Q: My wife and I are both 40 and have two kids—ages 5 and 7. We are considering buying a joint last-to-die life insurance policy that would cost a fixed $7,105 per year for ten years. That’s a total of $71,050 and the policy would pay $500,000 when the last of us dies. This is a proposition from our advisor after we have made our retirement plan. We have concluded that we have enough savings to retire at 55 with a very comfortable nest egg made up of TFSAs, RRSPs, and defined benefit pension plans, as well as money in non-registered investments.
We do not have any debts except a remaining mortgage of $95,734. We also have life insurance and disability insurance with our employer that would cover our needs if one of us were to die or could not work anymore. The goal of this joint last-to-die policy would be to transfer money tax- free in the future as all other needs are covered either by our savings or our employee benefits.
I am wondering if buying this policy is really a good move and if the cost of this product is reasonable? We can afford the cost without changing our lifestyle but our advisor is not independent so the policy would be sold by its institution and that’s what makes me wary. I am a DIY investor managing our savings using a couch potato strategy of plain vanilla ETFs. I am wondering if I would be better off investing that money by myself even with taxes ahead? We have no health problems and we can expect to live a long time, which means the $500,000 may depreciate a lot until we die.
A: Alessandro, you’re doing well, and with that comes different opportunities such as life insurance. There are a couple of points in your question worth discussing.
First, the insurance. Why do you want it? And does it make financial sense to have it? Second, your mortgage. Is the interest tax-deductible?
So is life insurance a good option for you? Here are two possible reasons for you to consider it:
- The death benefit on insurance is tax-free so the strategy is to transfer taxable assets (investments) to a non-taxable asset (life insurance), allowing a tax-efficient transfer of your wealth to your children, and…
- It can be used to insure against market declines around the time of death. If markets decline, market losses may be covered by the insurance. Knowing this may allow you to invest a little more aggressively than you would without the insurance.
Does the insurance make sense? It depends. I would generally need to know your age, your investment total, allocation, Adjusted Cost Base of your investments, and how you plan to use your money in retirement.
Hey, maybe you plan to spend everything and just leave your TFSA and your home to your children? No need for insurance then.
Before investing in a permanent policy I’d recommend a financial plan first. Sometimes a concept looks good on its own but doesn’t always work as planned when integrated into everything else you’re doing.
If you don’t want to do a plan first, and you want to know at what age you’d have been better off investing rather than buying the insurance follow the following steps:
- Calculate what the $7,105 premium would grow to if invested at 5% (your call on the interest rate) over the next 10 years. I get $93,834.
- Now use the rule of 72 to calculate how long it will take the $93,834 to double. At 5% (72/5 = 14.4) it will take about 14 years to double.
- Now put the two together. If you are 45 and start investing the $7,105 annually at 5% you will have $93,834 at age 55. In 14 years (age 69) it will double to about $187,668. At age 84 it will be about $375,336.
I am sure you can work though the example and find the age when investing beats the insurance.
But one word of caution: The only problem with doing simple calculations like this to answer complex problems is they can lead you down the wrong path.
If you invest this money in a non-registered account you’ll likely have to pay tax on interest, dividends, or capital gains while it is growing and then more tax when you sell.
Remember the insurance payout is tax-free.
Also, if the amount of insurance you are purchasing is based on a simple capital gains projection, you may be asked to purchase more insurance than needed. Think about it. If you are purchasing insurance, less money is going to investments. Your estate will have a lower investment value and therefore a lower capital gain liability.
Bottom line: Life insurance can be an excellent estate planning tool when used properly.
I quickly wanted to touch on your mortgage. You have about $100,000 on your mortgage and $100,000 in non-registered investments. Is your mortgage interest tax deductible? If not, consider a debt swap. Sell your investments, pay off your mortgage, borrow against your home and invest. That leaves you in the same situation but now your interest is tax deductible. There are a couple of tax issues to watch for but for someone like you in a high tax bracket, you will cut your effective interest in half.
Thanks for your question, Alessandro, and I’m sure this gives you enough to consider before making your final decision.
Allan Norman is a Certified Financial Planner and Chartered Investment Manager with Atlantis Financial.
This commentary is provided as a general source of information and is intended for Canadian residents only. Allan offers financial planning services through Atlantis Financial Inc. and can be reached at email@example.com
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