Thomas A. Rogers, CFP, CIM, FCSI, EPC - Insurance Advisory: RSP

Thomas A. Rogers,
CIM, FCSI, CFP, EPC
Financial Advisor for
Your Monetary Affairs

An Unappreciated Risk
and casual walk through
The Essence of Universal Life

Introduction
The context
for the investment

Dilemma
The Damocles sword
of The Tax Collector

Universal Life
Turning the table
on The Tax Takers

Tax Free
Compounding Capital !
Eh? What's the catch?

Free Choice
Investing Capital Portion
You are free to choose

The Cost
What are the costs?
How is return affected?

Show Me
Some comparisons with
taxable investment elsewhere.

Flexible Features
Additional Advantages
You will be pleased to know about.

More Insurance Investing
Other ways to use insurance
to your investment advantage.

Introduction

An Analysis of
The Comparative Advantage of
Insuring Retirement Plans against Federal and Provincial Estate Taxes
by
Thomas A. Rogers

- As an investor, you have a duty to safeguard your own well being and, you also have a duty to your beneficiaries to protect the assets you will be leaving to the benefit of others.

- One major threat to the preservation of your capital is the income tax and probate fees that can be levied against your estate. A particularly vulnerable area is your Registered Retirement Savings Plan or your Registered Retirement Income Fund.

- An effective way to protect these assets is through the purchase of Universal Life Insurance if it can be demonstrated that it is competitive to other investment alternatives of a conservative nature available to you.

- This analysis is designed to assess the comparative advantage, and in some cases the potential for disadvantage of the Life Insurance investment option.

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Data derived is based on an insurance investment offered by a leading well known Canadian financial service group. Depending upon your age and circumstance a like investment may be secured to suit your needs. Results will vary among policies of different insurers owing to differing policy variables. E. & O. E.

Dilemma

The Tax Dilemma
Challenging the Surviving Intact of your RRSP or RRIF

Under current tax legislation when a person dies, without a surviving spouse or a dependant child, the value of his or her Registered Retirement Savings Plan or Registered Retirement Income Fund as the case may be.....

is considered to be taxable income in computing income for the person's final tax return ......

In the event this is a substantial amount, which very often it is; most, if not all of it will be taxed at the highest rate possible. In Ontario this is presently 47%.........

If your registered plan was worth $100,000 when you died, your estate would receive only $53,000 less applicable probate fees....

What can you do about it ? Topic Menu

The Defence

Defend with Universal Life
Turning the Table on the Tax Takers

Universal Life is composed of two attractive investment components......

No.1 is the Life Insurance itself, and No.2 is the compounding investment in the Sheltered Investment Account.....

The portion designated to Life Insurance is based on its face value, your age and your health.......

The amount free to compound largely tax free in the Sheltered Investment Account must be in relation to your insurance face value according to the tax act....

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Tax Sheltered Yes! Tax Sheltered Compounding
No catch but reasonable restriction

The portion of the net investment income allocated to your Sheltered Investment Account is only subject a minor investment income tax (15% or less according to insurer's allocation) while in the policy.

It continues to compound thus sheltered from tax while the policy remains in force.

All proceeds, including Insurance and Sheltered Investment Account paid to your beneficiaries are received tax free too. No probate fees either!

The reasonable restriction set by the tax act is referred to as the Maximum Taxable Actuarial Reserve (MTAR) and may be summarized as the value of a sinking fund growing at an assumed interest rate minus the cost of insurance that would be required to equal the face amount of the policy at age 85.

Within limits set by this MTAR, the Sheltered Investment Account may be allowed to increase as the Insurance portion is systematically decreased and in time the policy could be composed entirely of the Sheltered Investment Account.

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Free Choice

The Choice is Yours
Allocate or Rotate among Selections

You may select the investment medium for your tax sheltered Sheltered Investment Account.
Your rate of return is determined by the performance of the your selected option such as the following:

Equity Options linked to TSE 300 or S&P 500 index growth.

A rolling 5 year interest rate fund or 3, 5, and 10 year Guaranteed Investment Options.

A combination of Income and Equity as managed by expert external investment advisors

Any mixture you decide upon periodically as most suitable based on your own judgement.
There are many other investment options offered by Insurance Companies. The above is merely representative.

What's the cost effect?

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The Cost

The Policy Costs
What are they? What's their Effect?

Policy costs are to cover commission, administrative expenses and policy taxes. For detail located elsewhere, see costs

These costs are generally amortized or smoothed out over the first decade or during the premium payment years.

After the initial years, insurance companies begin to bonus policies by adding an increase to the return earned by the Sheltered Investment Account. The bonus can serve to significantly reduce annual charges or compensate for earlier costs.

While costs and the insurance portion are ultimately overcome by the tax Sheltered Investment Account, the advantage over the alternative investment is secured by the insurance value during the initial years.

