People are always looking for an edge. They want wealth management ideas that will provide a better return, more guarantees, tax savings, and diversification.
When I mention that insurance might provide many of those answers, I get ?the look.?
The look says many things to me. They usually include: I don?t trust insurance. I am too old for insurance. Insurance is too expensive. I already have enough money to cover off risks
But most wealthy Canadians who are looking for an edge use insurance for many reasons outside of traditional risk management. Here are my five ways to use insurance to get an edge:
A 68-year-old has a corporation with $1-million of investments.
They tried not to draw from the corporation because they didn?t want to pay the tax bill. The problem is that when they pass away, the children will want to liquidate the company and will face a big tax bill. Again, insurance can be used to help increase an estate and minimize taxes. We discussed the high passive tax rates on investments in a company. In this case, the company can over time use much of this $1-million to both fund an insurance policy and also possibly shift funds to grow tax free within the insurance policy. The reason is that with certain policies there is an insurance component and an investment component.
In this scenario, the best tax strategy is to eventually move most of the funds into the policy so that when the 68-year-old passes away in 15 or 20 years, most of the corporate assets would be paid out to the shareholders (beneficiaries) tax free. In addition, the rate of return on this investment (funds into the insurance policies and funds paid out) can be well over 6% annualized ? even with effectively investing in a GIC/money market plan within the policy.
A 40-year-old couple have high incomes and use all their RRSP room.
She has 70-year-old parents ? at least one of whom is reasonably healthy. The same insurance policy as outlined in example No. 1 can be used but instead of being funded by the parents, it is funded by the 40-year-old couple.
If the insured parent or parents live to 90, the now 60-year-old couple will receive a tax free inheritance that they funded themselves. As an investment alternative, the benefits are tax free growth, a solid rate of return in the neighbourhood of 7% after tax (13% pre-tax equivalent) annualized. In addition, the payout will take place around the time the 40-year-old couple might be retiring.
A 60-year-old doctor has a corporation.
He also has life insurance that he and his wife took out 30 years ago. The doctor?s corporation has $600,000 of investments today. If that doctor gets his life insurance policies properly valued by an actuary, let?s say they are valued at $400,000. In many cases, the doctor can transfer the life insurance policies to his corporation and get a few significant benefits.
The biggest benefit is that the doctor can effectively swap the $400,000 worth of insurance policies into the corporation and then get $400,000 of assets out of the company tax free. This could save as much as $130,000 of taxes depending on the province.
Another benefit is that the insurance policies are now funded using corporate, pre-tax dollars.
Passive investments in a corporation pay the highest tax of all. If the assets are owned personally, you can lower taxes if you are not in the top marginal tax rate or by investing for growth or dividends.
This strategy does have a few tricky areas related to cash surrender values and average cost basis of the insurance, but the benefit can be significant for anyone with a corporation who has insurance held personally. The key is that even if the policy is owned by the corporation, when it pays out, the funds can be mostly or entirely paid out of the company tax free ? so the beneficiaries get the same amount whether the policies are held inside or outside the company.
A 70-year-old couple know they will be leaving their estate to their children.
Based on conservative projections (with a lot of certainty around expenses and pension income), they will be leaving roughly $3-million. Since they are financially comfortable, and know they will end up with roughly $3-million that they never spend, they can use insurance to boost their returns and reduce taxes.
They would look at buying a joint last to die ? permanent insurance policy (universal life or term to 100 ideally). Let?s say they shift $23,000 a year for 20 years into insurance ($1-million face value), and this $23,000 a year was otherwise sitting in safe, non-registered investments such as bonds, cash or GICs. The couple?s lifestyle won?t change at all with this transfer of funds, but they will get five big benefits over doing nothing:
Their estate size will likely be about $400,000 larger than if the investments were left as is 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% pre-tax somewhere else. That is a return that not many people have seen consistently for over a decade.
Their tax bill would be lower because the assets moved from being taxed fully in a non-registered account, to being tax sheltered in the insurance policy.
They diversified their net worth into an asset class (insurance) that is a contract that doesn?t change value. It is not tied to the stock market or real estate market the way their other assets would be.
The insurance is paid out directly (not to the estate), as a result, there is a lower probate fee bill (this is very important in provinces like Ontario with effectively a 1.5% probate fee on estates).
A 60-year-old couple want to leave much of their estate to charity.
The current plan is that their will says to leave 90% of the estate to three named charities. A better alternative for the couple and the charity would be to look at funding an insurance policy with the ?owner? of the policy and the beneficiary of the policy being one of the charities.
If structured correctly, the couple can use the annual insurance premiums as an annual charitable contribution and use the tax credit (45% to 50% of donation in most provinces) to lower taxes each year.
For example, if the couple put in $20,000 a year to the three insurance policies, they would effectively be paying $10,000 or $11,000 after tax. The charities, would likely receive a payout on the policy, totalling $1.5-million. If the couple left things as the status quo, the charities would receive meaningfully less for three reasons:
Insurance payouts on their own can provide a decent growth rate on permanent insurance policies. Easily over 10% compared to a pre-tax equivalent investment.
The couple got a full tax benefit every year. If they did a very large lump sum charitable donation through their estate, they would miss out on much of the donation tax credit.
The tax free growth within the insurance policy would allow more money to pay out rather than if the assets were taxed every year in the hands of the couple.
If planned well, the couple can still make annual donations ? or may lower the amount of insurance, to allow for annual donations to be made.
As a side note, most charities would rather own an insurance policy than be left money in the estate ? as it usually means the charity receives a cheque shortly after the insured passes away. If left in an estate, it can take much longer to receive the money, and in some cases, family disputes around a large charitable donation can lead to people contesting the will.
As with all wealth management strategies, what might be appropriate for some people may not make any sense for others. The five strategies above simply represent opportunities and ideas that many people never even think about, even though they could often help them to better achieve their goals.
Ted Rechtshaffen is president and wealth advisor at TriDelta Financial, a boutique wealth management and planning firm.
Source: http://business.financialpost.com/2012/11/10/five-ways-insurance-gives-you-an-edge/
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