Investment Multiplier Strategy

Transcription

1 Investment Multiplier Strategy Build your clients net worth by multiplying their assets and giving them a tax break. Turning taxable investments into compounding tax-sheltered* assets with guarantees. Your business. Your clients. Real solutions.

2 Here s the story Seventeen years ago, Henry and Helen Tallar took a calculated risk and started Tallar Enterprises, a small family partnership. With a lot of hard work and some good financial planning the husband and wife enterprise grew into Tallar Products Inc., a thriving small business corporation. Henry and Helen are competent business people. Their current strategy, however, doesn t maximize the results of their hard work. If their financial plan remains as it is, the real rate of return on their conventional investments may be eroded by income taxes. If they need to utilize their shareholder loan account, it may create cash flow or financing issues for their company. Despite their current affluence, Henry and Helen would feel safer if they could somehow increase their financial asset base. The solution By following a disciplined financial and estate plan, Henry age 47 and Helen age 49 are in a solid financial situation. They have made the maximum RRSP contribution every year, paid down non-deductible debt and built a conservative portfolio of investments. Henry and Helen each take a generous salary and bonus from the company. This bonus helps keep the company tax rate low but creates an investment challenge for them since their income increases. For years now, they have also reinvested back into the business through shareholder loans. Their financial advisor indicated that too many outstanding shareholder loans may be a future obstacle to financing a sale or succession arrangement. Asset diversification could potentially provide a more stable financial position for them, their business and their family. But the after-tax return on fixed income investments is often lower than the rate of inflation, meaning they re losing buying power. The real question is, How should Henry and Helen invest? The challenge Henry and Helen need a solid, tax smart way to build future value, without increasing risk. Henry and Helen estimate their annual excess income, available to invest, is at least $75,000 and they expect this to grow as the business grows. At the same time, their successful business and family responsibilities translate into a need for more permanent insurance. When asked if their current assets will cover all future needs, their response is no. With a little probing, Henry and Helen admit their existing assets could likely provide a comfortable lifestyle until their mid-seventies. They still question how to make sure they have additional assets to utilize, should they ever need, or want, extra cash. Henry and Helen are also conscious there are obstacles that make conservative investing a challenge for the following reasons: The annual return on the fixed income investments in their portfolio is fully taxable and the after-tax return is often lower than the rate of inflation. Example: 5% interest less 45% tax less 3% inflation = -0.25% net return Withdrawals from their equity portfolio in later years for retirement income will add deferred capital gains to taxable income. Traditional leveraging strategies include the risk that loan interest and investment returns can vary widely. Paying premiums with after-tax dollars makes more life insurance seem expensive. Building assets for business and family can be a challenge. The story of Henry and Helen outlines an interesting challenge and an opportunity for you to present a great solution for your clients who may be in a similar situation. The investment multiplier strategy. Here s a solution that will give Henry and Helen the comfort of knowing they have created multiple pools of assets to help provide financial security in retirement. The investment multiplier strategy (IMS) makes it possible to borrow from their insurance policy on a tax-deductible basis and multiply their investment power. A required minimum deposit with this strategy in the amount of $50,000 is not a problem, since Henry and Helen are planning to invest more than that annually. The plan Henry and Helen decide to purchase a joint last-to-die SunUniversalLife policy with a $2 million dollar level death benefit. The policy is designed with a level face amount and yearly cost of insurance. For Henry and Helen this means that as the fund value of their policy increases, the actual amount of the insurance decreases while the face amount remains level. This helps keep the cost of insurance very reasonable and also allows for an increase of the fund value inside the policy. The total policy proceeds, including the fund value, is payable tax free on death to their beneficiaries. Payments up to just under the tax-permitted maximum are made into the policy each year. Henry and Helen plan to deposit the yearly maximum deposit for eight years for a total deposit of $675,063. This fits well with their business plan. Policy funds that are not borrowed are assumed to earn 5.0% in the following scenarios. Here s how it works: At the start of each year the maximum tax-free amount is borrowed from the policy and the proceeds are then used to invest in either an investment generating taxable interest/dividends or a business-building investment. By the beginning of the eighth year Henry and Helen are effectively accessing and reinvesting over 97% of their gross deposits. The total amount borrowed earns a guaranteed return of 8% while borrowing costs are fixed at 10%. Henry and Helen pay the interest costs annually. Under current tax rules 1 the loan interest is tax-deductible provided the outside investment will generate taxable income. There s no risk that the interest rate spread will vary. They could leave the policy loan outstanding until death or they could repay the loan from the investment portfolio or the business. They might do this to reduce demand on cash flow or because the tax rules have changed or they perhaps simply don t like the idea of having a loan burden associated with the policy, which would reduce the death benefit. 1 tax rules are subject to change and there is no guarantee that the current rules will apply in the future. The federal Department of Finance has indicated that the tax rules pertaining to interest deductibility are under review. 2 Investment Multiplier Strategy Investment Multiplier StrategY 3

