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Yes, the life insurance industry is a tax haven, and will
likely always enjoy that status, because of all the special
laws created, just for it. You can spend time wondering why,
or you can use their heavily favored status to your advantage.
One popular strategy is the life insurance tax shelter.
In the last 10 years, Canadians have stuffed millions and
millions of dollars in these programs. The reason is that
they allow either tax-deferred or TAX-FREE treatment of your
investment dollars, with no risk.
What is an insurance tax-shelter?
Simply put, an insurance tax-shelter is a plan issued by
a life insurance company that allows you to deposit any amount
of money and shelter all of the growth of the investment
from income tax.
How does it work?
Revenue Canada allows insurance companies to issue these
plans and maintain their tax-shelter status as long as they
satisfy certain conditions.The insurance company must maintain
a minimum amount of insurance on each plan to keep it tax
exempt. The insurance however, can and should be low cost
decreasing coverage, only enough to keep the plan tax exempt.
The amount is based on a Revenue Canada formula and each
plan must meet an annual test.
What makes the strategy work?
Why do these plans out perform other non-sheltered investments?
Your earnings build-up TAX-FREE within the plan. The annual
expense charges of the plan cost less than the tax which
would have to be paid on the investment earnings of a similar
investment such as GICs, bonds,etc.
Example: Assume an 8% annual rate of return.
A couple, both age 45, in a 50% tax bracket would have to
pay a total of $43,244 of income tax on the earnings of an
investment of $10,000 per year for 10 years. In contrast,
if they invest $10,000 per year for 10 years into a tax-sheltered
insurance account, earning the same rate of return, they
would pay only $10,701 in total expense charges (including
insurance cost) to the insurance company over the 10 years.
The plans are flexible, allowing you to vary the amount of
you deposit, and choose the investment type of the plan from
GICs to investment Index Fund.
How do you get your money out?
When it comes time to take income, you can take income from
your plan one of three ways. Here are two income strategies
for Canadian residents (for tax purposes). Make direct withdrawals
from the tax-deferred account and receive part of your income
TAX-FREE.
Under special arrangement, you can leverage the account
with a bank. The bank will take your plan as a security loan.
You can then make a single loan or a series of loans as income.
The bank will capitalize the loan payments, so you will never
have to make payments. The loan is repaid from the TAX-FREE
insurance pay-out, when you die. The insurance pay-out in
excess of the bank loan balance is then paid out TAX-FREE
to your beneficiaries. Since a loan is not taxable, you can
earn all of your income TAX-FREE.
By comparison, if you tried this with your RRSP, your financial
institution would be forced to withhold 25% and send it to
Revenue Canada.
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