Looking to shelter your client’s investment income? If so, you have plenty of options these days.
The most commonly used structures are, of course, the old-fashioned RRSP and the newer TFSA. And once those have been maximized, one can always turn to corporate class funds to defer taxation until sale and convert investment return into capital gains — and in some cases, dividends. Another commonly used strategy is the use of insurance as a tax shelter.
The insured retirement plan
Insurance as a tax shelter isn’t a new concept. Participating whole life and universal life policies have been used for tax planning for as long as each policy has existed.
The most commonly used insurance tax-sheltering strategy today is what’s sometimes known as the insured retirement plan (IRP). Simply put, an IRP works as follows: A universal life (UL) policy is purchased on the investor’s life (whole life can be used instead, but typically a UL IRP is easier to grasp). Premiums paid to this policy are deposited into the policy’s investment account, where they’re invested as per the policyholder’s instructions. Options typically include:
- Savings accounts;
- Guaranteed interest accounts;
- Index tracking accounts (the equivalent of an ETF);
- Managed accounts (that track mutual funds).
Premiums paid to the policy are charged a premium tax that varies, depending on the policyowner’s province (2% in Ontario), and the balance of the premium is deposited into the investment accounts as per the above point. Then, every month for 10 years, 15 years, 20 years or life (depending on the type of policy purchased), a cost-of-insurance charge is applied to the investment account to pay for the insurance portion of this policy. The premiums deposited into the UL policy are flexible, and can be set at any amount between the cost of insurance and the MTAR maximum for that year.
I won’t bore you with how the maximum is calculated, but let’s just say there’s an annual cap that’s often more than five to seven times the minimum.
These additional premiums, or over-funding, then grow tax-sheltered within the UL. And while the insured is alive, he or she can access the funds by way of: Withdrawal (which will likely result in taxation); or using the policy as collateral for a line of credit or loan that allows the policyholder access to 50%-75% of the cash policy’s value, without triggering any tax. On death, the policy would pay off the loan.
Finally, on death, the full value of the policy, investments and death benefit would be paid out tax-free to the beneficiaries.
Just about everyone I have ever explained the IRP to has a love-hate relationship with it. They love the tax shelter, but they hate the fact that they have to pay for insurance in order to get it. I, too, have often wished I could separate the tax shelter from the insurance itself. Unfortunately, to date, no insurer has been able to find a way. Manulife has come close, though, with a new policy they call Ultravision.
Ultravision is a face-plus fund UL policy that differs from other face-plus UL policies in three ways:
So what’s the big deal? The spread rate.
First of all, this policy can no longer collapse. Since the insurance charges are now a percentage of the account value instead of a lump sum, this means the account value can only be reduced by a fraction and never the whole amount. After all, a 1% charge on account value can never total 100% of the account value.
Secondly, the spread rate puts this strategy in familiar terms when clients consider its cost. Clients are used to comparing fees such as MERs; now the cost of this strategy is in easily relatable terms.
Essentially, Ultravision can be summed up as a structure that allows one to invest in various GIAs, indexes or mutual funds on a tax-sheltered basis.
In exchange for this tax-sheltering benefit, the investor has to pay an additional fee. Oh — and the insurance? Well that’s practically a bonus. I mean, would an investor rather pay a slightly higher MER or pay taxes on their investments? I’m pretty sure most would choose the former. As for access to these funds, it works like a standard IRP.
Spread rate: A case study
So now that we know the benefit, how much does it cost? Well, the cost of investing is broken down into three parts:
Let’s consider a 45-year-old male non-smoker of average health with $75,000 who’s looking to invest in this strategy over the next five years. The following would occur:
An Ultravision policy with the above parameters is quoted and software calculates a face value of $271,482 is required to shelter these funds.
In year 1, $25,000 is deposited and the policyholder is charged a 1.2% spread rate.
In year 2, $25,000 is deposited and the policyholder is charged a 0.81% spread rate.
In year 3, $25,000 is deposited, and the policyholder is charged a 0.60% spread rate.
In years 4 and 5, no deposits are made, and a spread rate of 0.6% is charged.
In year 5, the spread rate is locked in for life.
In year 6, the policy is bonused about $734.64. This refunds the client for the difference between 0.60% and the 1.2% and 0.81% spread rates paid in years 1 and 2.
The client can choose to make additional deposits until year 10.
Every year, the insurance death benefit will adjust to the minimum level required to shelter the funds within the policy. And at age 85, all spread rate charges cease and the policy is fully paid up. By then, the death benefit will have adjusted down to $10,000.
So in the end, the client gains a tax shelter for what amounts to a Seg Fund MER. In addition, the client’s estate gains the insurance death benefit at time of death.
Ultravision vs. corporate class
How does Ultravision compare to investing in a simpler tax-efficient structure such as a corporate-class portfolio? To understand this, we have to consider various scenarios.
In the end, there’s no clear winner. Both strategies have their pros and cons, and as always, it’s important to consider the client’s goals when deciding if Ultravision is a good option. But I do commend Manulife for bringing this to the Canadian market. Ultravision delivers all the benefits of an IRP without the negatives, and has armed advisors with yet another powerful tax-planning strategy.
More than that, they’ve managed to do it in a way that looks and feels like an investment product. The spread rate resembles an MER, and even the compensation is level and resembles a mutual fund trailer. So, Ultravision is probably the closest we’ll ever come to UL without that pesky insurance.