Keith L. Hatton, CFP, CLU, CH.F.C.

Also see Tax Sheltering (other articles)

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The Financial Post

Guide to Investing & Personal Finance - Insurance Planning

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Insurance strategy offers retirement tax break...

PLEASE NOTE: ALL NAMES FROM ARTICLE OMITTED. FOR MORE INFORMATION PAGE BOTTOM

A little-known leveraged life insurance strategy known as an insured retirement plan (IRP) can be used to generate tax-free income in retirement and leave more for your heirs. Most people, including many investment advisers and life insurance agents, have never heard of IRPs, or they think they're too good to be true. But these plans have been around for more than a decade.

In fact, Tim xxxxx and Michael xxxxx, two investment advisers who are licensed to sell life insurance products through RBC Dominion Securities Financial Services (they are among the minority of advisers who straddle the worlds of traditional investment banking and life insurance) call the IRP "the most effective tax-neutralization strategy that exists in Canada today."

Technically, an IRP is not an insured retirement plan. Rather, it is a retirement plan inside a universal life insurance policy, plus an exit strategy, according to Bob xxxxxx, associate broker with xxxxxxxxcorp Insurance Agencies Inc. of Xxxxxxxxxx, Ont.

The key to the tax minimization strategy is to borrow money from a bank on retirement, a loan that is ultimately repaid with a tax-free death benefit. This is also called leveraged life insurance, which admittedly flies in the face of traditional retirement advice to clear all debts.

In addition to life insurance, a universal life policy includes a tax-sheltered cash-value fund that cannot exceed the policy's face value. Deposits are made over several years into investments selected by the policy-holder. An annual premium is withdrawn from the policy to pay for the insurance coverage.

When the policyholder wants to draw on the income in retirement, the accumulated capital is used as collateral for a series of bank loans. These, in effect, provide tax-free income. Interest is tacked on to the outstanding loan balance. The loan isn't paid off until after the policyholder dies.

The loans are structured so the sum of loans plus interest never exceed 75% of the accumulated investment account. If designed properly, there should be a hefty nest egg left to go to your heirs, also tax free.

The policy is funded with contributions well in excess of the cost of the underlying insurance. Xxxxx and Xxxxxx stress the plan best suits affluent or middle-income people who have maximized their registered retirement savings plan contributions.

Unlike RRSP contributions, IRP payments are not tax-deductible. But IRP payouts are tax-free, while RRSP proceeds (normally taken through a registered retirement income fund, or RRIF) are taxable.

For that reason, people in certain income bands may even want to consider an IRP instead of an RRSP, although the investment performance of an RRSP or RRIF is likely to be superior. That's because IRPs do not invest directly in stocks or mutual funds but in indexes, such as the Toronto Stock Exchange 300 or Standard & Poor's 500 composite stock indexes, or bond indexes.

As the RBC advisers put it: "Life insurance companies can only pay interest on the surplus account values in policies. The companies do, however, have the ability to tie the rate of interest to certain stock market indexes."

Because it's not registered, the IRP is not bound by RRSP-style foreign content restrictions.

"You should consider an IRP if you currently own or require life insurance and can wait at least 15 years before you require the supplemental income produced by the IRP," Kraik says. To start an IRP, you must qualify for life insurance, he adds.

The accompanying chart shows the difference between making annual RRSP contributions of $10,000 from age 30 to 65 with annual contributions of $6,000 to an IRP.

These amounts are equivalent in after-tax dollars. The total death benefit when the IRP is first set up is $270,000, and is augmented by investment growth and annual $6,000 IRP premium payments.

The example assumes a person is in the 40% marginal tax bracket before retirement and in the 50% bracket afterward. The money is projected to compound at 9% a year, with 3% annual inflation. That return can't be guaranteed, however.

Note the RRSP growth stops at age 65 and decelerates when it becomes a RRIF at age 69.

The IRP, worth $2.5 million at age 66, is used as collateral to borrow $141,000 each year for 14 years, tax free. At the end you owe the bank $2 million, or $4 million with interest. The cash surrender value of the policy, worth $1.5 million at 65, grows to $5.4 million by age 80.

With the $1-million death benefit, the policy is worth $6.4 million in total at the end, Xxxxxx calculates. So after your estate pays back the bank upon your death, your heirs are left with $2.4 million, tax free. Meanwhile, the RRIF's assets have fallen to zero by age 82.

Tax Sheltering (other articles)

Keith L. Hatton, CFP, ChFC, CLU of Hatton Financial Inc. recommends the IRP as a complement to - rather than replacement for - an RRSP/RRIF combination.

How IRP, RRSP compare

Leveraged insurance can preserve cash flow after retirement

Source: RBC Dominion Securities Inc.

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Keith L. Hatton,
CFP, CLU, CH.F.C.

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