Withdrawing from a RRIF in a middle tax bracket and then allocating that money to permanent life insurance may be an effective strategy for clients who meet specific criteria.designer491/iStockPhoto / Getty Images
A big challenge associated with RRSPs and RRIFs is working out how to withdraw accumulated funds tax-efficiently. One strategy that may be effective for a narrowly defined group is to use RRSP/RRIF withdrawals to buy whole life insurance or universal life insurance.
“In specific situations, it can work really well for retirees with large RRSP/RRIF balances – but it’s more the exception than the norm,” says Maili Wong, senior wealth advisor and senior portfolio manager with The Wong Group at Wellington-Altus Private Wealth Inc. in Vancouver.
“Drawing mid-tax-bracket withdrawals during retirement and then redirecting those after-tax dollars into a permanent life insurance policy can build up tax-sheltered assets … whether the focus is about passing on the money to the next generation or philanthropy or a combination of both.”
She says there are specific criteria for clients who may want to consider this approach. They’re usually 60 to 80 years old and must be insurable. They have large RRSP/RRIF balances that they don’t need to support their retirement lifestyle, and they expect their projected terminal tax bracket will be higher than their current tax bracket (without proper planning). They should also have strong liquidity, low debt, and a willingness to engage in a long-term strategy that requires paying ongoing premiums.
Ms. Wong outlines two potential scenarios.
In the first, a client wants to preserve as much value as possible from the RRSP/RRIF for their heirs by converting taxable registered assets into a larger and more predictable tax-free inheritance. (For simplicity, assume there’s no spouse to receive a tax-free RRSP/RRIF rollover.)
In this case, planned RRSP/RRIF withdrawals that keep income in a middle tax bracket can be directed into a permanent insurance policy with an appropriate premium structure (for example, paying premiums for 10 years). Heirs are named as policy beneficiaries so the death benefit goes directly to them – tax-free, outside the estate and bypassing probate in jurisdictions where it applies.
In the second scenario, for clients who want to leave a legacy to charity as well as to heirs, the RRSP/RRIF value on death is earmarked for a charity (named as the RRSP/RRIF beneficiary), but earlier withdrawals are used to fund a permanent insurance policy that provides a tax-free inheritance for heirs. On death, the estate benefits from a donation receipt for the donated balance remaining in the RRSP/RRIF, which may reduce or eliminate the taxes due on the RRSP/RRIF.
A variation for clients with even greater charitable intent would be to direct RRSP/RRIF withdrawals to a permanent life insurance policy in which the charity is both owner and beneficiary, which creates a donation receipt for every premium paid. Any assets remaining in the RRSP/RRIF on death may be left to family. That would be fully taxable, but the RRSP/RRIF has been drawn down, so more money is going to charity and less to taxes.
“I wouldn’t do anything without a full financial plan and talking to [the client’s] tax accountant,” Ms. Wong says of these approaches. “But it’s certainly worth looking at … to see if there’s a fit for them as part of their holistic plan.”
Whole life or universal life?
Hemal Balsara, head of tax, retirement and estate planning for individual insurance at Manulife in Toronto, says his team generally doesn’t recommend withdrawing from an RRSP or withdrawing more than the minimums from a RRIF.
However, if minimum RRIF withdrawals are “redundant capital” – not needed to support a client in retirement – then the tax efficiency of life insurance and the beneficiary designation that allows the death benefit to bypass probate may be attractive for a small subset of the population.
For clients who qualify for life insurance when RRIF withdrawals start (or already have a life insurance policy in place), he points out that participating whole life offers a rising death benefit that is an advantage for those who anticipate living longer. On the other hand, universal life is a more conservative approach with a fixed death benefit and therefore a predictable outcome.
As minimum RRIF withdrawal percentages rise as a client ages, premiums can be based on the first-year withdrawal, with future excess amounts used for other purposes. Alternatively, early-year withdrawals can be topped up from other sources in anticipation of higher amounts being available for premiums in later years. The additional deposit option available on some whole life policies adds flexibility to help manage higher-withdrawal years.
For Mike Spicer, financial planner and president of MKS Financial Services Inc., at Sun Life Financial Distributors (Canada) Inc. in Regina, the whole life/universal life question depends on client goals – whether they’re looking primarily to grow assets, solve a tax bill or access cash values to fund retirement or gift assets to family or charity. He runs multiple scenarios to work out the best approach for a specific situation.
“The end goal is to try and move taxable assets to tax-free assets,” he says. With a RRIF, that sometimes means skimming off more than the minimum, but less than an amount taxable at the top tax bracket, and then allocating that money to permanent life insurance.
“In the end, sometimes it just comes down to the client saying, ‘I have more than I’ll ever spend, so let’s maximize the entire amount I’m going to leave behind,’” Mr. Spicer says.
“Life insurance is one of the safest investments you can have, with guarantees built in that the markets don’t, … which is exactly what people in their retirement are usually looking for.”