Universal Life – liked or loathed?

What a great and timely topic!  Just to clarify things, UL is not a new product – it was originally available under the name “Variable Life” more than 60 years ago – this is just the latest incarnation and undoubtedly not the last version we will see.

The original concept stands true to today’s products – un-bundle things and see what might happen.  Let the policy-owner play with some things and the insurance company can twiddle the remaining parts.  Nothing new with the 2012 version, although both consumers and insurance companies have learned a few things along the way.

Most life insurance companies in Canada offer at least one version of this product while others offer three or four.  Generically, the owner selects a death benefit amount, a death benefit type, any additional benefits desired and a premium deposit from within a broad range and which investment options they desire.

Let’s start with the amount and type of death benefit coverage.  The least complex product is usually called “Level Death Benefit” and is very simple.  When the life insured dies (while the policy is in force of course!), the insurance company pays a flat amount to the named beneficiary – whether it is 1 day from now or 50 years in the future – the death benefit never changes.  There are often two other choices – “Indexed Death Benefit – IDB” and “Face Plus Fund – F+F”, both of which, if offered, come with increased costs.  With IDB, the amount of life insurance increases each year by either a fixed percentage or by reference to an outside index such as the Consumer Price Index – the cost also goes up annually.  For F+F, the death benefit is the original amount purchased plus any accumulated cash values and are paid to the beneficiary after the death of the insured.

Additional benefits may include such items as a Disability Waiver of Premium Rider, Guaranteed Insurability Benefit or a Family Insurance Rider.  Disability Waiver provides that premium deposits are waived if the owner is disabled according to the terms of the policy.  Guaranteed Insurability means that the life insured can get additional insurance in the future without providing medical evidence – within limits and up to certain ages only.  Family Riders typically provide term insurance coverage on a spouse and dependent children.

The Premium Deposit ranges from a minimum amount calculated by the insurance company (that only covers the cost of providing the death benefit and any riders) up to a maximum amount (also calculated by the insurance company) the allows the policy to accumulate cash values up to the maximum limits permitted by the Income Tax Act.  The owner can choose any amount from minimum to maximum and anywhere in between – and they can change the amount at any time of their choosing.

On to investment choices.  Initially, insurance companies felt they had to offer literally dozens of choices – one company had 49 options!  Fortunately, some level of rational thought has returned and most policies offer a range of 4 to 12 although some do offer more.  It is normal to offer a series of guaranteed interest accounts that function in the same manner as GICs and range from Daily through 1, 3, 5, 10 and maybe 20 years.  Rates are published at regular intervals and can also be found on the website of the respective insurance companies.  On the equity side of the investment house, most companies offer 4 or 5 indexes – such as a Canadian Balanced Index, Canadian Equity Index, Canadian Fixed Income Index or similar on an International basis – plus two or three performance benchmarks using well-known mutual funds.  It is important to note that the UL policy does NOT invest in these indexes or funds – it merely mimics the results of the movement – up or down – of the benchmarks.

There have been some horror stories in the history of UL – particularly when advisors were using assumptions – with the approval of the insurance companies I must add – that had projected results in the 14% to 18% annual range – and of course, that never happened.  The result was that many policies collapsed and clients were left without their life insurance – in some cases if clients wanted to retain their coverage they had to make additional deposits – sometimes in the tens-of-thousands of dollars!  Thankfully, most insurance companies now severely limit illustrated growth rates and insist on showing results under three different assumptions – usually at something such as 2%, 5% and then an alternative rate of maybe up to 7% or so.

The taxation of UL is no different than for any other permanent insurance product.  CRA rules allow the plan to accumulate values up to prescribed limits.  At death, there is no taxation of any portion of the death benefit.  If the plan is surrendered or cash values are withdrawn from the policy before a death claim occurs, a portion of the withdrawal may be taxed as Ordinary Income.  Most insurance company’s illustration software provides samples of how this works based on the level of deposits the client has chosen.

