Continuing Education for Advisors knowledge continuing training educate online awareness participate The individual investment shelter A tax-effective solution for building wealth using exempt life insurance
Learning objectives By the end of this course you will be able to: Explain what the individual investment shelter (IIS) strategy is. Know who to target for the IIS strategy and which products you can use to implement it. Understand key estate planning considerations using traditional non-registered investments. Describe the advantages the IIS strategy offers in estate planning. Effectively present the IIS strategy to clients. 2
What is the individual investment shelter (IIS) strategy? Clients face unique challenges if they have significant non-registered investments that they wish to pass on to their beneficiaries. During their lifetime, income tax reduces the annual investment return. In addition, when the investments are liquidated, any deferred capital gains are realized and become taxable. Both of these factors serve to reduce the estate value. For clients concerned about protecting the value of their estate, the IIS strategy compares the benefits of a permanent cash value life insurance policy to traditional non-registered investments. It demonstrates how to maximize estate value by minimizing the erosion of investment assets through taxes and other costs. Clients also benefit from ongoing tax-preferred asset growth and a tax-free death benefit for their beneficiaries. 3
Which clients should I target for the IIS strategy? The typical client profile is: Age 60+ with significant non-registered assets High income and net worth who do not require cash flow generated by capital Has excess income or assets that they won t need in their lifetime Concerned about eroding estate capital and would like to leave more to his or her beneficiaries 4
Which products can I use for the IIS strategy? You can implement the IIS strategy using permanent cash value life insurance, such as universal life or participating life insurance. Key features of universal life insurance: Opportunity for tax-preferred savings growth Guaranteed cash values Premium flexibility Diversified investment opportunities for clients comfortable managing investments and volatility Key features of participating whole life insurance: Opportunity for tax-preferred savings growth Guaranteed cash value and death benefit growth Access to cash values Opportunity to earn policyholder dividends, offering steady long-term growth and stability The product choice will depend on the client s specific situation and risk tolerance. For purposes of this course, we will focus on how the IIS strategy works using participating whole life insurance. Learn and earn! Take the CE credit course Participating life insurance on advisor.ca to learn more about how participating life insurance works. 5
Estate planning considerations with traditional non-registered investments Clients with traditional non-registered investments may unknowingly have an over-inflated estimate of their estate s value. This is because of three key factors: 1. Taxes reduce investment income 2. Excess investment income may reduce government benefits 3. There are costs to transfer assets upon death 6
1. Taxes reduce investment income Any returns on non-registered investments are taxable. The example below shows the after-tax value of a $100 return at a 40.16% marginal tax rate*: Interest income: Income before tax $100.00 Less: Marginal tax ($100 x 40.16%) 40.16 After tax value $59.84 Dividend income: Grossed-up dividend ($100 plus 41%) $141.00 Marginal tax ($141 less 40.16%) 56.63 Less: Federal dividend tax credit (16.4354% of $141) 23.17 Less: Ontario dividend tax credit (6.4% of $141) 9.02 Total tax $24.44 After tax value ($100 - $24.44) $75.56 Capital gains income: Income before tax $100.00 Less: Marginal tax ($100/2-40.16%) 20.08 After tax value $79.92 You must include any unrealized capital gains in taxable income for portfolio rebalancing at death, during which time there will be a deemed disposition. Postponing capital gains realization can impede portfolio management. *Based on 2011 federal and Ontario tax rates. 7
