There are two sides to every story, and that includes RRSPs. On one hand, they help Canadians save by providing incentives for tax-free growth, tax deductions for contributions to personal RRSPs, and matching programs provided by employer-designed group RRSPs and pension plans. On the other hand, any unplanned withdrawal from registered plans must be fully taxed as regular income. To solve this problem of tax inefficiency upon a surprise withdrawal, many advisors are having success cross-recommending (a.k.a. client-focused cross-selling) insurance solutions to protect registered assets.

Case study

Frank and Maria DaVinci are a reasonably successful yet modest couple about to retire. Through hard work and diligent saving, they have amassed a sizable registered pool of $400,000. Upon second death, the entire RRIF or LRIF (non-annuity) value will be deemed to be taxable income on the terminal return in the estate. This creates a problem where between 25% and 50% of a RRIF’s value may be lost in the form of income taxes, probate fees, executor fees, etc. The lowest cost solution to this problem is to let an insurance company pay the estate costs.

  • Age 65, non-smokers
  • 40% marginal tax rate
  • $400,000 RRIF paid out at legislated minimum
  • 6% growth rate
  • Age 80 net estate value $212,496 (after $166,024 of taxes paid)
  • Age 90 net estate value $146,738 (after $106,172 of taxes paid)
  • $150,000 joint and survivor Term 100 insurance for terminal taxes:
  • approx. $2,100 annually

    We can see that protecting estate-conscious clients’ RRIF assets with insurance provides a greater estate benefit with minimal impact on their living values.

    However, what impact will health concerns have in their pre-retirement years? Let’s turn the clock back to 1983 and make Frank and Maria a 40-year-old couple in the springtime of their investing lives. Five years later, at age 45, Frank has a heart attack or is diagnosed with cancer or another illness that sidelines him from work and costs the family $65,000 in recovery costs. This number could represent lost wages from work, the difference in disability benefits paid to actual living and health care costs, and/or a voluntary leave of absence from work for either him or Maria. However, these are after-tax dollars. To create this money, we’ll have to redeem our RRSPs and pay tax:

  • Pre-tax cost to withdraw from RRSPs $100,000
  • Average tax rate 35%
  • Net spendable dollars $65,000

    That’s assuming that at age 45, they had $100,000 in their RRSPs. If they didn’t, they would be in a much more dire financial situation. In any case, that $100,000 of gross registered value could have doubled twice at 7.2% over 20 years to be worth $400,000 when they retire at age 65.

    However, they could have protected themselves with additional disability insurance and/or critical illness insurance. For critical illness coverage at age 40, they could have locked in their insurability for as low as $90 a month for a Term 10 renewable plan with a variety of carriers, or they could have gone with more robust term 100 or limited pay, return-of-premium type plans for as much as $300 a month. This protection would have secured that $400,000 asset at retirement, giving them an additional $35,000 to adjust their lifestyle, as well as locked-in coverage for Maria.

    Let’s assume that they do get to retirement with no health shocks. The reality is many employers are reducing or eliminating retiree benefit plans. But seniors still have strong needs for health care, dental care, prescription coverage, etc. Any increased health costs not covered by government programs would need to be covered through a withdrawal of assets or a reduction in other lifestyle expenses. Or they could purchase individual health insurance for little more than $100 or as much as $300 per month depending on the level of protection they choose.

    Many retirees don’t fully give up working, though, often taking on consulting jobs or running their own businesses, which may qualify the premiums as a tax deduction. By paying the premiums with RRIF income, their income inclusion could then be offset by the tax deduction for the premiums paid, resulting in a dollar-for-dollar transfer from asset to asset protection, multiplying the value of their overall family dollars.

    The last opportunity to protect assets would be when assisted living becomes a reality. Long-term care insurance will protect them from rapidly depleting their registered assets. If Frank’s or Maria’s cost of care increases their monthly living expenses by $3,000 a month, this could require an additional $5,000 in monthly withdrawals for them at a 40% marginal tax rate. Regardless of the potential for some deductions for medical expenses, this increased drain on their assets will have an impact on their ability to sustain these living costs and greatly affect any residual estate value. By purchasing long-term care insurance, the DaVincis can ensure a better chance of keeping their assets around and secure their potential legacy for the next generation.

    For years, advisors have successfully been positioning life insurance as a means to protect a registered asset’s value for the next generation from an exorbitant tax consequence in the estate. Nothing has changed, and this is still a great solution. However, there are many more products at our disposal now to help reduce the potential for increased tax inefficiency if we must draw down these assets during our lives.

    Chris Paterson is vice-president of sales for Manulife Financial.