3 Advantages of the investment multiplier strategy: Henry and Helen, not the bank, decide when and what amount to borrow. The guaranteed 8% interest is earned in a tax-deferred exempt life insurance policy. The deductible 10% interest on the loan will reduce the net taxable income from their investments. The after-tax cost of borrowing is less than the guaranteed return of 8%. Investment assets are multiplied, building future estate values with no additional risk. The result With the investment multiplier strategy, Henry and Helen multiply their projected invested income into an extra $1.5 million in assets by age 75 or an extra $2.3 million by age 80. These funds are available for retirement, personal care or other family needs. And those extra assets can generate a lot more income than they would otherwise have, simply by investing into a regular taxable portfolio. If either Henry or Helen live to age 90, their estate will receive $9.1 million net of tax and estate settlement costs using this strategy. An income example Henry is now age 75 and they need to increase their retirement income. One option is to use the accumulated investment portfolio and insurance policy as collateral for a series of loans. Assuming they can borrow at 7.0%, they can receive an income of $150,000 indexed at 2% for 15 years. If either Henry or Helen live to age 90 they will have enjoyed a cash flow stream of $2.79 million, creating a loan balance* that will be retired on death. The investment multiplier strategy will still have grown their net total estate benefit to nearly $4.1 million, after paying all the bills! That s a nice legacy. * based on assumed rate of 7% Important points to remember investment multiplier strategy: Is a sophisticated strategy with inherent financial and tax risks. Interested clients will need to consult their own tax, accounting and/or legal advisors. Requires an annual policy review and transaction planning. Actual amounts of future payments and loans available will depend on investment returns and must be recalculated annually. Is a solution to be offered with long-term follow-up. Will result in a negative cash flow for seven to ten years. Must be implemented at least until the breakeven point. Otherwise, your clients situation would be less positive than before they started the strategy. Should only be used by clients who can commit to the strategy for the long term. Requires policy loans to be specifically requested each year. Loans will not be offered automatically. Means clients should be planning on slightly less than the maximum exempt payment to make sure investment fund growth, especially with 8% return, doesn t affect MTAR (Maximum Tax Actuarial Reserve) contribution room. Means clients must consider future investment bonus may also change available deposits and loans. Necessitates an ongoing relationship with clients to make certain the strategy is executed properly. Illustrations** will not be matched by actual results. Careful follow-up with interested clients will be necessary at least one month prior to each policy anniversary to enable all necessary transactions to be completed before the policy anniversary. Otherwise, there could be unintended tax consequences, e.g. a taxable loan gain if interest isn t paid. The story of Henry and Helen demonstrates how this sophisticated financial strategy can multiply substantial excess income or capital into solid, future financial security for your clients. The investment multiplier strategy can also generate profitable transactions for you as their advisor and help to foster a closer client relationship through the necessary annual policy transaction planning. For additional technical information, see our reference paper on interest deductibility posted on ** note: Illustrated values are based on assumptions that will change over time and are not guaranteed. Actual results will differ upward or downward from those shown depending upon future experience. Even a small change in the assumptions can have a large negative or positive impact on these non-guaranteed illustrated values. Planning considerations Interest deductibility The strategy only works if the interest on the policy loan is deductible. The requirements for interest deductibility are set out in section 20(1)(c) of the Income Tax Act Canada (ITA). Essentially there are four requirements: a) The interest is paid or payable in the year. b) The borrowed money must be used to earn income from a business or property. c) The amount of interest must be reasonable. d) The borrowed money is not used to earn exempt income or to acquire a life insurance policy. It is strongly recommended that you read the Sun Life Financial reference paper entitled interest deductibility available from our advisor site at Further information can be found by consulting the CRA interpretation bulletin IT-533 Interest Deductibility and Related Issues, which is available from 4 Investment Multiplier Strategy Investment Multiplier StrategY 5

