July 22, 2016
If you live in Ontario, chances are a big portion of your money goes to tax.
In fact, if you are a high-income employee with a salary of over $220,000, you are paying a marginal tax rate of 53.5%. The government, split between the provincial and federal bodies, takes over half of your money just in income tax alone. Add in HST (13%), property tax and high fees on many consumer products, and very quickly you’re paying upwards of two-thirds of your income to the government! Households making a middle-class salary will also end up paying almost half of their income in taxes. And the government’s share of your money is only getting larger.
How can you keep more of your own money?
There are many well-known strategies available to minimize your tax burden, such as investing in tax-sheltered vehicles (RRSPs and TFSAs). However, a strategy often over-looked is life insurance. A properly planned insurance policy can provide both a tax-free benefit at death as well as offer a highly tax-efficient savings vehicle for the duration of your life.
Tax Saving Tool: Life Insurance
There are two types of life insurance, term and permanent.
Term insurance, similar to renting a house, is temporarily “owned” as it will only last for a set period of time. While helpful for covering an immediate risk, such as a mortgage, term insurance results in premiums at renewal and is not available after age 85.
Permanent insurance, however, is similar to owning a house – you can build equity within your policy and maximize your savings (tax-free) while your death benefit continues to increase. While typically a permanent policy requires larger deposits than the cost of term insurance, permanent insurance can provide significant savings and even outperform standard investment plans.
Generally speaking, permanent insurance comes in three types: term to 100, universal life and whole life.
Each offers even premiums and a guaranteed payout at death (regardless of age). Whole life and universal life, however, offer a savings component that accumulates cash within the policy. This cash value can be invested and grow on a tax-sheltered basis. At death, this money can be paid out along with the death benefit tax-free. It’s the investment side of permanent insurance that offers a lot of savings potential.
Build Your Savings with Whole Life
For whole life, your premiums are mainly split between the death benefit and the investment component, or cash surrender value (CSV). Not only does this policy typically pay you dividends, which vest at the time these are paid, but it also can provide solid investment returns over the years.
It’s a very convenient investment vehicle as you don’t need to worry about making investment decisions on how to allocate the funds. The insurance company makes these decisions for you. It’s not uncommon to find whole life policies paying higher dividends than equity portfolios. In fact, there are examples of individuals who have built up over $500,000 in CSV with over a $1,000,000 death benefit.
This sum of money is yours to be paid out regularly or can be used for other purposes, such as to cover your premiums if a payment is ever missed. While this money accumulates tax-free, keep in mind the government has put limits (albeit generous limits) on how much money can go into the investment component of your policy. Every premium payment you make not only secures your insurance coverage at death but also automatically invests and grows over time.
Changes are Coming and You Should Act:
Securing a permanent life insurance policy and locking in a low premium rate should be the goal of most, assuming it fits within your budget. Insurance only gets more expensive as you get older. Perhaps the most compelling argument in favour of obtaining permanent insurance now is that changes are coming soon.
Starting January 1st, 2017, there will be new rules on how permanent life insurance policies can accumulate tax free growth in Canada. In a nutshell, there will be an adjustment to premiums to reflect mortality rates and will be limiting the use of insurance as an investment. It is likely that you will have to pay more for insurance next year while receiving a lower rate of return on the cash values within your policy. The new rules will decrease the tax-sheltering limit in the long-term and, especially in universal life policies, will drive up premiums over the years.
The good news is that any policies purchased and placed (i.e. delivered to the clients in insurance speak) before 2017 will be grandfathered under the current rules and limits.
Permanent insurance can be a powerful tool moving forward but if interest exists today, the net may be a little higher than if you wait a year or two.
This article was collaborativelly written by the Rubach Wealth team. If you found it useful and would like to receive educational personal and business tips for Canadians, please subscribe to our complimentary monthly newsletter.