THE
SECRET ALTERNATIVE TO THE RRSP
Leveraged
Life as a Pay-now Save-Later strategy
by Risha Gotlieb
special to The Star
Canadians may have fallen in love
with RRSP's to the tune of $26 billion contributed in
1996-but there are other retirement investment programs that also offer a tax
shelter.
An investment advisor at Townson & Co. Insurance Agencies of
Townson stresses that leveraged life insurance is one of the most effective tax
minimization strategies available to Canadians today- and possibly one of the
best kept secrets.
While the concept has been around
for more than a decade, most people including financial advisors,
have never heard of it. This may be due to the fact that insurance companies
have only recently started to package and market it.
Also, most insurance companies
marketing the concept require their sales force to be well versed in the
complexities of both life insurance and investments, which is a rare breed.
Therefore, there are very few in the industry extolling the programs benefits.
Bud Townson,
president of Townson & Co. was on the ManuLife Financial task force that developed their version
of the leveraged life insurance concept. Most major insurance companies,
including Canada Life and Standard Life, offer a similar plan under different
names.
The plan uses a universal life
insurance policy that contains an investment fund. It is the fund that makes it
possible to transform your life insurance into a retirement strategy with tax
neutralizing power. As Townson points out, the
insurance component of the plan makes it a low risk investment vehicle.
To get maximum benefit from the
strategy, you should first have a need for a permanent permanent
insurance policy, preferably one that features significant cash values. Second,
you should be prepared to invest into it for at least 10-15 years.
Contributions into the investment
portion can be as much or as little as you desire as long as they don't exceed
the limits set out by the Income Tax Act.
To illustrate the strategy of
leveraged insurance, Townson provides an example of a
30 year-old female client who purchased a $300,000 policy. Let's say the client
contributes $500 a month until the age of 55.
Using an assumed interest rate of
6 percent, the cash value of the plan will have grown at a tax-free compounding
rate to a total of $352,000. Then at age 55, she will no longer
be required to make contributions. This is due to the fact that the
regularly scheduled withdrawls are made from the
investment portion to pay for the life insurance portion of the plan.
Although the policyholder has
stopped making contributions, the account value of the plan continues to grow
and at age 65, it will have a cash value of $713,000. With an average life
expectancy of 82 for females, the policy's death benefit at that time would be
about $2.4 million.
If the policyholder decides to
retire at 65, she can now use her insurance policy as collateral to borrow
money from a bank. It she decides to borrow $52,000 each year for ten years at
a rate of 8 percent- she will have accumulated a debt of $1.5 million.
This debt is then paid off up on
her death by the insurance policy , leaving her estate
the balance of $950,000 in tax-free insurance benefits. Also, because the
annual amounts of $52,000 are loans-and not income, they are tax neutral.
Generally speaking, lending
institutions will loan up to 75% of the cash value of the insurance policy.
The investment portion of the
plan has various investment vehicles from which the policyholder may choose.These range from daily interest savings to
index accounts, which reflect the performance of indexes such as
the Toronto Stock exchange 300 or Standard & Poors
500 composite stock indexes, or bond indexes.
There are of course some risks to
a leveraged life insurance plan, as with any sophisticated planning strategy.
" These risks, however can be minimized if the plan is properly structured"
says Joel Cuperfain, a lawyer specializing in tax and
estate planning with ManuLife Financial.
He adds their
are more tax complexities when it's used for corporate situations rather
than for individuals. In corporate scenarios. for example, it's often used to fund buy-sell agreements and
partnership buyouts.
"Perhaps one of the biggest
risks is that the tax rules could be changed" Cuperfain
says.
Indeed, changes in the income tax
act could effect this policy, but this is true with
other investment strategies, including RRSP's.
Another concern that Cuperfain has is interest rate uncertainty.
" The actual rates of return within the policy are not guaranteed" he
says. "Also the interest earned by the policy is not linked to he interest rate on the bank loan"
The two rates do not necessarily
work in harmony: in fact, it's possible that the bank loan rate will increase
as the earnings rate decreases.
Also, the rate of return on your
investment fund will have some variables that are determined by the insurance
company.
"It's important to look very
carefully at exactly what's being offered in the investment" says Townson. " Any institution
has a defined spread between what they are earning and what they pay
out"
She emphasizes that leveraged
insurance concepts are generally sold as supplements to RRSP's.
They are also effective retirement strategies for business owners and
self-employed professionals who need permanent insurance anyway.
In addition, Townson
recently used a version of the concept successfully in situations involving
charitable donations.
If you are considering leveraging
life insurance , it's advisable to seek out
professional advice. This should include a knowledgeable insurance broker, a
tax accountant and a legal adviser.