For retirement saving, for most people, the most important vehicle is an RRSP. Saving within a universal life insurance policy is advised to someone usually only after that person has used all his / her RRSP room.
While within an RRSP one can have more investment options than in a UL, the main reasons for this priority given to RRSP is still probably that contributions to an RRSP are tax deductible. This is really an important aspect, but not to the extent that would warrant the big RRSP rush in every February. The existence of this rush is a kind of evidence showing how unbalanced the view most people have about the important features of RRSPs, namely, how undervalued the other main feature, long term effect of tax deferment, is in general.
While universal life policies are not at par on the somewhat overvalued feature, tax deduction, with regular RRSPs, they have certain advantages on the other aspect, tax deferment. The advantage is not obvious, because it is not there in the accumulation period. However, it kicks in at age 71, when RRSP owners lose some of their freedom in managing their money, or may kick in even before that if the person dies.
- If the tax sheltered money is in an RRSP, and it goes to someone else than the spouse, the money is taxed before being given to heirs. If it was tax sheltered in a universal life insurance contract, it will be paid out to the beneficiary/ies/ tax free.
- If the money is tax-sheltered in a universal life insurance policy, there is no obligation to make any change at age 69; there is no need to start to withdraw income from it even if that is not needed.
- The account value of a universal life insurance policy can be used as a collateral for raising a perpetual (not taxable!) loan from a bank, as opposed to the forced (and taxable!) depletion of capital in normal RRSPs. This advantage in the use of the accumulated capital is a major one, and a strong point for the insurance policy.
Whether each of these strengths of universal life insurance policies will remain there is something to be seen, of course. For some people, they provide good food for thought, to say the least.
There are others, who do not have enough money to save in a tax-shelter, however attractive it might be, beyond their RRSP limit. These people will obviously want to use the tax deduction feature of RRSPs.
It is good to know that they can find RRSP eligible investment options within universal life insurance policies as well.
Uses of universal life insurance
- Final expenses, such as a funeral, burial, and unpaid medical bills
- Income replacement, to provide for surviving spouses and dependent children
- Debt coverage, to pay off personal and business debts, such as a home mortgage or business operating loan
- Estate liquidity, when an estate has an immediate need for cash to settle Federal taxes, Probate, or debts outstanding.
- Estate replacement, when an insured has donated assets to a charity and wants to replace the value with cash death benefits.
- Business succession & continuity, for example to fund a cross-purchase or stock redemption buy/sell agreement.
- Key person insurance, to protect a company from the economic loss incurred when a key employee or manager dies.
- Executive bonus, where an employer pays the premium on a life insurance policy owned by a key person. The employer deducts the premium as an ordinary business expense, and the employee pays the income tax on the premium.
- Controlled executive bonus, just like above, but with an additional contract between an employee and employer that effectively limits the employees access to cash values for a period of time (golden handcuffs).
- Split dollar plans, where the death benefits, cash surrender values, and premium payments are split between an employer and employee, or between an individual and a non-natural person (e.g. trust).
- Non-qualified deferred compensation, as an informal funding vehicle where a corporation owns the policy, pays the premiums, receives the benefits, and then uses them to pay, in whole or in part, a contractual promise to pay retirement benefits to a key person, or survivor benefits to the deceased key person's beneficiaries.
- An alternative to long-term care insurance, where new policies have accelerated benefits for Long Term Care.
- Mortgage acceleration, where an over-funded UL policy is either surrendered or borrowed against to pay off a home mortgage.
- Charitable gift, where a UL policy is donated to a qualified charity, or the policy owner names a charity as the beneficiary.
- Charitable remainder trust replacement, where a policy owner wants to replace assets donated to a Charitable Remainder Trust.
- Estate equalization, where a business owner has more than one child, and at least one child wants to run the business, and at least one other wants cash.
- Life insurance retirement plan, or RRSP alternative. High income earners who want an additional tax shelter, with potential creditor/predator protection, who have maxed out their RRSP and who have already maxed out their qualified pension plans.
- Term life insurance alternative, for example when a policy owner wants to use interest income from a lump sum of cash to pay a term life insurance premium. An alternative is to use the lump sum to pay premiums into a UL policy on a single premium or limited premium basis, creating tax arbitrage when the costs of insurance are paid from untaxed excess interest credits, which may be crediting at a higher rate than other guaranteed, no risk asset classes such as bonds or GIC's
- Whole life insurance alternative, where there is any need for permanent death benefits, but little or no need for cash surrender values, then a current assumption UL or GUL may be an appropriate alternative, with potentially lower net premiums.
- Annuity alternative, when a policy owner has a lump sum of cash that they intend to leave to the next generation, a single premium UL policy provides similar benefits during life, but has a stepped up death benefit that is income tax-free.
- Pension maximization, where permanent death benefits are needed so an employee can elect the highest retirement income option from a defined benefit pension.
- Annuity maximization, where a large non-qualified annuity with a low cost basis is no longer needed for retirement and the policy owner wants to maximize the value for the next generation.
- RMD maximization, where an IRA owner is facing required minimum distributions (RMD), but has no need for current income, and desires to leave the IRA for heirs. The IRA is used to purchase a qualified SPIA that maximizes the current income from the IRA, and this income is used to purchase a UL policy.
- Creditor/predator protection. A person who earns a high income, or who has a high net worth, and who practices a profession that suffers a high risk from predation by litigation, may benefit from using UL as a warehouse for cash, because in some states the policies enjoy protection from the claims of creditors, including judgments from frivolous lawsuits.
Contact our office today to see how this valuable protection integrates into a well thought out Financial Plan.