Insurance and Retirement
Preparing for the eventual transfer of assets between generations has been the traditional purpose of life insurance. Over time and with innovations in the insurance industry, life insurance has evolved to also include wealth creation, and income generation elements.
Insurance products can be owned by an individual or inside a corporation depending on the unique situation of each person, family and business; that is, who pays the premiums (or deposits depending on the insurance type) is relevant.
Permanent (whole), Universal and Participating life insurance policies offer a number of potential benefits to individuals, businesses and families depending on who pays the premiums and who is the beneficiary.
In addition to the lump-sum death benefit that provides asset protection for beneficiaries, insurance policies offer various degrees of tax avoidance and deferral that contribute to their attractiveness.
Permanent life insurance provides a prescribed death benefit and accumulates a “cash value” inside the policy. Its “permanence” is based on the lifetime coverage that it provides with the investment element.
Universal life insurance, on the other hand, is a permanent policy and investment account combined. This type of life insurance allows for some investment choice flexibility and tax deferred growth of them.
Participating life insurance is the next level of sophistication allowing for both tax-deferred wealth creation, and the possibility of earning dividends. Dividends can be used to pay premiums or purchase additional insurance.
When a policy is associated with a corporation, there are significant tax advantages to put in place starting in 2016. The rules officially change on January 1, 2017 so it is important to establish the policies in 2016.
More information can be found at: https://www.advisorresearchgroup.ca/doc/insurance-changes-for-2017-introduction-to-the-changes/
In retirement, with expanding life expectancies, insured annuities are an attractive alternative for many investors. The idea is simple, under the annuity contract (which contains an embedded life insurance policy), an investor will receive defined periodic payments for a known amount of time. If that time-frame is fixed, it is called “Term Certain.” If the policy is until death, it is known as a “Life Annuity.” Life annuities can be based on one person or two, the latter case is referred to as “joint and survivor.”
Three major inputs determine the size of the annuity payments: the amount of capital being invested, the prevailing interest rate and the insurability of the annuitant(s). In simple terms, $1 million invested at 9% per annum generates $90,000 or $7,500 per month. The monthly amount, $7,500, is then used to fund the insurance premiums and make the annuity payments. In our current low interest rate environment, the generated monthly “revenue” is much less than $90,000 on $1 million.
This example is overly simplified but the flip-side is that it now takes much more capital to generate income that is attractive, notwithstanding the security that Life Annuities provide.
Annuities funded with registered funds from an RRSP are fully taxable, and payments are treated similarly to RRSP withdrawals from a tax perspective. Non-registered annuities assess the payments as a mixture of Return of Capital (ROC) and interest. The interest portion is subject to income tax, the ROC is not.
With taxation rules changing in 2017, consult your advisor to determine the effects of this change on your contract.
In almost all cases, beneficiaries receive the eventual death benefit tax-free. There are several, highly technical exceptions that require the advice of a qualified and licensed insurance agent and account. To ensure that beneficiaries receive the benefit tax-free, consult your advisor for assistance addressing particular elements of a unique situation as the tax savings are crucial to validate this approach.
Before an annuity contract is purchased, it is advisable to compare capital requirements and payments between issuers. Since many assumptions are made, payments and the financial strength of the issuer should be assessed.
Generally, the older you are, the shorter the term, so the higher the payments. It is important to determine the most advantageous time to buy an annuity with life insurance attached.
- Annuitant – the person or persons on whose life the annuity is based
- Beneficiary – the person who will receive the funds if the owner or annuitant dies prior to the annuity being redeemed
- Issuer – the issuer and payor of the insurance and annuity
- Owner – typically the same person(s) as the annuitant, but technically the purchaser
- Term – the length of the contract, either in years or until death
Regardless of the type of insurance, and whether you are using it to accumulate wealth (tax-deferred and/or inside a corporation) or fund spending in retirement, insurance offers significant benefits for some that some more traditional forms of investing do not. And just the tax-free death benefit alone can make a significant difference.
Jeff Devlin, CFP
Elementus Wealth Management Inc.