Using Life Insurance to Enhance Returns, Guarantees, Tax Savings and Investment Diversification – Part 1
Canadians are always looking for a financial edge. But any mention that life insurance might provide better returns, guarantees, tax savings, and diversification gets me “the look.” The objections I get are, we don’t trust insurance! We’re too old for insurance! It’s too expensive! We already have enough money to cover our risks!
Most wealthy Canadians who are looking to improve their finances use life insurance for many reasons outside traditional risk management.
Here’s a couple of ways to use life insurance to get an edge:
Example 1: A 70-year-old couple leaving their estate to their children
Since they are financially very comfortable, and know their estate will end up with roughly $3 million that they never spent, they can use life insurance to boost their returns and significantly reduce taxes on their final estate.
They deposit $23,000 per year for 20 years into a $1 million permanent insurance policy, invested in GICs. This has no impact on their lifestyle and provides significant tax sheltering benefits versus leaving it in a regular non-registered investment.
Their estate will be about $400,000 larger than a non-registered investment with a 5% pre-tax yield. If both pass away at age 90, the after-tax yield would be over 7% compounded. If one survived until 94, it would still be equivalent to making almost 9% before tax elsewhere. Their tax bills are lower, as the assets were moved from fully taxed interest income to being tax sheltered in the insurance policy, still with the principal protection of GICs.
In the process they have diversified their net worth into an asset class (an insurance contract) that has guaranteed value. Unlike their other assets, it is not exposed to future stock market or real estate market valuations.
In the end, the life insurance proceeds are paid out tax-free directly to their beneficiaries rather than their estate, thereby bypassing probate.
Example 2: A 40-year-old, high income couple who have used up all of their RRSP contribution room
She has parents aged 70, one of whom is reasonably healthy.
Using the same insurance policy as outlined in the above example, except funded by the 40-year-old couple instead of the parents.
If one of the insured parents lives to age 90, the now 60-year-old couple will receive a tax-free inheritance that they have funded themselves. Again, the benefits are tax-free growth, plus a rate of return of around 7% after tax (equivalent to 13% pre-tax) annualized over the 20 years. In addition, the payout will take place around the time the 40-year-old couple will be retiring.
In future articles I will illustrate some more creative uses of life insurance that can provide better returns, guarantees, tax savings, and diversification.
One thing to remember, is that younger people can kick start this process very economically with $1 million of term insurance while they are young and healthy. It can be converted to a permanent policy later down the road, with no need of further medical underwriting, regardless of their health at that time.