By: Kevin-Barry Henry, #1 Bestselling Author
Why would I want to buy life insurance at my age? That was the question that Margaret (not her real name), my client sitting in front of me was asking when I proposed the idea. There was a reason that I was proposing buying life insurance at her age of course, but I had not yet had the time to bring that reason forward so my very astute client wanted to know why. My answer surprised her.
“Because right now the government will inherit more of your RRIF than your two children will”.
Her facial expression changed. That statement was enough for us to at least poke our way down the path to see if this life insurance idea would be worth exploring “at her age”. I have written in this space already about how right now it might be the best time to buy life insurance because it is cheaper and easier to qualify for (read it here), so I won’t waste your time on that in this article. Just know that if you are shopping for life insurance, right now is a good time to be a buyer.
Let’s get back to Margaret. Like many in her situation, she has worked hard to accumulate her nest-egg by contributing to RRSP (Registered retirement savings plan) annually for the tax savings as well as the tax deferred appreciation that an RRSP enjoys. She had saved and done well. Time and compound returns had done their work. She was now sitting on a RRIF (Registered retirement income fund) account value of approximately $200,000, give or take a few dollars.
This wasn’t Margaret’s only asset as she had paid off the mortgage on the home she and her late husband raised their two children in, and as a retired civil servant, she had a great pension, along with the survivor benefit she received from her late husband Ron’s pension.
She had two children, now 42 and 37 who stood to be the beneficiaries of most of her belongings, with a little bit carved out for charities she believed in and supported.
“So how much will my children get?” was her question to me. She assumed that there would be some erosion of her RRIF to taxes, but that basically, her two kids would split the better part of $200,000 between them.
I had to be the bearer of bad news.
Let’s just review how an RRSP works and how it becomes a RRIF. RRSPs were created in the late 1950s to help Canadians fund their own retirement. When you open an RRSP, the deposit you make will grow inside the RRSP account without the gains being taxed, or “tax-deferred” for as long as it resides within your account. In addition, and to encourage Canadians to contribute every year, there is a nice tax deduction that you will see every year that you contribute, so there is a double bonus. Tax-deferred appreciation and a tax break for making your contribution. Seems like a great deal! And it is.
At some point however, the government would like you to retire, so in the year a person turns 71, they must convert their RRSP into a RRIF, and start taking money out of the plan. A RRIF is simply an extension of an RRSP, and you convert it from RRSP into a RRIF tax-free. There are government set minimums for withdrawals based on the size of your account, but you can decide with your advisor what amount suits your life and plan. You can get monthly deposits or simply an annual one-time payment, or whatever interval you like really.
When you do make withdrawals from your RRIF (or RRSP for that matter) the money is taxed as income. The government would like to make its money back.
When a person dies, the entire RRIF account becomes due at the exact same time as do all the other assets that person owns. That means that your final tax return could be a big one. In Margaret’s case, her $200,000 RRIF will become income instantly and that pushes her up the tax bracket ladder into some large percentages.
All provinces are different when it comes to taxation, but it is safe to say that Margaret’s estate will be closing in on a 50% tax bracket (without planning). So, if we do the math on Margaret’s RRIF, the estate will have to pay tax on her $200,000 RRIF as if it was income. Her tax bracket (without planning) could be close to 50%. Let’s say that for the sake of this example, her bracket would be 48%.
This is when Margaret’s eyes began to widen with a little fear and maybe some anger, as she mentally did the math. I will save you from doing the computations and tell you that 48% of $200,000 is $96,000.
$96,000 in taxes! That of course leaves $104,000 for her two children to divide between themselves. The government just became the largest beneficiary of her RRIF, and her children came second with $52,000 each.
Having come all the way back down from the RRIF/RRSP tax-trap path with Margaret, I now circled back to the beginning to her initial question: “Why would I want to buy life insurance at my age?” Because we had gone through her situation with her children and the taxation of her RRIF, the answer was easy.
Because you spend pennies to make dollars.
So how did we take care of Margaret’s problem? We decided to use her RRIF to insure her tax liability. In other words, we bought a life insurance policy for $200,000 for Margaret and paid her premiums from her RRIF.
Because the proceeds of life insurance are paid tax-free, her children will inherit the entire value of her RRIF plus whatever is left in her RRIF when they inherit it minus what her RRIF owes to the government. So now even if the value of her RRIF goes down in value, her children will inherit more, and the government will get less. Her RRIF can also continue to grow tax-free (less the insurance premiums).
Margaret is a non-smoker and in good health, so she went through the traditional underwriting questionnaire and nurse visit (usually pee in a cup and take a blood sample) to get her coverage.
But what if Margaret wasn’t healthy, or didn’t like the idea of medical underwriting? There are plenty of medical-free life insurance options available now with no underwriting required and you can get covered from your couch wearing pyjamas. Especially since covid has made nurse visits nearly impossible to schedule these last 18 months. All you need is a phone or a computer.
In Margaret’s case, we are simply using her asset to protect her assets. We have covered her tax liability, we also added a little bit of coverage to cover funeral costs, so Margaret is using her RRIF to pay her children and not the government.
Make sure you speak with your licensed advisor or reach out to me (Book 15 minutes here) to talk about a strategy like this one. It is not for everyone, and you need to be aware that taking money from your RRIF, even if it is for buying life insurance, will create a tax liability, so be sure that you understand all the parts involved. It needs to work for you and your family, not just the life insurance company.
Still, it is a great solution for someone like Margaret, and certainly for her children. Margaret told me she sleeps better at night knowing that her children will inherit her assets and not the government, and that makes me very happy that I asked her such a silly question about getting life insurance at her age.
With Gratitude,
Kevin-Barry Henry
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