full cost and restrictions of conventional borrowing with the available policy loan provisions and with paying from cash. The sound comparison includes the effect on operating liquidity, not just the interest stated in either agreement.

Collateral also complicates what happens at death. A lender may have a claim on policy proceeds to satisfy the corporation's debt. The corporation should understand who is legally entitled to any remaining proceeds and how the assignment documents affect its capital dividend account. The legal relationships and the form of the assignment both matter, so the accountant and lawyer should read the lender's documents before they are signed.

Both borrowing routes have limits. A conventional lender can enforce its own agreement if the corporation defaults. Neither route removes the need to fund ongoing premiums. Before pledging a policy, ask the insurer, lender, accountant and lawyer to work from the same proposed documents.

Who should own and pay for the policy, and who should receive the death benefit?

For a corporately owned arrangement, ownership, premium payments and beneficiary designations should be decided with the accountant and a lawyer before the contract is issued.

A common starting point is for the dental corporation to own the policy, pay its premiums from corporate funds and be named beneficiary. Those roles should be recorded accurately, not inferred from who signs an application or whose life is insured. The dentist may be the insured person without being the policyowner or the beneficiary. The trade-offs between the two routes are compared in personal or corporate ownership of the contract.

Why decide early? Changes made after issue may have tax consequences, require insurer documentation or interfere with a future financing plan. A practice sale, a new shareholder, a move between corporations or a change in family circumstances can make an apparently simple designation consequential.

Corporate money should not quietly pay for a personal arrangement. If a corporation pays an owner's personal premiums, or uses policy proceeds to cover personal expenses without proper treatment, the shareholder benefit rules may apply. If the corporation receives a policy loan and the dentist wants to use the proceeds personally, the accountant should first determine whether that can be done through properly documented compensation, a dividend or another lawful transaction, and what tax follows. A corporate loan does not make corporate funds the shareholder's personal cash.

On the death of an insured person, proceeds received by a private corporation may create an addition to its capital dividend account, or CDA, the account defined in subsection 89(1) of the Income Tax Act. Broadly, the addition reflects the death proceeds received less the policy's adjusted cost basis immediately before death. It is therefore not automatically the full death benefit, and a policy loan or an assignment can change what the corporation actually receives.

A private corporation with a sufficient CDA balance may elect to pay a capital dividend to its shareholders, subject to the rules and to an election filed on time, based on the accountant's calculation of the balance. That is a corporate tax mechanism, not an automatic payout to the dentist's family, and the steps are described in paying a capital dividend after a death. Outstanding debt, a collateral assignment, shareholder agreements and the corporation's other obligations can all affect the result. The accountant and lawyer should model death, disability, sale and succession outcomes before anyone chooses the owner and beneficiary; disability in particular is covered in disability and the capital plan.

What costs and risks should an incorporated dentist weigh?

The main drawbacks are early policy costs, a long funding commitment, uncertain dividends, borrowing costs and the possibility that tax or business needs will differ from the original plan.

A participating whole life policy is life insurance, not an investment. It has guaranteed cash values under its contract, but its illustrated dividends are not guaranteed. Its early accessible value can be substantially less than the premiums paid, and the real costs of those years deserve a close look. If practice cash is tight, the commitment can compete with wages, tax instalments, debt payments and a reserve for urgent repairs. Surrendering or changing course early may be costly and can trigger a taxable policy gain. The policy also depends on the insurer accepting the person to be insured: it reviews health, lifestyle and finances and may offer standard terms, charge more, exclude a risk or decline, so the premium and early values are not known until it makes an offer. Do not commit practice cash to a design before receiving the insurer's terms.

Borrowing does not erase the financing cost. The insurer charges interest on a policy loan. If interest is not paid, the debt grows. An outstanding loan reduces the death proceeds available after the insurer settles what is owed. Sufficiently large debt, missed premiums or other contract problems can cause a lapse, with possible tax consequences. A collateral lender's terms introduce separate credit and enforcement risks.

Tax treatment needs continuing attention. Exempt status depends on the policy meeting the regulatory test, not on calling it whole life. The passive income and CDA calculations use different definitions and apply at different times. The corporation should keep policy statements, loan records, premium records and its accountant's adjusted cost basis calculations together.

There is also insurer risk. Assuris protects eligible Canadian policyholders within limits if a member insurer fails, and it calculates that protection after policy loans. Assuris is not a government guarantee.

This approach does not suit a corporation without reliable surplus cash, a dentist who expects to need most of the funds soon, or an owner unwilling to maintain and review a policy over many years. It may not suit a practice whose urgent priority is expensive existing debt, unstable revenue or an underfunded operating reserve. It is particularly unsuitable if its appeal depends on dividends occurring, on a particular tax outcome, or on immediate access to most of the premiums paid.

The author is paid commissions by insurers when a policy is bought. That makes independent accounting and legal review, and a clear comparison with simpler financing choices, especially important.

What should a dentist ask before arranging a corporate policy?

Ask whether the corporation has a durable financing need, real spare funding capacity and a documented reason to use this particular insurance contract.

Start with the practice rather than a proposed premium. List likely equipment replacements, leasehold work and expansion decisions. Separate needs that could arise soon from those that might arise after years of funding. Decide how much cash must remain immediately available for staff, taxes and unexpected closures or repairs. Then consider how the corporation would restore money used for each planned purchase.

Next, ask the accountant to review retained earnings, available cash and associated corporations. Ask how the small business deduction and an exempt policy would apply to this corporation. Request separate explanations for premiums, policy loans, possible policy gains and proceeds on death. If the shares may be sold one day, ask whether holding the policy could change the tax result of that sale.

Ask the lawyer to check the regulator's corporate rules, shareholder agreements, ownership and beneficiary designations, and what happens if the practice is sold or the dentist dies. If collateral borrowing is contemplated, the lawyer should also examine the lender's proposed security documents.

Finally, compare the contract's guaranteed values with any non-guaranteed illustration. Ask how much could be available when a practice expense is likely, what happens if premiums stop, how loan interest is handled, and what remains payable on death with an outstanding loan. Compare those answers with keeping liquid reserves, paying down debt and using ordinary commercial credit.

A short written list keeps these meetings focused. Before the contract is issued, ask for and keep in writing:

• which corporation will own the policy, pay the premiums and be named beneficiary, and why;
• the guaranteed cash values year by year, shown apart from any illustrated dividends;
• the premiums the corporation must keep paying, and what happens if one is missed;
• how the insurer sets loan interest, applies repayments and treats unpaid interest;
• the policy's current adjusted cost basis;
• the accountant's view of the policy's effect on the passive income calculation and on the capital dividend account;
• the regulator's current share rules for the professional corporation, confirmed by the lawyer.