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Maxed out RRSP & TFSA? An Alternative Tax-Sheltered Retirement Strategy

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There is an alternative tax-sheltered retirement strategy that is a substitute for RRSPs or tax-free savings account. This strategy allows you to invest a set amount every year (that you can comfortably afford) and guarantees that you generally earn a return of around 8% after tax, annually. In your late working years or early retirement, you receive a tax free payout. The investment does not move up and down with the stock or real estate market.

Intrigued? Here is how it works:

•You have maxed out your RRSPs. This could be because your income is high and you have good savings, or you have a sizable pension contribution, or as a self-employed individual who receives dividends you have very little RRSP room to use, and your TFSA is maxed out.

•You have a parent or in-law, aunt or uncle, who is in reasonably good health for his or her age, and is somewhere between 60 and 80. Reasonably good health means no recent or current cancer, heart attacks or strokes or other major diseases.

•You take out a permanent insurance contract on this individual. With permanent insurance, if it is held until death, it is guaranteed to provide a payout. For example, if someone puts in $12,000 a year for 15 years, that totals $180,000. The insurance policy might pay out $360,000 in 15 years. This is different from a “term 10” or “term 20” insurance policy that covers only a fixed time period, and usually has a return of negative 100 per cent. Permanent insurance allows you to know the payout on the investment. The only unknown is when the payout will occur.

•To implement the strategy, you would search the market for the best permanent insurance solution given the age and health status of the individual. That will require an insurance broker who has access to the full market, focuses on estate planning and understands the strategy.

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To better understand this life insurance strategy, here is an example:

We have an imaginary investor, Joe, and he is 41. His yearly income is $200,000, and he has no more room in his RRSP or TFSA. He has $150,000 in non-registered investment assets (and these are being taxed).

Joe’s mother, Susan, is 70 and in decent health (except for a bad knee). Joe’s insurance broker has searched the market to find the best return for a permanent policy for a 70-year-old woman. Joe deposits $12,000 a year for 15 years and the policy is fully paid up – a unique feature of this particular product. This policy also has a return of premium. It essentially adds one dollar of payout for every dollar Joe puts in.

After one year, Joe has put in $12,000. If Susan passed away, the insurance payout would be $193,000, for a return of 1,508 per cent. Every year Joe puts in $12,000, the payout goes up $12,000. In year five, Joe would have put in $60,000 and the insurance payout would be worth $241,000. In 15 years, Joe has put in $180,000. In this case, the policy is now fully paid, and Joe doesn’t need to pay another dollar. The payout figure does not continue growing past this point.

As it turns out, Susan passes away shortly after, at age 85. Joe is now 56 years old. The insurance policy pays out $361,000 to the beneficiaries. In this case, Joe is the sole beneficiary.

If Joe had put the same $12,000 a year for 15 years into a non-registered GIC, to have the same after-tax return as this strategy (assuming Joe pays a 46 per cent marginal tax rate), he would have to find a GIC paying 15.35 per cent.

Not only did this strategy provide Joe with extra tax shelter, but it guaranteed he would at least double his money, tax free, whether Susan lived to age 71 or age 95.

Read Part II to learn about the benefits of using life insurance as a retirement savings tool.

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