4 AND GET A TAX BREAK. Turning taxable investments into compounding tax-sheltered assets with guarantees. Meet Henry and Helen As a couple with a successful Building assets for our business and family can be a challenge for many business and adolescent of us. The story of Henry and Helen presents an interesting challenge children, Henry and Helen and a great solution that may also work for you. enjoy good incomes. They They own Tallar Products, a thriving small business. They each take a also have large financial generous salary and bonus from the company. The bonus helps keep the responsibilities. They are company tax rate low, but creates an investment challenge. They have looking for solid, tax-smart been building up a non-registered investment portfolio for their future ways to build future values financial security. And because of their success, they need to increase without increasing risk. their life insurance for their growing capital gains tax liability. The challenge High tax rates make conservative investing expensive. The annual return on the fixed income investments in their portfolio is fully taxable and the after-tax return is often lower than the rate of inflation. Traditional leveraging includes the risk that loan interest and investment returns can vary widely. Withdrawals in later years to generate income will add tax on deferred capital gains to taxable income. Quebec residents The Quebec Tax Act limits the annual interest deduction to the amount of the taxable investment income generated in the year. Amounts that you cannot deduct due to this limitation, create a Cumulative Net Investment Loss (CNIL) that may be claimed in full in the year of death. This may result in a lower total tax recovery than the one illustrated. Quebec residents need to complete Revenue Quebec form TP-163-I-V as well as the federal T2210. IMS TOOLS MULTIPLY YOUR ASSETS INVESTMENT MULTIPLIER STRATEGY Client fact sheet: This one-page sheet explains how the investment multiplier strategy. It highlights the benefits and encourages your clients to contact you for more information. Risks That You Need to Be Aware Of Lapse risk This strategy uses maximum policy loans immediately following the first annual payment into the policy. This means the next year s payment must be received at Sun Life Financial on or before the next policy anniversary. If the payment is late, your client may receive a lapse notice. This also means that the portion of the fund that isn t borrowed must be invested in the daily interest or a guaranteed interest account. A negative in any other account could also result in a lapse notice. Tax risk This strategy relies on the deductibility of the interest expense. Tax rules are subject to change and there is no guarantee that the current rules will continue to apply in the future. The Federal Department of Finance has indicated that the tax rules pertaining to interest deductibility are under review. It is the client s responsibility to make sure his/her affairs are structured to meet the requirements of the Income Tax Act with respect to interest deductibility. We strongly recommend any clients considering this strategy consult their professional tax advisor. Living past age 100 While the probability is low, it is not inconceivable that a client will live past age 100. In that case, the cost of insurance deductions will stop and the insurance will continue. Rather than continue to pay interest on the loan, the client may be well advised to use the fund value to pay off the loan. The policy would then continue in force as a fully paid up policy with a growing fund value. Making it easy Our goal is simple to make it as easy as possible for you to sell and service our products. By providing your clients with a concrete summary of the issues that face them, you will be better positioned to help them structure an effective financial solution. Many people have trouble visualizing how dramatically taxes can reduce the size of an estate. Clients also may not fully grasp the potential cost of the other funding options (cash, selling assets, and borrowing). So, how can you show them the magnitude of the problem and back up your recommendation? We can help with the following tools: What s the bright idea? SunUniversalLife The bright idea behind the investment multiplier strategy is SunUniversalLife. Besides providing your clients with a flexible financial planning tool, SunUniversalLife gives you the confidence to deliver: Optimal tax-deferred growth. Investment multiplier strategy software: With Sun Life Financial s powerful and easy-to-use software, you can create detailed client and advisor reports based on your clients actual financial situation. With a minimal amount of effort, you can clearly demonstrate the potential size of your clients asset and future tax liability based on their current plan, and then compare possible outcomes using several IMS strategies. The IMS software is part of our Eos product illustration system, available through your Sun Life Financial regional distribution office (RDO). Client reports: Our IMS software produces a full-colour report with text and colour graphs and detailed ledgers creating a powerful presentation of the problem and solution. Competitive, guaranteed level cost of insurance. A bonus option that combines a guaranteed investment bonus starting in year 2 with a unique cost of insurance discount controlled by the client, or a no-bonus option that provides lower management fees on investment account options. Large selection of competitive, tax-deferred investment options, including three exclusive Financial Post Index (FPX)* accounts and seven institutional managed accounts. Tax-free access to policy funds if required in future as a result of disability. SunUniversalLife Tools For further information about the versatility of SunUniversalLife, our client guide, comprehensive advisor guide, and investment account options booklet, can provide you and your clients with full details about the product s features and benefits. *FPX is a trademark of The National Post Company. 6 Investment Multiplier Strategy Investment Multiplier StrategY 7

5 The backup you need. With Sun Life Financial, you get the best behind-the-scenes support around. As one of our distribution partners, your own estate planning consultant or insurance specialist will be your first line of support. Plus, if you need additional assistance, we re here to help. Visit us around the clock to check out our broad range of tools and support services, including our proprietary sales concepts, Financial Advisor bulletins, a wide assortment of reference articles and case studies, client PowerPoint presentations, needs analysis software and full product guides. Sales, Marketing and Resource Team (SMART) For telephone consultation or advice, call us toll free from 8:30 a.m. to 4:30 p.m. (eastern time) at SUN/4786, option 1,4,1. Your call will be answered in person by an expert who understands your needs and can answer your specific questions about our products, software and sales support tools. Regional distribution offices Your own estate planning consultant or insurance specialist can call the regional distribution office near you to arrange for face-to-face case assistance, or consultation on advanced tax and estate planning issues. Call SUN/4786, option 5. * From front: Subject to limits as prescribed in the Income Tax Act (Canada) Sun Life Assurance Company of Canada,