​Life, Liberty...and Less Tax

Many of Canada’s über-rich have used insurance to reduce the tax exposure on investment income. Chris Karram of Safebridge Financial Group, offers a way to sell other clients on that essential

Many of Canada’s über-rich have used insurance to reduce the tax exposure on investment income. Chris Karram of Safebridge Financial Group, offers a way to sell other clients on that essential

A very common discussion around a kitchen table is “I can’t believe how much tax the government took from my paycheque this month.” That’s because Canadians are used to paying upwards of 50 per cent of their annual income back to the government, which means less money in their own pockets.

What makes it worse is when one is able to build an asset base that starts to earn interest, dividend or capital gain income on the money they’ve invested. Despite the fact that it feels good to know your portfolio is growing, it is easy to become disheartened when you realize that a good chunk of your profit is going to disappear forever.

The best known way to minimize the tax bill incurred on the growth of one’s portfolio is an RRSP. Just about every Canadian understands how their RRSP works, or at least the concept of how it works, but their tax planning seems to stop there. A very common misconception is that an RRSP is the only option when it comes to saving towards one’s retirement in a tax-preferred way. Thankfully, Canadians have more then one tax-preferred vehicle available, but choosing the best financial product for your situation takes some planning since different types serve different functions.

One specific vehicle that has been around for many decades is a permanent life insurance policy such as whole life or universal life. These two forms of life insurance have been used by many Canadians to protect their families from an unexpected death, the same way other life insurance products do. But what can be amazing about these policies are the tax advantages that come with owning them. In fact, many of Canada’s wealthiest people have used these types of insurance policies to shelter their investment income from tax despite the fact that they already had enough life insurance.

A permanent life insurance policy is generally made up of two components. The first is the obvious death benefit, which is the value that is paid out to the beneficiary upon the death of the life insured. The second component is the cash value, which is very similar to that of a traditional mutual fund.

The difference, however is that any money invested inside of a life insurance policy can allow the policyholder to accumulate cash values, within certain regulatory limits, without paying income tax on the growth. What’s more, the cash values inside of your policy can be accessed to supplement a retirement income through a policy loan, partial surrender or loan strategy that can actually create the equivalent of a tax-free income stream when needed. There are no age limits as to when or if you have to withdraw your cash value, and the “MTAR,” or “contribution limit,” is in no way connected to your income, but rather to your actual “cost of insurance.” If you want to invest more than the contribution limit allows, simply increase the size of your death benefit and away you go. However, it is important to note that straight cash withdrawals are subject to taxation based on the rates and rules in effect at the time you withdraw the funds.

Canadians who have maximized their RRSP contributions and are looking for an alternative method to save for their retirement are in a great position to take advantage of this tax-preferred life insurance vehicle. As well, those who are interested in protecting their assets from creditors or personal liability could very well be a great fit for a tax-advantaged life insurance policy.

There are different types of structures and products available within the permanent life insurance category. For the purpose of our example, we will look at a non-smoking male, age 35, who is looking to a buy a $1-million universal life insurance policy, and we will assume an annual return of only 6 per cent (if the markets perform better than that, your cash values will be even higher).

Let’s assume this individual was in a position to save $1,000 per month in addition to his monthly or annual RRSP deposits. If he were in a 46.41 per cent tax bracket, he would be left with a total of $601,547 after taxes at the age of 65. In comparison, if he were to invest that same $1,000 per month into the above mentioned universal life insurance policy, he would end up with a whopping cash value of $1,068,282! What’s more, if he wanted to prolong when he would start to withdraw his RRSP savings until the age of 69, he could draw an annual income of $85,808 from age 60 to 69. Let’s not forget that this is while time our “client” owned and continues to own a million-dollar life insurance policy.

As demonstrated, there are definitely many unique strategies available to Canadians when it comes to saving for their retirement, while minimizing their tax bill. The key to finding the right solution is to walk through the appropriate financial planning process to better define which product, or combination of products, is best suited for you.

Chris KarramAbout the writer: Karram is the founding principal and financial consultant with Safebridge Financial Group & Investment Planning Counsel.