2. Investment income may reduce government benefits Investment income is included in the amount of annual taxable income. Anyone who reports income over an amount specified by the federal government will have to repay a portion of their OAS pension (known as a clawback ). The full OAS pension is eliminated when the pensioner s net income reaches a pre-set cap. Although a reduction or elimination of the OAS pension may not be financially significant to high net worth clients, it still represents lost income that will require use of other savings in place of these funds. 3. Cost to transfer assets on death Traditional non-registered investments, such as mutual funds, do not allow for a beneficiary designation. As a result, probate fees and other legal and administrative costs will reduce the size of the estate that is passed on. Probate can also create a lengthy delay in transferring assets to the intended beneficiaries. NEXT! In the upcoming section, we will review a case study that shows how the IIS strategy is structured using participating life insurance and demonstrates the estate planning advantages it offers clients when compared to non-registered investments. 8
Meet Matt and Anna Here s the story: Matt, age 63, and Anna, age 60, are married and both are successful executives in the top marginal tax bracket. They are quickly approaching retirement and plan to begin in two years when Matt turns 65. They have planned carefully and expect to retire comfortably with income from their employer and government pensions, RRSPs and other benefits. Anna recently received an inheritance of $500,000 from her late mother. Since they are debt free and expect their retirement income needs will be taken care of, Matt and Anna want to pass these funds, as well as the balance of their estate to their three grown children. This money is currently invested in a balanced non-registered investment portfolio. Matt and Anna s goals are to: Increase the tax-efficiency of their portfolio to help maximize the value of the assets they transfer to their children; Minimize the impact that annual investment income will have on the clawback of their government benefits; and Reduce the volatility of their portfolio and the time they spend managing it. Matt and Anna have two options for the $500K inheritance: Set up the individual investment shelter using participating life insurance. Continue to invest in a non-registered portfolio that includes a diversified mix of equity and fixed-income investments. 9
OPTION 1: Set up the IIS with participating life insurance Matt and Anna s advisor recommends they buy a joint-last-to-die Sun Par Protector policy with a face amount of $750,000. They choose the life pay option, with paid-up additional insurance (PUAs) as the dividend option. Matt and Anna have also added the plus premium benefit. This allows them to accelerate the amount of PUAs purchased, resulting in a more rapid increase of total cash value and total death benefit. Total annual premiums for the plan are $46,423, which includes $28,183 for the base premium and $18,240 for the plus premium benefit. Assuming a five per cent pre-tax annual rate of return, Matt and Anna can move $46,423 per year for the next 12 years out of their non-registered investment portfolio to fully cover the annual premiums on their Sun Par Protector policy. Because they opted for the maximum allowable plus premium, they may be eligible for premium offset* after 12 annual payments are made. This is possible because the accumulated PUAs are projected to have built enough cash value to support premium offset. In addition to allowing Matt and Anna to purchase a $750,000 life insurance policy and benefit from the tax-preferred dividend growth over time, moving money out of their non-registered investments to pay for the insurance won t impact their planned retirement in two years or their lifestyle during retirement. And the IIS strategy is flexible. Matt and Anna have access to the cash values within their Sun Par Protector policy in the future, if needed. Why Sun Life for participating life insurance? We sold our first participating life insurance policy in 1871. We ve paid policyholder dividends every year since 1877 and have a large, prudently managed par account. We have over $16 billion in par account assets, and support 1.6 million par policyholders who have over $87.6 billion of participating life insurance with us. *Important to note Premium offset is an administrative feature (not a contractual right under the policy) that may allow a policyholder to use dividends and accumulated value within the policy to help pay future premiums if certain conditions are met. The premium offset date is not guaranteed. It may occur sooner or later, or not at all, depending on future dividend scale changes. If and when the policy goes on premium offset, at some point the policyholder may have to resume out-of-pocket premium payments. 10
OPTION 2: Continue to invest in a non-registered portfolio Matt and Anna decide to leave the inheritance money in a non-registered balanced bond/equity portfolio earning five per cent per year. Remember, on death, any deferred capital gains will be taxed and the remaining money may be subject to estate settlement costs, including probate fees where applicable. Assuming a moderate rate of return of 5 per cent annually, the value of Matt and Anna s portfolio will grow to $1,143,934 by the time Anna reaches age 85. While this number sounds impressive, see what happens when you compare this to the growth achieved if they had instead implemented the individual investment shelter using Sun Par Protector. 11
