Insured retirement plan is a retirement tax planning strategy using life insurance. Like any investment strategy, there’s 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.
Consider reading other articles we have written on insured retirement plans…
First though, a brief outline of how the strategy works.
How does Insurance Retirement Plan (IRP) work?
Well, it works well :).
Insurance retirement plan 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 theses 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 (similiar 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 polices 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.
On to the pros and cons:
- 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).
There you have it – in the right hanPros and Cons of Universal Life Insuranceds an IRP can be a very financially astute strategy. It does however require a careful identification of your individual risk assessment, which is why you should speak to an experienced life insurance advisor on this – which you can do simply by calling our toll free number above.