With recent market turmoil, many articles have espoused the virtues of dollar-cost averaging. The theory is that as the cost of a unit or security goes down, regular and disciplined investments will take advantage of reduced pricing and lower the average cost of acquiring the investment, at least on a temporary basis. But where does insurance planning fit into regular investment strategies?
First let’s consider RRSP planning. Consider Michael Wilson*, a married, 45-year-old middle manager at a telecommunications company. With a reasonable income, a mortgage that’s been paid down significantly and teenaged children, he’s looking at accelerating his savings via maximizing his RRSPs and is considering whether a conservative leverage strategy makes sense for him.
Yet at the same time, he’s concerned about protecting his family and livelihood in the event of an early death, illness or disability. Since moving to a new advisor who offers full financial planning and risk management, he has realized that he and his wife have not reviewed their insurance needs in a decade. The Wilsons are concerned about how to maximize the efficiency of their savings goals yet still find a way to afford valuable insurance protection.
Assuming he can afford to save $500 per month, Wilson is looking at potential tax savings of $200 each month in his 40% marginal tax bracket. Although he always wants to take his tax savings at the end of each year and reinvest it or pay down his mortgage, he often finds the money goes to a fun purchase like a new TV or family getaway.
Through prudent budgeting, Wilson’s new advisor convinces him that he can have the best of both worlds. Rather than waiting all year for their tax refund, his advisor suggests taking the tax savings now and purchasing their insurance protection. By using form T1213 (reduction of tax at source), they state the amount of their RRSP contributions for the year, and their employer reduces their taxes accordingly. By increasing the net cash flow through reducing tax flow, the advisor has found the dollars for Wilson to buy insurance coverage.
Wilson now has $200 freed up from remittance to the government with which to address his protection needs. As Wilson has a decent group disability plan at work that he cannot opt out of, his advisor suggests he focus his insurance budget on life and critical illness coverage. Since cost is an issue, they are focusing on term insurance until cash flow improves and Wilson is mortgage-free.
For $200 a month, Wilson could purchase approximately $2 million of 10-year-renewable and convertible-term life insurance, or over $300,000 of 10-year-renewable critical illness insurance. As he already has some life coverage, but is underinsured, he ultimately takes $500,000 of 10-year-term life coverage and $200,000 of critical illness coverage for less than $200 per month.
Let’s now look at leveraged investing. We’ll change a couple of variables in Michael Wilson’s case. In this instance, his mortgage is paid off. Wilson is looking for tax-efficient investing that offers some deductibility for his monthly costs. He is a relatively knowledgeable investor who understands both the benefits and risks of leverage. He likes the idea of accelerating his wealth through leverage and sees the potential for generating monthly tax deductions by servicing his interest but is nervous of the current market conditions.
His advisor suggests that he borrow a lump sum of $100,000 at 7% interest but dollar-cost average the lump sum into his portfolio over a period of between six and 12 months. This way, he can take advantage of any short-term downturns by purchasing his investments at a lower cost. However, if markets rise steadily, Wilson understands that he would risk purchasing at ever-increasing unit costs. So where does insurance planning fit? For the same reasons as the above scenario, if Wilson is underinsured, he could use the reduced tax flow each month to secure his needed insurance coverage.
Looking at it another way, if Wilson were suddenly to become ill, he would be focusing all of his personal and financial resources on recovery. Servicing his loan for his leveraged investment strategy would not be a priority, and he’d consider collapsing the investment to pay off the loan. His advisor suggests that he consider purchasing critical illness coverage to pay off the loan and provide a self-completion to the strategy in the event of a serious illness. This way, he would have his investment intact and not worry about the tax treatment of selling the portfolio to pay off the loan. For approximately $70 per month or an annual cost of about 0.8% of the total loan, he could protect his investment and redeem assets only if he needed to.
As you can see, comprehensive planning offers opportunities for total wealth management and risk management to work in synergy.
*Not his real name.
Chris Paterson is vice-president of sales, living benefits, at Manulife Financial and has over 13 years of experience marketing various insurance products.