Universal Life Policy Strategy

The Universal policy strategy the Personal Pension Plan:Complementary Strategies to Maximize Client Wealth

Background

Financial planners and accountants who are well-versed in the benefits of using an over- funded, corporately-held universal life policy (“U/L”) to provide for retirement income often ask whether the INTEGRIS Personal Pension Plan (“PPP”) is a better way to provide for retirement than the U/L strategy.

This briefing note suggests that the U/L and PPP are not competing strategies but complementary ones. In fact, if structured correctly, a client could have both a U/L and a PPP at the same time.

Refresher on U/L Strategy Characteristics

As a refresher, while there are many variants of the U/L strategy, many include the following features:

(a) Premiums paid by the corporation with after-tax dollars;

(b) Face value is payable to the corporation on the event of the owner’s death;

(c) Death benefit flows to the Corporate Dividend Account of the corporation;

(d) Premiums not required to pay for the cost of insurance are invested in a tax- deferred account and can be used as collateral to secure a line of credit and

(e) Owner can draw on secured line of credit to live in retirement

Because of the way in which tax rules operate both the PPP and U/L can be adopted by a business owner, with the costs of the U/L partially defrayed by the tax refunds/savings generated by the PPP.

Comparing the U/L with the PPP

The chart below summarizes how the two strategies compare:

How the two strategies are synergistic in nature

The PPP provides a business owner with multiple ways of moving corporate assets from a taxable non-registered environment, into a tax-deferred pension vehicle – the pension fund.

Because contributions to the PPP attract corporate (and sometimes individual) tax deductions, this generates tax savings/refunds in the hands of the corporate entity. The key sources of tax savings/refunds attributable to a PPP are: 

(a) Annual contributions (exceed RRSP limits at all ages)

(b) Special payments if the rate of return on assets is below 7.5%

(c) Corporate contribution to purchase years of past service

(d) Terminal Funding to enhance the basic pension benefit promised under the plan.

(e) Investment management and administration fees

(f) Interest paid to a lender if corporate borrowing occurs to fund the PPP

(g) GST/HST pension entity rebate for excise s the PPP

For example, take a business owner in Ontario who is aged 50 and wishes to retire early at age 62. Over the past 30 odd years of work, he has accumulated an RRSP worth $500,000. He has traditionally, over the past 11 years, paid himself $140,000 in salary and /or bonuses. He has $50,000 of carry forward RRSP contribution room as well. By upgrading from the RRSP (current worth $500,000) to a PPP, the business owner’s position would be as follows:

  • $127,344
  • Corporate tax-deduction for contributing to the cost of buying back 11 years of past service.
  • $586,185
  • Cumulative annual contributions to the PPP (tax deductible) from age 50 until age 62 retirement age.
  • $480,979
  • Tax deductible terminal funding corporate contribution to purchase ancillary benefits: early unreduced pension, CPP temporary bridge pension from 62 to 65 and indexing of benefits to CPI minus 1%.
  • $109,100
  • Deductions for investment management fees paid by corporation over 12 years from age 50 to 62, assuming an Investment Management Fee of 1% of Assets under Management inside the PPP.
  • $1,303,608
  • Total Corporate Deductions available to corporate sponsor of PPP
  • 15%
  • Corporate tax rate of corporation on revenues below $500,000
  • $195,541
  • Tax Refunds/Savings available to corporation as premiums for U/L strategy.

By way of illustration, let us assume that this (non-smoker) owner sets up a U/L policy with a face value of $1,000,000 and has an annual premium of $14,040.

Conclusions

The PPP ‘subsidy’ of $195,541 would fund the cost of the U/L policy for the next 13.9 years.

In essence, the owner will have created a $1,000,000 tax-free transfer of wealth from the corporation to the shareholder/beneficiaries, without having to disburse any additional corporate monies for the first 13.9 years since the cost of the U/L is borne by the tax refunds/savings generated by the PPP.

In addition, the PPP upgrade will also mean that his retirement savings will be $486,373 greater than had he remained in his RRSP while contributing the maximum amount each year .

At age 62, the PPP will pay an annual pension of $139,148 until age 65, at which time the annual amount will be $138,170 indexed to inflation minus 1% for the rest of his life.

The U/L will also have an investment account that can be pledged as collateral to obtain a line of credit. These funds will also be available to the business owner. Because the line of credit is not income (but a loan), the monies disbursed under the line of credit are non-taxable.

Thus the blend of taxable pension income ($139,128/annum) and tax-free payments from the secured line of credit, would also reduce the overall tax rate. This is because pension income is subject to pension income splitting and the $4,000 non-refundable pension amount credit, and the non-taxable nature of loans (the withdrawals from the line of credit).

On death, the $1,000,000 face value (minus any indebtedness to the lender if the line of credit was drawn upon) will be paid to the corporation and flow through the Capital Dividend Account of the company. The company can then declare a dividend that does not exceed the death benefit paid to the corporation to the surviving shareholders. That special dividend would typically not trigger any personal taxation because of the Capital Dividend Account.









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