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Insured Annuities

The insured annuity or “back-to-back” strategy is a popular concept to provide retirement income or to enhance the rate of return on the fixed-income portion of a portfolio. The basic strategy involves the purchase of an annuity to provide a lifetime stream of income, and a life insurance policy to replace the capital used to fund the annuity upon death.

When the insured annuity is personally owned, the annuity can qualify for prescribed tax treatment, which levelizes the annual taxable portion of the annuity. However, sometimes the capital to be used for the annuity is corporate-owned. Setting up an insured annuity under corporate ownership has some drawbacks but also some interesting additional features.

The first drawback is that the annuity will not qualify for prescribed tax treatment when it is owned by a corporation. This means that the annuity is taxed much like a mortgage; the first payment is mostly interest and little principal while a payment twenty years later is mostly principal and very little interest. As much as this is a drawback, there is a silver lining to the disadvantage – the after-tax cash flow from a non-prescribed annuity increases every year, creating an element of inflation protection.

An advantage created by corporate ownership of the insured annuity is the lowering of income taxes realized in the estate. Upon death, a person is deemed to have disposed of all of his or her capital assets, which would include the shares of the corporation. The value of those shares would reflect the assets in the company, which would include the life annuity and the insurance policy on the life of the shareholder who just passed away.

The Income Tax Act contains a special deeming rule for purposes of valuing the corporation’s shares upon the death of a shareholder. This rule provides that the value of a life insurance policy on the life of the deceased shareholder is its cash surrender value, irrespective of any other valuation technique.

The value of a life annuity might be determined by the same deeming rule, because by definition a life annuity is considered to be a life insurance policy under the Income Tax Act. However, a life annuity would not usually have a cash surrender value. The CRA has previously stated that a life annuity is not a life insurance policy for purposes of the deemed value of shares held upon death. In that case, valuing the life annuity is problematic. A valuator would likely take into account the criteria listed by the CRA in Information Circular 89-3 for valuing life insurance policies, including such items as state of health, replacement value, etc. For example, one would generally not buy a life annuity on an individual with a short life expectancy because the capital investment may never be fully returned in the form of annuity payments. Needless to say, the value of a life annuity would probably decline in value very sharply within a few years of issue.

If the value of the life insurance and life annuity are both low, it will reduce the value of the shares of the corporation. The lower share value means a lower accrued capital gain resulting in a lower tax consequence pursuant to the deemed disposition rules at death.

The second advantage of a corporate-owned insured annuity is the credit to the company’s capital dividend account arising because of the receipt of life insurance proceeds. The credit would allow the executor or beneficiaries to draw out tax-free capital dividends or structure post mortem planning to further lower the income tax liability of the estate.

Consider the following example of a corporate-owned insured annuity in the amount of $500,000 on a male aged 70, in good health.

 

1st year  Age71

5th year Age 76

10th year Age81

15th year Age86

Annuity payment (annual)

$39,992

$39,992

$39,992

$39,992

Taxable Portion of payment

Zero

$6,219

$4,652

$3,431

Corporate tax (net of RDTOH)

Zero

$1,244

$930

$686

Insurance premium (annual)

$18,944

$18,944

$18,944

$18,944

Dividend to shareholder

$21,048

$19,804

$20,117

$20,361

Equivalent rate  of return

5.3%

5.0%

5.0%

5.1%

The above table shows the tax liability associated with the annuity payment net of refundable dividend tax on hand (RDTOH). The company’s income tax liability is calculated taking into account taxable dividends paid in the year which would generate a refund of the refundable portion of corporate income taxes. This means that dividends associated with the corporate owned insured annuity must be paid in the tax year in which the taxable income arises.

The equivalent rate of return is much higher than that available in the market place today for conservative interest-bearing investments. However, the individual should be aware that the investment is locked-in and does not have any liquidity.

Additionally, as discussed above, the insured annuity adds little or no value to the tax value of the corporate shares, which could be worth $500,000 less from an income tax point of view. This could save the estate between $100,000 and $125,000 in taxes depending on provincial residence. The company has the same economic value, because the life insurance is designed to replace the amount of capital invested in the life annuity.

Planning involves taking into account the facts of the situation and using new strategies to rearrange the taxpayer’s current situation to better accomplish the specific objectives. Sometimes this means reviewing strategies typically designed for individuals and testing them in corporate scenarios. Of course, as with most planning strategies, there are numerous other details to be considered in implementing any plan, and the advice of a professional tax and estate planning advisor is crucial.

I/R 5200.01

 *Adapted from Edition 273 – 2012 of The Institute’s Comment.