Compare the results The graph shows that the IIS helps Matt and Anna leave their children and grandchildren a much larger inheritance than if they had continued to rely solely on taxable investments. Plus, the increased estate value continues to grow, no matter how long they live. Estate Values (in $ 000s) 4500 4000 3500 3000 2500 2000 1500 1000 500 53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 Age of Primary Insured Taxable: Estate Value IIS: Estate Value Taxable: Asset Value IIS: Death Benefit As you can see in the summary table, the projected IIS values are higher every year from the time of inception. Even after just one year, the net amount to the beneficiaries from the IIS is $1,262,197 more than double the value of the non-registered portfolio. Net to beneficiaries (at death) Individual investment shelter Alternative investment Individual investment shelter advantage Year 1 $1,262,197 $505,217 $756,980 Year 10 $1,579,347 $685,995 $893,352 Year 20 $1,977,526 $964,685 $1,012,841 Age 85 (Anna) $2,235,186 $1,143,934 $1,091,252 Age 95 (Anna) $2,830,409 $1,608,373 $1,222,036 12
The outcome By setting up the IIS, instead of holding their investments in a non-registered portfolio, Matt and Anna enjoy these benefits: Funds accumulate within the policy on a tax-preferred basis. This helps to minimize the annual taxable income and potential OAS clawback. On the death of the second spouse, the full value of the insurance is paid out as a tax-free death benefit to their beneficiaries. If Matt and Anna name their children or grandchildren as beneficiaries to the policy, the death benefit will be paid directly to them without passing through the estate. Along with helping to avoid settlement costs and the delays associated with estate administration, this could also prevent potential conflicts among the estate beneficiaries. Individual investment shelter vs. a taxable investment Structure: Taxable Investments Structure: Individual Investment Shelter $ Taxable Investment Annual Tax on investment income $ Participating Policy No Annual Tax on growth accumulated in the policy Annual Tax on deferred capital gains No Tax on life insurance death benefit $1,643,152 Liquidated Value available to pay to beneficiaries $2,834,201 Death Benefit available to pay to beneficiaries Beneficiaries named in policy $34,779 Estate Settlement Costs to distribute estate assets $1,608,373 $3,791 Estate Settlement Costs to distribute estate assets $2,830,409 No Estate Settlement Costs on Death Benefits paid directly to beneficiaries After-tax value to beneficiaries After-tax value of beneficiaries 13
IIS strategy summary 1. The IIS strategy compares the benefits of a permanent cash value life insurance policy to traditional non-registered investments. 2. The IIS strategy may be implemented using universal life insurance or participating life insurance. 3. The typical client profile is high net worth individuals who: 1) are age 60 and up; 2) have excess assets they will not need to use while living; and 3) want to maximize the estate value that is passed on to their beneficiaries. 4. Taxes on investment income, reduction or elimination of the OAS pension and the cost of estate administration are three key factors associated with non-registered investments that can reduce the value of an estate. 5. The IIS strategy maximizes estate value by minimizing the erosion of investment assets through taxes and other costs. Clients also benefit from ongoing tax-preferred asset growth and a tax-free death benefit for their beneficiaries. 14
Why partner with? 1. Brand, strength and integrity 2. Competitively designed and priced products 3. Sales strategy tools 4. Expert, accessible underwriting 5. Regional support 6. VIP treatment via Strategic Partner Program www.sunlife.ca/advisor Visit us around the clock to check out our broad range of tools and support services, including our proprietary sales concepts, Financial Advisor bulletins, case studies, needs analysis software and full product guides. Want to know more? If you already work with you can contact your regional distribution office to arrange for face-to-face case assistance, or consultation on advanced tax estate planning issues. Call 1 800 800-4SUN/4786 option 5. If you don t currently work with call 1 800 800-4SUN/4786 option 3, 1 to inquire about contracting. knowledge continuing training educate online awareness participate