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The Companion Advisor:
Taxes & EstatesHow to keep your nest egg afloat Written by Jamie Golombek, CA, CPA, CFP, CLU, TEP Perhaps the biggest financial concern these days is the possibility of outliving your money. And yes, there are ways to extend the life of your hard-earned savings and do so in a tax-effective manner. We'll explore one concept that can provide you with a permanent source of income for the rest of your life while protecting your capital for your beneficiaries. It is called the insured annuity, With an insured annuity you take a lump sum of money and invest it in an annuity with a life insurance company which guarantees you a fixed monthly payment for the rest of your life. To protect your capital, you simultaneously purchase a permanent life insurance policy using part of the monthly annuity payments to pay for the premiums. This strategy can be extremely tax-effective because of the favourable tax treatment given to "prescribed" annuities under the Income Tax Act. The tax rules prescribe a fixed portion of the monthly annuity payment to be non-taxable thus producing a higher after-tax return than a similar fixed-income investment such as a guaranteed investment certificate (GIC). In addition, because you can name a beneficiary on the life insurance policy, upon death the tax-free payout can be paid directly to the named beneficiary, bypassing the estate where it may otherwise be subject to probate tax. To really understand the benefit of such a strategy, let's take a look at Robert, who is still working full-time and has just turned 60. Robert is planning to retire at age 65 and is worried that when he does, he will have to start living on his accumulated savings. Since Robert would rather not rely on highly taxed RRSP withdrawals prior to converting his RRSP to a RRIF at age 69, he must look to his non-registered savings to provide retirement income upon age 65. While age 60 is likely too early to purchase an annuity, it's not too soon to purchase the permanent life insurance component of the insured annuity strategy. Robert may find that as he ages, not only will the insurance become more expensive, but if his health deteriorates, he may not be able to purchase the insurance or his policy may be prohibitively expensive. Let's say Robert plans to convert $300,000 at age 65 into an annuity. He buys the life insurance component today, at age 60, which costs him $7,020 in annual premiums for a term-to-100 policy. In five years he uses the $300,000 to purchase an annuity. Using today's annuity rates as a proxy (as rates could change significantly in five years), he could receive $22,980 of annual income of which only $5,638 would be taxable. Assuming Robert is in a 30% tax bracket upon retirement, he would pay tax of $1,691, netting him $14,269 of after-tax income after deducting the cost of the insurance. If he were to invest $300,000 in a GIC earning 5%, Robert would only net $10,500 aftertax. The insured annuity strategy has improved his after-tax annual income by $3,769 or 36%. As the chart above shows, if Robert's tax rate were 45%, the strategy looks even better, producing a $5,173 increase in annual after-tax income, an improvement of 63% over a GIC. The numbers look particularly attractive because Robert purchased the insurance at age 60 versus 65. But keep in mind he paid an extra five years of premiums. If the purchase was delayed until 65, the after-tax annual income would be lower because his insurance costs would be higher -- assuming Robert was even insurable. Jamie Golombek, CA, CPA, CFP, CLU, TEP is vice-president,
taxation and estate planning at AIM Trimark Investments. Jamie Golombek
is also a columnist in the Financial Post (The Tax Expert) and can be
reached at jamiegolombek@aimtrimark.com Notice:
Fiscal Agents Financial Services Group are not engaged in rendering tax,
accounting or legal professional services or advice. The comments in this
article are not intended, nor should they be relied upon, to replace specific
professional advice. Before acting on material contained herein. Readers
should seek advice that is appropriate to their personal circumstances
from a professional advisor.
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, Fiscal Agents Money Management Newsletter
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