Save It. Spend It. Leave It
Save it. Spend it. Leave it.
A strategy for asset efficiency
The problem: tax erosion
Assumptions: 40-year-old with $25,000 to invest annually for the next 20 years. Portfolio: 50% interest, growing at 4%, taxed at 46.17%; 20% dividends, growing at 5%, taxed at 33%; 30% capital gains, growing at 6%, taxed at 23.09%. Tax rate on dividend to estate: 32.57%. This graph compares the net estate value if investments were not exposed to tax on the growth annually (pre-tax) and what the after-tax reality looks like.
The solution: more ways to grow assets
Save it.
Spend it.
Leave it.
What you can do with this strategy
Use your assets more efficiently • Save it – Reduce erosion by taxes each year • Spend it – Receive income stream • Leave it – For beneficiaries and heirs
This strategy is for you if you . . .
• Need life insurance • Want to transfer your wealth to your beneficiaries and heirs • Are concerned about taxes on income • Are interested in strategic diversification
Is your current investment strategy optimizing your net worth? • Typical plans consist of investment vehicles that return – Interest income – Dividend income – Capital gain income – Mixes of these types of income
Start by examining tax efficiency
Non-registered investments
Tax-exposed
Registered investments
Tax-deferred
Permanent life insurance
Tax-advantaged
Consider life insurance as a unique asset
Save it
Spend it
Ways to access the cash value • Partial surrender • Policy loan • Collateral loan (in Quebec, movable hypothec)
Collateral loans involve risks
• Should only be considered by sophisticated investors with high risk tolerances and access to professional advice from lawyers and accountants • Terms or future availability cannot be guaranteed • Subject to lenders’ financial underwriting and other requirements • You should have enough income and capital to cover interest and loan repayment • Should be considered as part of a diversification strategy
Leave it
• Preserve more assets for beneficiaries and heirs • Death benefit goes to named beneficiaries tax-free
Borrowing options
Interest deductibility
• Loan interest is generally deductible if certain conditions are met – 20(1)(c) of the Income Tax Act – 20(1)(d) of the Income Tax Act
The advantage of the loan is greatly reduced if the interest is determined not to be deductible, or if future interest rates increase beyond the rate in this presentation.
Potential for additional tax deduction
• 20(1)(e.2) of the Income Tax Act – Policy assignment must be required by lender – Lender is restricted financial institution (bank, trust company, credit union) – Interest must be deductible – Maximum eligible deduction is lesser of premium payable or net cost of pure insurance – The proportion of the maximum amount that is deductible is the amount of the loan balance related to the death benefit
Lender due diligence
•
• • • • •
•
The issuance of a life insurance policy from London Life is separate from the lending side of this strategy These structures are not asset based lending Each client must qualify for the amount being applied for and must demonstrate that they can easily afford the interest payments Client should have sufficient other income and capital to cover interest payments or potential tax liability Bank lending terms and conditions may be subject to change Change in interest rate and performance of fund may cause loan to exceed maximum percentage of collateral creating a demand for repayment If insured lives beyond illustrated life expectancy, death benefit for life insurance need may be insufficient and shortfall may exist to repay bank with insurance proceeds
Lender due diligence
Five areas a lender will likely investigate to assess for a loan • Capital - size of loan must make sense relative to client’s net worth • Capacity – ability to service interest payments from reliable/sustainable sources • Collateral – the loan must be appropriately secured • Credit history – client must have a good repayment history • Character – a background check will likely be done
Tax implications create substantial differences in asset efficiency Example • Male, non-smoker, age 40, standard risk • Initial death benefit $750,000 • 20 Pay Life guaranteed 20 pay • Policy is assigned to bank as collateral for loan, meeting lending criteria at age 65 • Compared to investment mix: – Interest – Dividends – Capital gains See important notes and assumptions following these examples.
Tax implications can create substantial differences in asset efficiency: Comparison year age 85
Comparison assuming death at age 85 Cumulative deposits/premiums ($25,000/year for 20 years)
Investments
Life insurance
$ 500,000
$ 500,000
$ 1,054,636
$ 926,515
$0
$ 924,779
3.16%
4.63%
$1,485,493
$2,533,172
Results when cash flow is taken Cumulative net cash flow Net benefit at death after loan repaid, if applicable Internal rate of return, based on after-tax cash flows and net benefit to estate Results when no cash flow is taken Net benefit to estate
Internal rate of return is a cumulative rate that equates the growth in assets (or cash value and net death benefit) to the cash invested (or premium paid).