By: Nelson F. Deslippe, B.COMM., CFP, CLU, CH.F.C, Insurance Advisor, Integral Financial Services Inc.

6 Reasons NOT to Market your Benefit Plan

I meet with a lot of business owners each week; and they will often tell me that they make it a practice to review their benefit plan every two to four years.  This may involve inviting other brokers and consultants to work with them on presenting options from other insurers.  The typical motivation is due to cost increases in coverage and wanting to ensure  that they are getting the best deal possible from their current carrier and broker.  However, without a lot of forethought, a group benefits review of this kind can cause a lot of wasted time with a lack of meaningful results.

The reason for the lack of success with such a review of the group benefits market may be due to some of the following reasons.

1.      No real difference in offering – Benefit plan coverage provisions are virtually identical from one insurer to the next.   While some may have a slightly modified benefit clause, and others may tout they are embracing the future with technology, they are otherwise too similar to be considered genuinely unique.  I have sat through many insurer presentations where they describe their differentiators, only to be underwhelmed by how similar most of the insurers are, and perhaps that is not a bad thing.

2.      A lower price does not equal a lower cost – As a broker comes back with a plan design and premium comparison, there will always be an insurer presenting a lower price than what is currently being paid.  However, this does not mean that the price is sustainable.  I have found that given a five-year time horizon, most insurers will end up at virtually the same cost as most of their competitors.  This should not surprise us because insurers adhere to common actuarial tables, and have been quite efficient in reducing claims processing costs to the lowest possible levels. Based on this, switching on price alone is at best a short term win, that reduces costs below that required to support claims.  The result is tough first and second renewals with the new insurer.

3.    The loss of reserve at the insurer – Within each insured health and dental plan is a reserve of money used for paying claims if the client was ever to leave the carrier.  This reserve is called the “incurred but not reported” (IBNR) claims reserve.  When a decision is made to leave a carrier, whatever portion of this reserve is not used at time of termination instantly goes to the bottom line of the insurer.  The new insurance carrier now needs to build up a new reserve.  This typically accounts for an additional cost of 8-10% of Extended Health and Dental premium, built within your first and second renewals.  Based on this, switching insurance providers every two to four years does not make a lot of financial sense, as there is money being left on the table every time you switch insurers.

4.      The cost of change – There are often two costs within every benefit plan. The first is the cheque you write to pay the premium.  The second is the internal cheque you write for time spent by employees (during work time) to manage the benefit plan.  This can come by way of administration and by employees re-processing enrollment forms for switching to another carrier.  Often there are better uses of time for all employees than the time it takes to switch insurers.

5.      Confusion among employees – Communication is the key for any change at a business.  If there is a decision to change benefits providers, it is important that this is communicated appropriately to staff, as they will often come to their own conclusions on why there is a change.  One of the most common negative messages I have heard from employees who were in the midst of changing insurers is that the company must be financially struggling, if they are changing carriers to save money.  This is especially the case if the plan designs are otherwise the same and the only thing that is changing is the insurer.

6.      A waste of time – The whole exercise can be frustrating and often prove futile.  Without having clear objectives for why a benefits plan is being reviewed, the internal staff managing the marketing of the benefit plan is essentially throwing away time that could be better spent on other projects.

With this list of six, the obvious next question is what can be done if a business wants to review their costs and coverages on the benefit plan.  I suggest the following six things:

1.      Start with the objectives of the benefits plan – There are many reasons for why a business may want to provide their staff with benefits.  Knowing what your objectives are will help you guide the process in order to facilitate the best result possible.  The following is a short list of some of the most common objectives that I hear from business owners, and you may have your own to add to this list.

1)      Build morale within the team of employees

2)      Create a family atmosphere of financial protection and support

3)      Provide a competitive advantage in attracting top talent

4)      Reward long-term employees for their loyalty and expertise.

5)      Protect against any potential union involvement within the employee population

6)      It is an employee expectation that a basic benefit plan is provided.

2.      Pick the right broker/consultant – Working with someone who is up to date on industry trends, continuing their own personal development, and offers unique value add programs and services is a rare opportunity within group benefits.  Find that person or organization who is constantly evaluating what the market offers and matches it up with your objectives.

3.      Review the strengths and opportunities within the benefit plan – Determining whether or not your benefit plan is the right fit for your goals is imperative.  Seeking out what is working and what has an opportunity to be improved will increase the satisfaction employees have with the benefits plan.  It is not unusual to find that there are coverages being provided that are neither necessary or appreciated by employees and their families.

4.      Describe the ideal benefits plan – Work with your broker / consultant to develop an idea of what would ideally be offered to employees.  This can always be updated at a later date, but knowing what you want is a key step in picking the right plan.