UL is both a very good product and a very bad product – it is there to serve specific markets and is not right for every client or every situation.  Primarily, it is very good at providing an economical death benefit for larger face amounts where clients want the insurance to be fully paid up quickly and the insurance is designed to pay for taxes on death.  It is also good at accumulating cash on a tax-preferred basis if a client has substantial disposable income and does not want to attract any additional taxes on investment income.  I do expect those last two statements to come under some dispute from some quarters as some advisors and insurance companies think UL is the be-all, end-all of permanent insurance – but it isn’t!  Don’t be fooled – always ask for at least one other alternative besides UL from your advisor and evaluate things for yourself!

Market Round-Up – August 17, 2012

The Toronto stock market closed higher as rising commodity prices, positive economic data and another commitment to preserve the euro currency union left the TSX at a fresh 3 1/2 month high.

The S&P/TSX composite index extended gains to a fourth session, up 57 points to 12,090.

The Canadian dollar backed off a quarter of a cent to 101.1 cents US after the Consumer Price Index declined 0.1 per cent on a seasonally adjusted basis in July. That was lower than expected and reinforeced the view that the Bank of Canada will keep interest rates unchanged for some time to come.

U.S. markets were also up at the end of a positive week, helped along by positive readings on consumer confidence and an index of future U.S. economic activity.

The Dow industrials edged 25 points higher.

The Nasdaq composite index was ahead 14 points.

Oil gained 41 cents at US$96.01 a barrel.

The TSX ended the week up almost 1.7 per cent, leaving the main index up about 130 points year to date.

Have a great weekend!

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MONEY® Market Round-up – August 8, 2012

The Toronto stock market ended near its highs of the day as commodities drove the market ahead.

The S&P/TSX composite index closed up 201 points to 11,864, with every sector posting gains.

Much of the activity came from metals and mining stocks.

Copper ended higher, while the December gold contract dropped $3.40 an ounce.

The energy sector also got a boost as crude prices hit their highest level in two months.

September crude on the Nymex rose $1.47 to US$93.67 a barrel.

And an acquisition in the financials came with C-I-B-C acquiring the private wealth management business of M-F-S McLean Budden.

On Wall Street, traders found a renewed sense of optimism about the economy, with better earnings results than expected from several U-S companies.

And U-S employers posted the most job openings in four years — a positive sign that hiring may pick up.

The Dow increased 51 points to 13,169.

Nasdaq gained 26 points at 3,016.

The loonie ended the day above parity, up 44-one-hundredths of a cent to 100.25 cents US.

MONEY® Market Round-up

Tax-Free Money for What Matters to You

Budget 2008

Responsible Leadership
February 26, 2008
Tax-Free Savings Account

Canadians need to save for many different purposes over their lifetimes. Reducing taxes on savings can help.
That’s why the Government has introduced a new Tax-Free Savings Account (TFSA). It’s the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP).
The TFSA will allow Canadians to set money aside in eligible investment vehicles and watch those savings grow tax-free throughout their lifetimes. TFSA savings can be used to purchase a new car, renovate a house, start a small business or take a family vacation.
Canadians from all income levels and all walks of life can benefit.

How Is a TFSA Different From a Registered Retirement Savings Plan?
An RRSP is primarily intended for retirement. The TFSA is like an RRSP for everything else in your life.
Both plans offer tax advantages, but they have key differences.
Contributions to an RRSP are deductible and reduce your income for tax purposes. In contrast, your TFSA savings will not be deductible.
Withdrawals from an RRSP are added to your income and taxed at current rates. Your TFSA withdrawals and growth within your account will not—they will be tax-free.

Benefits of Saving in a TFSA
Because capital gains and other investment income earned in a TFSA will not be taxed, a person contributing $200 a month to a TFSA for 20 years will enjoy additional savings of $11,045 compared to saving in an unregistered account.

Responsible Leadership Budget 2008
Early Savings to Meet Many Needs
Canadians will also benefit by using the TFSA to start saving early for future needs and goals.

A Flexible Account for a Lifetime of Savings
Not everyone is able to save each and every year.

Those who cannot contribute $5,000 in a given year will be able to carry forward their unused contribution room to future years.

In addition, Canadians may want to use their savings— to buy a new car or a cottage, or start a small business— and the full amount of withdrawals can be put back into the TFSA in the future. Couples often save and plan together, so Canadians can contribute to their spouse’s or common-law partner’s TFSA, depending on the spouse’s or partner’s available room.

