At 68 years old, Martha Smith* confronted the question of how to maximize her income without subjecting her savings to the risk of the market. With GIC rates at nearly historic lows, she faced a tough, but common problem: she knew that her portfolio was not large enough to allow her to “live off the interest”. She needed to figure out how to withdraw her assets in a way that would generate predictable monthly income that was high enough to meet her expenses.
Like many Canadians, Martha held an antiquated view of insurance – she believed that life insurance was only for income protection. So she was surprised to realize that in many cases, insurance can actually also function as an investment – and offer advantages that traditional investments don’t.
For example, the insured annuity is a great example of an insurance product that offers a compelling alternative for people like Martha. An insured annuity strategy combines two common insurance approaches – an annuity and a life insurance policy – to produce a stream of monthly income that can be significantly higher than a GIC alternative, while preserving the original capital.
At today’s rates, if Martha invested $100,000 in GICs she would receive monthly cash of $375, assuming a GIC rate of 4.5%. However, interest is taxed as regular income; therefore on an after-tax basis Martha’s monthly cash flow from a GIC drops to about $290 – assuming a 22% tax bracket. (For higher income earners, the tax effect is even more dramatic.)
With an insured annuity, Martha would direct her $100,000 into two sections. The first part goes to purchase a permanent life insurance policy that will ensure that her beneficiaries receive $100,000 at the time of her death – tax free and not subject to probate (unlike non-registered assets like GICs). The remaining cash is used to purchase a traditional annuity. In Martha’s case, the after-tax cash flow on an annuity would be $410 per month, which is the pre-tax equivalent of earning 6.25% in a GIC. Her cash flow is guaranteed, for life. For someone earning $70,000 or more, the pre-tax equivalent would be about 8.25% - almost double the current GIC rate.
In other words, Martha can ensure that her $100,000 is protected, and significantly increase her monthly cash flow in a way that is guaranteed. The only drawback of an insured annuity is that while the original capital is protected in the form of an insurance policy, she won’t have access to the original capital again in her lifetime. In that sense, it’s important to review the insured annuity strategy in light of an existing retirement plan. The insured annuity strategy works best for people between the ages of 60 and 85, and does require a medical qualification.
Greg Holohan is a Wealth Advisor with ScotiaMcLeod, who specializes in unique investment, insurance and retirement strategies, and have provided financial solutions for many families in the Markham-Stouffville area. He can be reached at 905.479.8238 or greg_holohan@scotiamcleod.com. ScotiaMcLeod is a division of Scotia Capital Inc., member CIPF. All insurance products are sold through ScotiaMcLeod Financial Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank Group. When discussing life insurance products, ScotiaMcLeod advisors are acting as Life Underwriters representing ScotiaMcLeod Financial Services Inc.
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