What is an Insured Retirement Plan?
The Insured Retirement Plan is a strategy where you purchase a permanent life insurance policy (either a whole life insurance policy or a universal life insurance policy) to take advantage of different tax-advantaged benefits. A permanent life insurance policy provides life insurance coverage that lasts a lifetime as well as builds cash inside of the policy on a tax-deferred basis which can be accessed later in life in the form of withdrawals. These withdrawals later in life can be made tax-free with the use of a loan.
Like any investment strategy, there are pros and cons that need to be weighed and considered. The underlying strategy can be very advantageous (i.e., provide you more income), but you should be aware of the potential risks and drawbacks.
How Does Insured Retirement Plan (IRP) Work?
Well, it works well :).
An insurance retirement plan (IRP) is a tax beneficial strategy that takes advantage of two common tax benefits of life insurance: growth inside a policy is generally tax deferred, and secondly death benefits are not normally taxed.
IRP’s use both of these benefits to create a compelling (in the right circumstances) way to save for retirement. Importantly the IRP works best if your other tax advantages strategies are already maxed out (RRSP’s, TFSA’s, etc). Those other strategies in most cases are better than an IRP, so we look at implementing an IRP only when those other strategies are already fully implemented.
With that being said, here’s how an IRP works:
1) Accumulation/Saving phase: You purchase a permanent life insurance policy that has an investment option or a cash surrender value, typically a whole life or universal life. Over the course of your earning years, you pay the premiums on the insurance, with an eye to maximizing the investments. During that time, funds inside the policy grow on a tax-deferred basis (similar to an RRSP or TFSA for this part).
2) Withdrawal phase: Upon retirement, you now have a life insurance policy with a substantial investment component. If you were to withdraw those funds to use for retirement you would be subject to taxation. So we want to access those funds without withdrawing them. This is done via an annual bank loan. The annual bank loan is your retirement income, and the policy is used as collateral to back the loan. Interest and annual payments are recapitalized back into the loan – you are not expected to make payments on the loan.
3) Repayment phase: Upon your death, the life insurance death benefit is used to repay the loan. Investments in life insurance policies are paid out as a death benefit upon death, and death benefits are not taxed – so the accumulated loan is paid off with tax-sheltered money.
Summary of that – your investments are tax-sheltered during your earning years, your retirement income is not taxed, and the loan is paid off using your investments without any taxation.
What Will Life Insurance Cost Me?
- Your money is not liquid. If you need to collapse the policy to access the funds at any point you would expect substantial financial penalties. Therefore IRP’s are only suitable for use as a secondary retirement income strategy.
- Tax laws can (and do) change. It’s possible that the CRA could change the taxation of policies in a way that would negatively impact an IRP. While this probability may be low, given the long timeframes associated with an IRP, it’s not impossible.
- High fees. Investing in an insurance policy typically comes with high fees (including the cost of insurance). Minimizing the taxes of your investments should normally offset these higher fees, but again this means an IRP should be a secondary strategy.
- Tax sheltering of investment earning, and loan repayment using untaxed death benefits normally more than offset any of the negatives.
- Retirement income from an IRP does not impact any earnings tests. Because the ‘income’ is actually a bank loan, the funds are not included in any income-tested retirement benefits.
- You have an incidental life insurance policy. Should you pass prior to retirement, you still have a life insurance policy that would pay out to your beneficiaries (and that death benefit would include your investments saved to date, untaxed).
Things To Consider
- Type of policy and company. You can perform this strategy with either a whole life or universal life insurance policy. Depending on the policy type and company, you may be able to use different percentages of the policy as collateral (typically 75% or 95%).
- Cost of insurance. There are two general options; level for life (higher initially, but level) or annually increasing (really inexpensive initially, but increasing over time). Generally annually increasing would be used in order to maximize initial deposits to the investments, but you should balance expectations of growth in the investments against growth of the insurance costs.
- Risk. There are a variety of risks in this strategy, and they should only be undertaken if you have the financial wherewithal to withstand these downside risks. Risks include regular investment risk, your policy could collapse (if future investments are insufficient to pay future insurance costs), possible changes in tax laws, future changes to banking guidelines.
- Your broker. You should expect that your broker will shop the market to find the best policy, without regard to company. As well, you should expect that by default they will attempt to minimize they’re commission. Both of these can have a direct and substantial impact on your earnings.
There you have it – in the right situation, an (IRP) Insured Retirement Plan can be a very financially astute strategy.
Consider reading other articles we have written on insured retirement plans…