5.      Pick the right platform – There are a lot to choose from, and working with your broker / consultant, you can chose the best overall group benefits offering that meets the needs of you and your employees, at a cost that is fair and explainable.  An example of this would be the addition of employee and family assistance programs, along with a second opinion service and a disability management provider.  Used effectively, these programs can reduce the overall cost of claims, and add more value for staff.  There are also different methods for bundling these services whether the insurer provides them, or they are billed together on a third party administration platform.

6.      Build in the right supplementary services and programs – There are a lot of additional services and programs that can ensure that the claims that are being recognized and paid are necessary, legitimate and within the framework of acceptable mark-ups. Did you know that often prescription drug claims are charged at 10% to 20% over Manufacturers’ Suggested Retail Price?

Overall, conducting a market survey of what insures are providing for the sake of a price and coverage comparison can be a bad use of time.  Instead, conducting a full review of objectives and market offerings with a consultant or broker who is up to date with industry trends, will produce better results and maximize your return on investment for time and premium dollars.

If you are interested in conducting a review of your plan, please feel free to contact us at 604-542-3660 or michael@integral-financial.com.

 

By: Michael H. Kettner, GBA, Group Benefits Consultant, Integral Financial Services Inc.

Will Your Retirement Fund be enough to Support Your Health Care Needs?

Does your retirement plan include a budget for care when it will be needed? Most people don’t like to think of outliving their retirement funds but should care be needed, the costs can be staggering. I recently attended a presentation put on by Sun Life Financial and would like to share some stats and information with you from their research.

 Five Stages of Care in Retirement Years and the Costs Associated:

1.      Independent Care – may include healthier food, exercise programs, healthier choices. Cost $215/mo.

2.      Interdependent Care – need some help to do chores, family often helping out. Cost $670/mo.

3.      Supportive Living – in home care givers, bathing, dressing, feeding, medications. Government support is minimal. Cost $6575/mo.

4.      Crisis Management – sudden serious accident or illness results in more care needed. More professional health care support workers involved in care for more hours in a day. Cost $9615/mo.

5.      Dependence – total dependence on caregivers, 24 hour care usually in a Long Term Care Facility. Cost $12,060/mo.

Current cost of health care is increasing by 4% per year. It is estimated $1.2 Trillion will be needed to fund Long Term Care in the future. With current Government funding, only half will be covered, leaving a $590 billion dollar short fall.

Attached are some links to articles to review to start thinking about what you will do and how much money you may need for future care. 

http://business.financialpost.com/2014/01/11/what-happens-when-your-spouses-care-is-draining-your-savings/

http://www.theglobeandmail.com/globe-investor/personal-finance/retirement-rrsps/checkup-overdue-on-retirement-health-costs/article17074471/

http://brighterlife.ca/2014/02/28/why-save-for-retirement-to-pay-for-health-care/

http://brighterlife.ca/2013/09/30/will-you-be-able-to-pay-your-health-care-bills-infographic/

Long Term Care insurance is an option to help pay for the costs of care when needed, or the money can be used for other expenses as well.

Sun Life Financial recently launched a new product called Sun RHA. This product will pay out for life once you qualify. It is about 30-60% cheaper than their traditional Long Term Care product because they built in a longer waiting period before you can claim. This can be a supplement to funds you have in place for care, but may not have enough. With built in inflation protection, it can help insure you won’t run out of money, as the benefit will grow by 3% each year.

If you would like to find out more about your options for ensuring you’ll have money for care down the road, please contact me, glennis@integral-financial.com or call me at our office number 604-542-3660 Ext. 5. I’d be pleased to assist you.

 

By: Glennis J. Deslippe, BSN, CHS, GBA, Living Benefits Specialist, Integral Financial Services Inc.

 Source: Sun Life Financial April 2014

 

Three Risks in Retirement

It’s no secret that many Canadians are facing retirement in some capacity in the coming years.  The days of company pension plans, where the employees know exactly how much they’ll be receiving and have that income indexed for inflation, are dwindling rapidly. So when we sit down with our retirees or pending retirees there are three key components of retirement that we discuss:

Inflation Risk

A couple who has a collective 30 year retirement can have their buying power reduced by nearly 60%.

Effects of inflation per $1,000

Number of years 0% 1% 2% 3% 4%

1

$1,000 $990 $980 $970 $962

10

$1,000 $905 $820 $739 $676

20

$1,000 $820 $673 $545 $456

30

$1,000 $742 $552 $402 $308

Longevity Risk

While it may sound unrealistic, there is a sizable risk that one of the two adults will live well into his/her 90’s.  Therefore, not only will that couple’s buying power be reduced by nearly 60%, they need to make sure that their money can outlive them and not the other way around. 

