There are a few money saving strategies that are not commonly discussed. I would like to share two real-life examples that I have recently encountered. One is for business owners and the other is for a family. The first involves insurance protection for a business loan and the second, protecting capital in an estate.
First example, business loan:
It is common for lending institutions to request disability and life insurance protection on business loans and mortgages. Typically, during the application and approval process, creditor insurance is offered. It is a tick of a box to accept, there are a few medical questions, the process is easy and the insurance coverage is almost immediate. However, the hidden cost is overlooked. The entire insurance cost is added to the total cost of the loan, which results in interest being charged on the insurance. Most times, the lending institution does not present alternative strategies.
In this case study, two ND’s decide to form a partnership and open their first clinic. They apply for a business loan of $90,000. The loan is approved with a requirement of disability and life insurance coverage. The lending institution receives absolute assignment to the insurance; meaning if one of the partners become sick, injured, or dies the loan payment would be covered.
The total cost of insurance is $11,000 for this particular 5-year term. The insurance cost is tacked onto the loan, thus, adding insult to injury, interest is also payable on the insurance premium. The interest cost alone on the insurance is over $2,000 for the 5-year term. We looked for an alternative cost-saving and effective solution, which was to apply for personal business loan insurance for the two partners using one of the largest national insurance carriers. The monthly premium to their business, for the insurance, was now about $75; the cost for the 5-year term was about $4,550, providing a saving of 60% in insurance premiums. This is in addition to avoiding $2,000 of interest charges. The combination of saving interest and reducing premiums provided over $8,400 of available money for reinvestment into the business.
The downside to this process is that it does not provide immediate coverage. When applying for individual insurance, a medical history is taken and there may be medical tests required. Considering the possibility of some delay, an extension in time for approval should be expected. This loan insurance application took longer for approval due to health related issues. However, with a little patience and understanding of the process the final approval was received. The final result was still a remarkable savings of over 48%.
Second example, estate planning:
This case study discusses how to preserve the capital of an estate by using life insurance. This strategy is called a back-to-back insured annuity. I find most people are quite surprised to learn that registered accounts such as RRSPs and RIFs are fully taxable at time of death, unless there is a rollover provision to transfer the funds to a surviving spouse or partner.
My client, we will call her Jane, has just turned 71. Jane is retired with a full pension. In addition, she receives CPP and Old Age Security. Therefore, Jane has plenty of income to cover expenses and her lifestyle. She has two daughters and a granddaughter. Her intention is to leave the value of her RRSP to her daughters, as she has enough retirement income to live comfortably. Now at age 71, her RRSP of $130,000 must be converted to a Retirement Income Fund (RIF) and she must start drawing income from this RIF account. This income will be taxable. When Jane passes away the RIF account will be deemed “disposed of” the moment before death and fully taxed at the highest tax bracket of 44%. Therefore, her estate would owe approximately $57,000 in taxes, leaving $73,000 to the beneficiaries, her daughters. The estate would also have to absorb expenses such as probate fees, accounting & legal fees, and executor fees. In order to protect the inheritance for her daughters, the strategy recommended in this situation is to insure Jane for the taxable portion of her estate. This will preserve the capital, cover estate costs and cover funeral expenses. The most cost effective way to achieve this is to purchase a $100,000 life insurance policy that is paid up at age 100, with no more premiums after age 100. Jane has longevity in her family. Therefore, using the RIF account to purchase an Annuity would be the better option as it provides a guaranteed monthly payment for Jane’s remaining lifetime. This annuity will be used to cover the cost of the life insurance. The Term 100 insurance annual premium is $4,141. The annual annuity payment to Jane is $7,981.92, leaving about $1,446.34 after-tax per year. We suggest contributing the $1,446.34 to a Tax-Free Savings Account. If Jane were to pass away at 92, the life insurance value would be $100,000, helping to preserve the value that was in her original RRSP retirement account. She would also have $30,373.14 in Tax-Free Savings. During this time she would have received over $159,638 in annuity payments.
This strategy has now converted Jane’s $130,000 taxable money into a tax-free amount of $130,373.14 for her family at the time of her death.
Published in the BCNA Bulletin Summer 2012
The information in this article are presented for general knowledge and the content should not be relied upon as containing specific financial, investment, tax or related advice. Clients must seek their own independent professional advice to discuss their own personal circumstances before implementing this type of arrangement.
E&OE/2012 SBILLAN Wealth solutions doing business as SB Wealth Solutions