Now that people are living longer, it’s no surprise that one of the biggest concerns among aging Canadians is the genuine fear of outliving retirement savings. And most people would also like to leave a legacy of some sort to their families and other beneficiaries. Trust and Estate Practitioner Mark Halpern shows you how to achieve your goals.
Low interest rates are the ‘new normal’ while the stock market continues to enjoy a gravity-defying ride (so far) that cannot last forever.
Many investors, especially aging Baby Boomers on the cusp of retirement, can’t afford to sustain losses on their portfolios. They need security of income and want to leave an estate to their family and/or charity.
Annuities have long been recognized as one of the best secured investments available. An annuity pays income at regular intervals, usually monthly, starting either immediately or at some date in the future.
A ‘term certain’ annuity pays out for a specified number of years, while a life annuity makes payments for as long as you live. A joint life annuity makes payments for as long as either you or your spouse lives.
However, after death, the money is no longer available to give to heirs—and this last detail presents an unwelcome challenge for people who are unaware of the insured annuity strategy.
Insured annuities – 7 key advantages
An insured annuity provides a unique combination of an annuity plus permanent life insurance. This type of annuity includes many attractive features:
■ You receive regular payments while you are alive;
■ You cannot outlive this source of retirement income;
■ You maintain your estate for your beneficiaries;
■ You increase your after-tax income;
■ You are assured of the security that characteristically comes with an annuity investment;
■ Your estate will be able to bypass probate; and
■ You can use it as an effective solution for yourself or your corporation.
Insured annuities offer tax advantages
An insured annuity is also very tax-effective. Annuity payments consist of two parts: interest income plus return of capital. The capital part is not taxed. And while the interest portion is taxed, the tax hit is often much less than with interest that other types of investment pay, which is always taxed at a relatively high rate.
Insured annuity vs. GIC
Here’s an example that compares a guaranteed investment certificate (or GIC) plan with an insured annuity strategy:
The GIC approach—Norman is 70 years old, with $500,000 invested in GICs at the bank. He earns two per cent interest, which provides income of $10,000 a year.
Norman has other investments, such as a Registered Retirement Savings Plan (RRSP), Tax-Free Savings Account (TFSA), Canada Pension Plan (CPP), plus non-registered investments, which give him a marginal tax rate of 46 per cent.
This means he pays $4,600 in tax on his GIC income, leaving him with only $5,400 of the $10,000 the bank paid. Interest income is highly taxed so it doesn’t leave Norman with very much for his lifestyle expense needs.
Norman likes GICs because there is no volatility, an assured income, and peace of mind knowing his $500,000 will be preserved to leave for his family.
The insured annuity approach—Helen is also 70 years old, with $500,000 invested in GICs, generating the same $5,400 each year, after taxes. She too has other investments, including an RRSP, her CPP and some other, non-registered investments.
With the help of a certified financial planner, Helen changed tactics when the GIC came due by reinvesting her $500,000 in an insured annuity that pays her $33,252 a year—a good deal more than the GICs.
Helen is taxed on just a portion of the annuity ($2,196), amounting to tax of $1,010 a year. After taxes, Helen is now left with $32,242 ($33,252 – $1,010), considerably more than she was receiving with the GICs.
In contrast to Norman’s situation, however, the capital is coming back to Helen. If she had opted for a regular annuity instead of an insured annuity, the payments would stop on her death and the money would revert to the insurance company that manages the annuity. But Helen, like Norman, wants to leave some money to her children and other heirs.
Ensure an inheritance for family and heirs
Her financial advisor implemented an easy fix to help Helen with this issue. Now, every time she receives the annuity payment, she uses a portion of the money to pay the premiums on a term-to-100 life insurance policy that will pay her family $500,000 when she dies via an insured annuity. This matches the amount Norman plans to leave his family. Yet Helen now enjoys a much higher after-tax income than she could get with the GICs, even after paying the insurance premiums.
Insured annuities also offer many estate planning advantages which include eliminating probate fees and other associated costs, taking weeks instead of months to process, maintaining privacy and protection from creditors.
Helen now nets $13,975 annually compared to Norman’s $5,400. She more than doubled her available after-tax income while enjoying the considerable estate planning benefits that accompany this strategy.
The main drawback of an insured annuity is the loss of liquidity. Investors need to have other funds set aside for emergencies and must qualify for the life insurance coverage.
Insured annuities for corporations
Insured annuities are also available to corporations. Meet Joan and Peter, a couple whose investment portfolio is held within a corporation, their holding company. They accumulated assets from the income of their family business and ultimate sale of the operating company.
As conservative investors, their risk-averse portfolio consists entirely of interest-bearing investments, including GICs; however, these don’t meet their income needs.
The interest income is fully taxable at the corporate rate. Net income from these investments is paid out from the company to them and taxed again as taxable dividends. If the corporation is wound up on their death, the proceeds are paid as taxable dividends to their beneficiaries.
A corporate insured annuity works very much like a personal insured annuity, in that the couple switches out of the GIC-like investments and the funds are moved into an annuity, using the income to buy a corporately-owned insurance policy.
From a tax perspective, a corporately-held policy provides greater after-tax income than other fixed-income investments held within a corporation.
Corporate vs. personal insured annuities
A corporate insured annuity differs from its personal counterpart in that the corporate annuity must be bought on a non-prescribed or accrual basis. Effectively, this means the taxable amount of the annuity income is higher in early years, then starts to fall, with the positive result that the after-tax income increases over time.
The net cash flow from the annuity is used to buy the corporately-owned insurance policy to replace the assets upon death. Because of the way the policy is set up, beneficiaries or shareholders receive funds as tax-free dividends, usually providing a higher net income than fixed-income investments held within a corporation.
A great idea, but ask for help
A personal insured annuity should be an integral part of a larger diversified plan. Don’t do this alone. Seek the advice of an experienced financial advisor as well as a trust and estate practitioner to help you determine your retirement and estate planning needs.
Now that people are living longer, it’s no surprise that one of the biggest concerns among aging Canadians is the genuine fear of outliving retirement savings. Most people would prefer to leave a legacy of some sort to their families and other beneficiaries.
An insured annuity may be a good solution for you.
Mark Halpern is a Certified Financial Planner (CFP), Trust and Estate Practitioner (TEP) and one of Canada’s top life insurance advisors. He is CEO of WEALTHinsurance.com® and illnessPROTECTION.com®, with special expertise for business owners, entrepreneurs, medical professionals, high-net worth individuals and their families. He can be reached at 416-364-2929, toll-free at 1-866-566-2001 or mark@WEALTHinsurance.com.
This is an edited version of an article that was originally published for subscribers in the July 7, 2017, issue of the Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in the Investor’s Digest of Canada.
Investor’s Digest of Canada, MPL Communications Inc.
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