A Warm Welcome To The TFSA

Effective in 2009, Canadians 18 years of age and over will be able to accumulate money on a tax-sheltered basis in a TFSA and ultimately withdraw the proceeds tax-free for any purpose over their lifetime. While contributions are not tax-deductible, you will acquire $5,000 of TFSA contribution room each year. In addition, the $5,000 will be indexed to inflation.

Equally important, unused contribution room can be carried forward indefinitely to future years, without limitation. For example, if you contribute $2,000 to a TFSA in 2009, your contribution room for 2010 will be $8,000 ($5,000 for 2010 plus $3,000 carried forward from 2009). One interesting twist is that you can “recontribute” amounts taken out of the plan. In other words, any amount that you withdraw in a particular year will be added to your contribution room for the following year.

The ability to accumulate investment capital in the TFSA on a tax-free basis, and pay no taxes when you withdraw all or a portion of the proceeds, will allow you to use the TFSA for many purposes. Beyond the obvious use of building a pool of retirement capital, particularly for those who have maxed out their RRSPs, we envision these plans being used to accumulate a downpayment for the purchase of a home, to save for an automobile, to set aside money for a wedding – you name it. A TFSA would also be an excellent vehicle for capital that you want to keep liquid for emergencies.

While qualified investments will be the same as for an RRSP, I can see the TFSA being an excellent vehicle for fixed-income investments (GICs, bonds, money market) to eliminate the heavy tax burden of interest income as much as possible. Or alternatively, to hold investments generating foreign dividends which do not receive the benefit of the dividend tax credit and hence are taxed at a much higher rate.

Furthermore, the income generated within the TFSA will have no impact on our income-tested benefits such as the Canada Child Tax Benefit, the Goods and Services Tax Credit, and the Age Credit, nor will it impact the clawback of Old Age Security benefits. And, if you give money to your spouse or common-law partner to take advantage of TFSA contribution room, there is no “attribution” of the income earned, as is the case when you transfer property to a spouse or common-law partner.

Here are some other TFSA details worth noting:

A TFSA plan can be transferred tax-free on death to a spouse or common-law partner as the “successor account holder”. Or, the assets of the plan itself can be transferred regardless of whether the survivor has available contribution room, and without reducing the survivor’s contribution room.
In the event of a marriage or common-law partnership breakdown, an amount may be transferred from one spouse’s TFSA to the other’s, but this will not reinstate contribution room of the transferor, nor will it impact the available contribution room of the transferee spouse.

The Canada Revenue Agency will track TFSA contribution room when you file your annual income tax return, just as they currently do for RRSP contribution room.

You can have more than one TFSA.

Capital losses won’t be deductible against capital gains.

As you read this, the question that probably comes to mind is: “How does a TFSA compare to both an RRSP and unregistered savings?” The chart and commentary on the previous page is from the Federal Budget documents. It assumes $1,000 is available for investment and details the effect of contributing to a TFSA, RRSP or a traditional unregistered savings account.

What is interesting about this comparison is that it assumes that your effective tax rate will be the same at the time you contribute and on withdrawal. In any individual situation it will be important to look at all future potential sources of income, say on retirement, e.g. pensions, non-TFSA investments, and the effective tax rates that result, in order to further analyze the pros and cons of TFSAs and RRSPs.

For example, if an analysis determines that you will have a lower effective tax rate in retirement, then the RRSP is the preferred, first choice savings vehicle. Alternatively, if you will have a higher effective tax rate in retirement, then the TFSA is a good vehicle for you. On the surface, however, it seems to me that the TFSA will be an extremely useful vehicle for most Canadians.

Kirk Polson, CFP, CLU,CH.F.C., Fee-Based Financial Planner, Polson Bourbonniere Financial Planning, Markham, ON, (416) 498-6181 or (800) 263-0120, [email protected], http:// www.worryfreeretirement.com.

Dale’s note: The TFSA may replace or precede the RRSP as one of the best ways to save for your retirement. However, each person should crunch your numbers for the future tax effects of these investment vehicles. What investments you put in the open, registered and tax-free accounts take on even more importance now.
Canadian MoneySaver • PO Box 370, Bath, ON K0H 1G0 • (613) 352-7448 • http://www.canadianmoneysaver.ca • JUNE 2008