Other asset classes may require more capital How much capital do other asset classes require to equal the cash flows and net estate benefit from life insurance? Other asset classes may require more capital
See important notes and assumptions following these examples.
Other asset classes may require more investment risk What return do other asset classes require to equal the cash flow and net estate benefit from life insurance? Other asset classes may require higher rates of return
See important notes and assumptions following these examples.
Important notes and assumptions
• Insured person: male, non-smoker, age 40, standard risk, with $25,000 to invest annually for next 20 years • Life insurance: London Life participating life insurance, 20 Pay Life with Paid up additions, $750,000 initial death benefit, $25,000 premium for 20 years, paid-up additions, based on London Life’s dividend scale and premium rates as at December 2012 • Collateral loan: 5% interest rate, interest paid and immediately borrowed, interest deductible, 90% maximum loan/cash value ratio at age 90
Important notes and assumptions • Investment mix used in comparisons: 50% interest (4% growth rate, 46.41% tax rate), 20% taxable dividends (5% growth, 29.54% tax), 30% realized capital gains (6% growth, 23.21% tax) • Comparison at death in policy year 45, age 85 • Figures not adjusted for time value of money. Required rate of return on investments illustrates pre-tax return required to achieve same after-tax internal rate of return as life insurance • Examples are not complete without a complete London Life illustration, including cover page, reduced example and product features page, all having the same date. Read each page carefully as each contains important information
Important considerations
• Long-term strategy using life insurance – Cash value accumulates over time – There is a cost to providing life insurance benefits, premiums need to be maintained • Best used for diversification – Don’t put all your assets in this strategy • Requires a third-party lender – Interest rates assumed are subject to change – Subject to bank underwriting at that time; require additional income sources and net worth
Important considerations
• Banks will lend more on participating life insurance than on universal life insurance – Values are vested once credited – Downside protection risk, guarantees • Universal life insurance • You must meet the bank underwriting, including net worth and sources of income
Diversify your portfolios with investments and life insurance • Avoid the tax-grind on passive investments • Use your assets more efficiently • Diversify your portfolios with investments and life insurance
A strategy for asset efficiency
The problem: tax erosion
Assumptions: 40-year-old with $25,000 to invest annually for the next 20 years. Portfolio: 50% interest, growing at 4%, taxed at 46.17%; 20% dividends, growing at 5%, taxed at 33%; 30% capital gains, growing at 6%, taxed at 23.09%. Tax rate on dividend to estate: 32.57%. This graph compares the net estate value if investments were not exposed to tax on the growth annually (pre-tax) and what the after-tax reality looks like.
The solution: more ways to grow assets
Save it.
Spend it.
Leave it.
What you can do with this strategy
Use your assets more efficiently • Save it – Reduce erosion by taxes each year • Spend it – Receive income stream • Leave it – For beneficiaries and heirs
This strategy is for you if you . . .
• Need life insurance • Want to transfer your wealth to your beneficiaries and heirs • Are concerned about taxes on income • Are interested in strategic diversification
Is your current investment strategy optimizing your net worth? • Typical plans consist of investment vehicles that return – Interest income – Dividend income – Capital gain income – Mixes of these types of income
Start by examining tax efficiency
Non-registered investments
Tax-exposed
Registered investments
Tax-deferred
Permanent life insurance
Tax-advantaged
Consider life insurance as a unique asset
Save it
Spend it
Ways to access the cash value • Partial surrender • Policy loan • Collateral loan (in Quebec, movable hypothec)
Collateral loans involve risks
• Should only be considered by sophisticated investors with high risk tolerances and access to professional advice from lawyers and accountants • Terms or future availability cannot be guaranteed • Subject to lenders’ financial underwriting and other requirements • You should have enough income and capital to cover interest and loan repayment • Should be considered as part of a diversification strategy
Leave it
• Preserve more assets for beneficiaries and heirs • Death benefit goes to named beneficiaries tax-free
Borrowing options
Interest deductibility
• Loan interest is generally deductible if certain conditions are met – 20(1)(c) of the Income Tax Act – 20(1)(d) of the Income Tax Act
The advantage of the loan is greatly reduced if the interest is determined not to be deductible, or if future interest rates increase beyond the rate in this presentation.
