We highly recommend also reading the blog post recently posted on our website. It is titled “Have You Been IRP’d By your Financial / Insurance Advisor?”. You can find the post by clicking here.
The Insured Retirement Plan is a retirement tax strategy that uses life insurance in 3 distinct tax-advantaged ways.
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The IRP strategy starts with the purchase of a universal life insurance policy. During the income earning years, deposits are made into the investment portion of the policy, where they grow on a tax sheltered basis. Upon retirement, rather than withdrawing the investments as income, instead the policy is used as collateral for a loan. The loan is used as tax-free income upon retirement. Up[on death the outstanding balance of the loan is paid by the insurance policy.
As we are using life insurance for tax minimization and not life insurance, this strategy is suitable for high net worth individuals. You should have your retirement already looked after financially so that the Insured Retirement Plan is a secondary stragety. It is not appropriate for those that need life insurance for insurance purposes or those that have other tax advantaged opportunities available (such as RRSP’s and TFSA’s).
An Indepth look at Insured Retirement Plan
The strategy initially involves the purchase of a universal life insurance policy during your income earning years.
Universal life insurance policies have two components – an insurance coverage (with associated cost) and a discrete tax-sheltered investment. Funds paid into the policy above the base insurance costs are deposited into the tax sheltered investments.
- Tax advantage #1 – Tax Sheltered Growth. The goal initially is to minimize the insurance costs (and thus maximizing the deposits into the tax sheltered investments). Over time the investments grow on a tax sheltered basis. This is an important part of the strategy, as unlike RRSP’s and TFSA’s, the limit on the amount of deposits you can do is limited by insurance guidelines (basically the size of the policy) rather than income-dependent guidelines. There are specific policy attributes that will be used during policy setup in order to maximize the investment portion and minimize the insurance costs.
- Tax Advantage #2 – No Taxes on Withdrawals. At retirement, we now have a life insurance policy with investments that have been growing on a tax sheltered basis. Now we want to access these funds for retirement. However if we simply withdraw the funds, taxes will be payable. So instead, we use the value of the investments as collateral for a loan (Many/most banks will allow use of these polices as collateral under current conditions). Loans are of course, not taxable. You’ve now managed to access the growth in your investments, without paying taxes on the growth during the accumulation years, or on withdrawals. During the withdrawal years, your loan is recapitalized by the bank, no payments are made.
- Tax Advantage #3 – Loan + Interest Paid Off Tax Free. Upon your death, the death benefit of the insurance policy consists of the insurance component of the policy + your deposits to the investments + the tax sheltered growth of the investments. The total of these are paid out tax free, initially to repay the full outstanding loan balance and any remaining amount to your named beneficiaries. The death benefits under normal conditions are not taxable.
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.
Urgent – Jan 1 2017 Deadline
This strategy is partially based on the ability to tax shelter investments inside a policy and that is being minimized for policies in 2017. The amount that can be tax sheltered inside a policy is determined by a complex calculation based on the amount of insurance. Policies placed inforce after 2016 will be subject to a less tax favourable calculation. Effectively they will be requiring the purchase of more life insurance (thus increasing costs, and reducing investments) to tax shelter investments. Policies place inforce prior to 2017 will be grandfathered under the old, more tax-favourable rules.
You don’t have to start making deposits into the investment portion right away – but you do need to get the insurance coverage in place prior to that deadline. If you’re considering this strategy, it’s important that you do so without delay. We expect the insurance industry is going to have a rush at year end 2016. Along with holidays, reduced staffing at head offices, year end processing, and normal year end higher volume levels, we expect that some policies left to the last months of 2016 will not be issued in time to be eligible. Be proactive.
Corporate Insured Retirement Program
There is a variation of this strategy where the policy is owned by a corporation. This strategy is similar in benefits with respect to taxation, with some addition of dividends being used as an income stream. It is thus suitable for business owners looking for a tax-optimized strategy to withdraw income from their corp.