 The probability of a healthy 65-year-old living until…

Age

Single female (%)

Single male (%)

At least one member of a couple (%)

70

96

93

99

80

81

71

94

90

44

33

63

95

23

16

36

Source: Annuity 2000 Mortality Table, Society of Actuaries. For illustration purposes only.

Volatility Risk

During retirement, an investor’s rate of return can have a significant impact on his/her portfolio’s ability to last.  For example, if an investor experiences poor rates of return early in retirement, it will have a significant impact on how much income he/she receives versus an investor receiving positive returns early in his/her retirement.

 

By: Adam Graham, BA, Investment Funds Advisor, Integral Financial Services Inc.

Dynamic Weekly Market Wrap-Up

For: Friday, May 9, 2014

The TSX closed at 14534.06, down -12.89 points or -0.09% over the past week. YTD the TSX is up 6.70%.

The DOW closed at 16583.34, up 32.37 points or 0.20% over the past week.YTD the DOW is up 0.04%.

The S&P closed at 1878.48, up 1878.48 points or 285.00% over the past week.YTD the S&P is up 1.65%.

The Nasdaq closed at 4071.87, up 20.37 points or 0.50% over the past week.YTD the Nasdaq is down -2.52%.

Gold closed at 1289.9, up 2.20 points or 0.17% over the past week.YTD gold is up 7.13%.

Oil closed at 100.03, down -0.23 points or -0.23% over the past week.YTD oil is up 1.44%.

The USD/CAD closed at 1.09025, down -0.0073 points or -0.67% over the past week.YTD the USD/CAD is up 2.54%.

Source: Dynaminc Weekly Market Wrap-Up as provided by http://www.dynamic.ca/

Dynamic Weekly Market Wrap-Up

For: Friday, May 2, 2014

The TSX closed at 14765, up 231 points or 1.59% over the past week. YTD the TSX is up 8.39%.

The DOW closed at 16513, up 152 points or 0.93% over the past week.YTD the DOW is down -0.39%.

The S&P closed at 1881, up 18 points or 0.97% over the past week.YTD the S&P is up 1.79%.

The Nasdaq closed at 4124, up 48 points or 1.18% over the past week.YTD the Nasdaq is down -1.27%.

Gold closed at 1298, down -4.00 points or -0.31% over the past week.YTD gold is up 7.81%.

Oil closed at 99.75, down -0.89 points or -0.88% over the past week.YTD oil is up 1.16%.

The USD/CAD closed at 1.0982, down -0.0052 points or -0.47% over the past week.YTD the USD/CAD is up 3.29%.

Source: Dynaminc Weekly Market Wrap-Up as provided by http://www.dynamic.ca/

Dynamic Weekly Market Wrap-Up

For: Friday, April 25, 2014

The TSX closed at 14534, up 34 points or 0.23% over the past week. YTD the TSX is up 6.70%.

The DOW closed at 16361, down -48 points or -0.29% over the past week.YTD the DOW is down -1.30%.

The S&P closed at 1863, down -2 points or -0.11% over the past week.YTD the S&P is up 0.81%.

The Nasdaq closed at 4076, down -20 points or -0.49% over the past week.YTD the Nasdaq is down -2.42%.

Gold closed at 1302, up 7.00 points or 0.54% over the past week.YTD gold is up 8.14%.

Oil closed at 100.64, down -3.83 points or -3.67% over the past week.YTD oil is up 2.06%.

The USD/CAD closed at 1.1034, up 0.0021 points or 0.19% over the past week.YTD the USD/CAD is up 3.78%.

Source: Dynaminc Weekly Market Wrap-Up as provided by http://www.dynamic.ca/

Dynamic Weekly Market Wrap-Up

For: Thursday, April 17, 2014

The TSX closed at 14500, up 242 points or 1.70% over the past week. YTD the TSX is up 6.45%.

The DOW closed at 16409, up 382 points or 2.38% over the past week.YTD the DOW is down -1.01%.

The S&P closed at 1865, up 49 points or 2.70% over the past week.YTD the S&P is up 0.92%.

The Nasdaq closed at 4096, up 96 points or 2.40% over the past week.YTD the Nasdaq is down -1.94%.

Gold closed at 1295, down -24.00 points or -1.82% over the past week.YTD gold is up 7.56%.

Oil closed at 104.47, up 1.07 points or 1.03% over the past week.YTD oil is up 5.94%.

The USD/CAD closed at 1.1013, up 0.0031 points or 0.28% over the past week.YTD the USD/CAD is up 3.58%.

Source: Dynaminc Weekly Market Wrap-Up as provided by http://www.dynamic.ca/