Potential for additional tax deduction
• 20(1)(e.2) of the Income Tax Act – Policy assignment must be required by lender – Lender is restricted financial institution (bank, trust company, credit union) – Interest must be deductible – Maximum eligible deduction is lesser of premium payable or net cost of pure insurance – The proportion of the maximum amount that is deductible is the amount of the loan balance related to the death benefit
Lender due diligence
•
• • • • •
•
The issuance of a life insurance policy from London Life is separate from the lending side of this strategy These structures are not asset based lending Each client must qualify for the amount being applied for and must demonstrate that they can easily afford the interest payments Client should have sufficient other income and capital to cover interest payments or potential tax liability Bank lending terms and conditions may be subject to change Change in interest rate and performance of fund may cause loan to exceed maximum percentage of collateral creating a demand for repayment If insured lives beyond illustrated life expectancy, death benefit for life insurance need may be insufficient and shortfall may exist to repay bank with insurance proceeds
Lender due diligence
Five areas a lender will likely investigate to assess for a loan • Capital - size of loan must make sense relative to client’s net worth • Capacity – ability to service interest payments from reliable/sustainable sources • Collateral – the loan must be appropriately secured • Credit history – client must have a good repayment history • Character – a background check will likely be done
Tax implications create substantial differences in asset efficiency Example • Male, non-smoker, age 40, standard risk • Initial death benefit $750,000 • 20 Pay Life guaranteed 20 pay • Policy is assigned to bank as collateral for loan, meeting lending criteria at age 65 • Compared to investment mix: – Interest – Dividends – Capital gains See important notes and assumptions following these examples.
Tax implications can create substantial differences in asset efficiency: Comparison year age 85
Comparison assuming death at age 85 Cumulative deposits/premiums ($25,000/year for 20 years)
Investments
Life insurance
$ 500,000
$ 500,000
$ 1,054,636
$ 926,515
$0
$ 924,779
3.16%
4.63%
$1,485,493
$2,533,172
Results when cash flow is taken Cumulative net cash flow Net benefit at death after loan repaid, if applicable Internal rate of return, based on after-tax cash flows and net benefit to estate Results when no cash flow is taken Net benefit to estate
Internal rate of return is a cumulative rate that equates the growth in assets (or cash value and net death benefit) to the cash invested (or premium paid).
Other asset classes may require more capital How much capital do other asset classes require to equal the cash flows and net estate benefit from life insurance? Other asset classes may require more capital
See important notes and assumptions following these examples.
Other asset classes may require more investment risk What return do other asset classes require to equal the cash flow and net estate benefit from life insurance? Other asset classes may require higher rates of return
See important notes and assumptions following these examples.
Important notes and assumptions
• Insured person: male, non-smoker, age 40, standard risk, with $25,000 to invest annually for next 20 years • Life insurance: London Life participating life insurance, 20 Pay Life with Paid up additions, $750,000 initial death benefit, $25,000 premium for 20 years, paid-up additions, based on London Life’s dividend scale and premium rates as at December 2012 • Collateral loan: 5% interest rate, interest paid and immediately borrowed, interest deductible, 90% maximum loan/cash value ratio at age 90
Important notes and assumptions • Investment mix used in comparisons: 50% interest (4% growth rate, 46.41% tax rate), 20% taxable dividends (5% growth, 29.54% tax), 30% realized capital gains (6% growth, 23.21% tax) • Comparison at death in policy year 45, age 85 • Figures not adjusted for time value of money. Required rate of return on investments illustrates pre-tax return required to achieve same after-tax internal rate of return as life insurance • Examples are not complete without a complete London Life illustration, including cover page, reduced example and product features page, all having the same date. Read each page carefully as each contains important information
Important considerations
• Long-term strategy using life insurance – Cash value accumulates over time – There is a cost to providing life insurance benefits, premiums need to be maintained • Best used for diversification – Don’t put all your assets in this strategy • Requires a third-party lender – Interest rates assumed are subject to change – Subject to bank underwriting at that time; require additional income sources and net worth
Important considerations
• Banks will lend more on participating life insurance than on universal life insurance – Values are vested once credited – Downside protection risk, guarantees • Universal life insurance • You must meet the bank underwriting, including net worth and sources of income
Diversify your portfolios with investments and life insurance • Avoid the tax-grind on passive investments • Use your assets more efficiently • Diversify your portfolios with investments and life insurance
