Regulations 306 and 307 of the Canadian Income Tax Act (ITA) provides that the cash value accumulation is exempt from annual accrual taxation in certain life insurance policies. This essentially opens up much more equity investments to the benefits that accrue from having investments inside RRSPs. The accrual is tax free and so grows more quickly than regular investments. Generally, the type of investment is more limited. You cannot purchase individual stocks and bonds, but there are a significant range of funds available offering exposure to indices and international markets. It is similar to a Roth IRA in the US.
The idea is that you buy a life insurance policy, where you pay for both insurance and investment (like a participating policy), and there is a tax free accrual of asset value within the policy. The growth in investment value is used to pay for the monthly insurance fee. When you need money, you can borrow against the paid-up (cash) value in the policy and such loans are not considered income. It is similar in concept to a reverse mortgage to unlock the equity in your home. The extra advantage is that the loan is automatically life-insured so that it gets paid off when you die. The cost of such borrowing is more than compensated by the tax sheltered growth during the life of the policy.
Because I had been a CEO for a high technology company, the Board had carried "Keyman" insurance on me. So I wanted to use the guaranteed insurability of that policy to purchase a smaller amount to plug this hole. Fortunately, the person I had dealt with for the keyman policy was a very knowledgable investment advisor for a broker. He introduced me to this type of policy that acts like a Tax-Deferred Savings plan (TDSP).
You can shift your fixed assets into this life-insured investment portfolio over a period of time (contributions are limited by the Income Tax Act in any year - in my case it is over eight years). The contributions are invested in a variety of funds. You can change the funds once a quarter. The company has added new funds that offer more alternatives since I started. Then the investment growth is used to pay for the insurance. Any excess investment growth accrues inside the policy tax free. The policy acts like an RESP (no tax deduction going in but no matching).
I purchased my policy from Industrial Alliance when it was National Life. They had the lowest insurance premiums of all the companies that bid for my business at the time. They call theirs a Flex Account. The document on the preceeding link is intended for their advisors and so is not easy to understand. I had a good financial planner from Canaccord who helped me through it. These shelters are offered by many of the majors such as Sun, GWL, Freedom55, and I am sure all the others too.
Here is a chart that illustrates how the tax free growth occurs:
You will notice in the above chart that the tax-free accumulation slows down in later years. This is because the insurance premium is like increasing term. It is structured this way to maximize tax-sheltered investment growth in the early years. Here is a further chart that illustrates how the tax shelter aspect enables growth beyond what traditional tax shelters offer:
Statutory plans includes both RRSPs and contributory company pension plans. Finally, here is an illustration of how the resulting higher asset growth can transfer to your benefit:
A more complete explanation is in these PowerPoint shows from GWL (where these chart came from) on Enhanced Retirement and Insured Asset Transfer.
Here are some key items defined:
For a more extensive explanation of terms and issues, and a full glossary, go here. I have provided this summary because I have had great experience with this investment vehicle. After some initial scepticism (too good to be true?), I have now had the benefit of 3.5 years enjoying this instrument and it has exceeded my expectations. After contributing X each year for three years (in December), the cash value is now 3.82X and the Insured Value is 13.43X! And all this in fairly safe instruments.
I am sharing this information freely for the benefit of other investors and I have no interest in selling or referring such business.
Copyright 2006 the authors
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