As costs and insurance premium have been surpassed, tax sheltered compounding accelerates its lead.

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Representative Examples of the UL Tax Defense

Click through the examples below illustrating the Sheltered Insurance Defense using a joint Universal Life insurance policy at different ages compared with an Unsheltered conventional accrual attempt.

If launched at Age 35 by Ted & May Threefive:
Ted income $75,000, May $50,000 increasing with 2% inflation. Marginal tax rate=37% Ted Max RRSP contrib. $9,500 (after pension contribution), May contributes $9,000. Ted investable funds after expense, pension, and universal life contributions $8,151, May is $4,376. Rate of return after MERs on RRSP and Unsheltered investment account for Ted and May is 6%. RRSP current balance Ted = $25,000 , May = $15,000. Unsheltered Investment accounts: Ted = $20,000 , May = $15,000. Universal life contribution is $5,000 each. Basic return for policy's investment account is 5% net of MER + bonus of 1.5% which begins in year 11.
If launched at Age 45 by Ted & May Fourfive:
Ted income by then $91,425, May $60,950 increasing with 2% inflation. Marginal tax rate=40% Ted Max RRSP contrib. $11,580 (after pension contribution), May contributes $10,971. Ted investable funds after expense, pension and universal life contributions $9,622, May is $853. Rate of return after MERs on RRSP and Unsheltered investment account for Ted and May is 6%. RRSP current balance Ted = $231,085 May = $193,404. Unsheltered Investment accounts: Ted = $118,470, May = $61,767. Universal life contribution is $10,500 each. Basic return for policy's investment account is 5% net of MER + bonus of 1.5% which begins in year 11.
If launched at Age 55 by Ted & May Fiftyfive:
Ted income by then $111,450, May $74,300 increasing with 2% inflation. Marginal tax rate=43% Ted Max RRSP contrib. $14,117 (after pension contribution), May contributes $13,374. Ted investable funds after expense, pension and universal life contributions $23,938 May is $7,937. Rate of return after MERs on RRSP and Unsheltered investment account for Ted and May is 6%. RRSP current balance Ted = $579,397 May = $503,201. Unsheltered Investment accounts: Ted = $123,425, May = $62,206. Universal life contribution is $17,000 each. Basic return for policy's investment account is 5% net of MER + bonus of 1.5% which begins in year 11.
If launched at Age 60 by Ted & May Sixty:
Ted income by then $123,050, May $82,033 increasing with 2% inflation. Marginal tax rate=43% Ted Max RRSP contrib. $15,586 (after pension contribution), May contributes $14,765. Ted investable funds after expense, pension and universal life contributions $31,088 May is $10,099. Rate of return after MERs on RRSP and Unsheltered investment account for Ted and May is 6%. RRSP current balance Ted = $857,996 May = $751,681. Unsheltered Investment accounts: Ted = $653,851 May = $383,364. Universal life contribution is $25,000 each. Basic return for policy's investment account is 5% net of MER + bonus of 1.5% which begins in year 11.

See also the further examples back at

flexible features ?

Examples shown are for illustration purposes only, rates are subject to change.

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Insured Investor receives: Policy Value + Tax Free Compounding Capital Value + after tax value of Retirement Plan
Uninsured Investor receives: After Tax Value of Compounding Investment + after tax remainder of Retirement Plan.

Dave & Shirley
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- Dave and Shirley are retired school teachers with combined RRSP assets of $100,000.

- The surviving spouse will receive the other's Retirement Plan tax free, upon the first death as a rollover.

- Accordingly they have opted for a joint "Last to Die" Universal Life policy.

- Actuarially this procedure enables their insurance premium to be that of an individual male of only 51 years.

- Their marginal tax rate has been averaged at 41.7% for this comparison.

- Illustrated is their insurance advantage vs an equal amount in a taxable 8% investment.

Charmaigne
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- Charmaigne would like as much as possible of her estate to go to her two struggling creative children.

- She has built up a reasonable RRSP after her pension contributions. She is now receiving her pension.

- She has other savings too which she has invested conservatively for income rather than capital gain.

- From a tax perspective the only truly vulnerable asset she has is her RRSP.

- Her marginal tax rate is 41.7%. She invests on a relatively low risk basis following a balanced approach.

- Illustrated is her insurance advantage vs an equal amount in a taxable 6.5% long term investment.

Andrew and Maria Martin
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- Andrew, a retired Executive, through diligence and prudence has accumulated considerable means.

- Ordinarily, purchase of life insurance for Estate preservation might not be economic at his age.

- However, a joint last to die policy with Maria (72 also) results in an insuring age of 60.

- The Martins have grandchildren they would like to have as beneficiaries rather than Revenue Canada.

- Channelling a portion of designated estate assets into Universal Life prevents further taxation of its earnings.

- This is feasible provided the Universal Life investment can compete on a total return basis.

- They have asked if this can be demonstrated assuming a long term balanced portfolio return of 6.5%

Ron and Sally
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- Ron is 44 and Sally is 42. Their joint 'last to die' policy is based on an insurable age of 30 !

- Ron's Mom is elderly and in 'tentative' health, his Dad died a few years ago.

- The savings and insurance proceeds coming to Ron and Sally will give them a large investment portfolio.

- Ron is secure in his career with a major Canadian bank and is currently at the mid management level.

- The couple have two pre-teen daughters, own their home and have paid off their mortgage.

- Their RRSP's total $200,000 and are estimated to peak at $1,000,000 several years into retirement.

- The face value of their equity linked Universal Life policy will be an additional major accessible asset.

- Grateful for his parent's prudence, Ron wishes to ensure a similar financial security for his children.

Insured Investor receives:- Policy Value + Tax Free Compounding Capital Value + after tax value of Retirement Plan
Uninsured Investor receives:- After Tax Value of Compounding Investment + after tax remainder of Retirement Plan.

Michael Peters
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- Michael has 2 RRSP's worth $600,000. A 'regular' plan and a 'locked in' plan.

- He wants tax protection so his niece will receive the full benefit of his plans when he dies.

- He is not able to benefit from a lower insurable age via a joint policy as he is single.

- Unsure about his future financial requirements, he is reluctant to make a large annual commitment.

- He has requested a comparative analysis with minimal contribution to tax free compounding.

- This example demonstrates the significance of the investment portion in concert with the insurance benefit.

- With the investment portion minimized the insurance benefit on its own eventually becomes uncompetitive.

- However, there is a solution for Michael owing to the flexibility of Universal Life. See flexible features ?.

Extra Benefits

Flexible Features
More
Useful aspects of Universal Life

The Tax Sheltered Investment Account may be accessed at anytime. Amounts withdrawn prior to death will be taxable as ordinary income to a minor degree in the early years, if at all, but do become more fully taxable in later years. However....

Rather than withdrawing funds, investors may borrow the cash value of the Sheltered Investment Account. Interest paid or accrued may be tax deductible while income continuing to be earned within the policy compounds on a tax sheltered basis. (turning the tax table again!)

So long as sufficient funds are available in the Sheltered Investment Account, clients may elect to have premiums paid from that source. In fact....

In most cases, assuming the anticipated growth of the tax Sheltered Investment Account is realised, by over funding the insurance cost through maximized premiums in the early years, sufficient resources will accumulate after 4 to 6 years to fund future insurance costs life long !

By continuing full premium payment for a few additional years, the compounding of the tax Sheltered Investment Account will continue to grow even after covering the insurance premium on its own. Indeed the insurance portion and cost can be designed to diminish entirely as the Sheltered Investment Account equals and exceeds the original face value.

After a policy has been in force for a few years, cost offsetting special bonuses are added to the compounding returns of the tax Sheltered Investment Account. One company increases the selected/linked growth rate up to 1% beginning in the 6th year, while another increases the return by 1.5% beginning in the 11th year.

As well as providing an immediate estate benefit from the insurance value, Universal Life provides a means for accumulating tax sheltered future wealth to augment (if necessary) the retirement funds available from Retirement Income Funds or other Pension Funds...and in the event of illness available funds may be withdrawn tax free from the Sheltered Investment Account.

Too often investors are limited in their allowable Registered Retirement Savings Plan contributions due to the contributions made to their company pension plans. The Universal Life compounding tax Sheltered Investment Account is a viable alternative or adjunct to the RRSP.

Besides Universal Life's long term insurance benefit, the provision of a compounding tax Sheltered Investment Account enables many parents to provide a funding source similar to the more complex and 'contingent' Registered Educational Savings Plan. Or, it can be used to build sheltered funds to supplement the RESP.

A Final and important reminder, you may select from several attractive policy riders to protect this valuable asset in the event of accident or failing health.

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Other Ways of
Insuring to Your Investment Advantage

Depending on your circumstances, Insurance products can be used as part of a plan to help you preserve the value of your estate, enhance your portfolio, minimize taxes and ensure your beneficiaries are provided for. Here are some of the ways:

As in the RRSP defence, defend against tax on large unrealised capital gains taxable upon demise.

Insured Annuities dramatically improve yield over GIC's, secure higher rate for life and protect capital.

Universal Life provides means to transfer wealth tax free and reduce tax on investment income.

Segregated mutual funds offer guarantee against capital loss, creditor and probate protection.

Charitable Annuities offer unique tax advantages over other forms of charitable giving.

Guaranteed Interest Annuities pay proceeds directly to a named beneficiary thus by-passing probate.

Explanations with illustrations are available on each of the above. Please enquire.