Crash Test Your Retirement Plan

Protecting Your Retirement Future Against Critical Illness

When planning for a comfortable retirement, individuals typically focus on mitigating common financial risks such as inflation, interest rate fluctuations, and longevity. However, a less frequently considered, yet potentially devastating risk is that of a critical illness. "Crash testing" a financial plan for a critical illness event is crucial because it prepares for a risk that has a significant chance of occurring (30%) and can entirely derail retirement aspirations. This proactive approach ensures that even the most meticulously crafted financial plans can withstand unforeseen health challenges.

The impact of a serious illness on personal finances can be profound. Treating and coping with conditions like a heart attack, stroke, or cancer often entails significant costs that may not be fully covered by provincial health plans or basic employee health benefits. Without a safety net, individuals or their families are often forced to deplete their retirement savings or other investments to finance recovery. This scenario highlights the necessity of anticipating such a crisis and having a strategy in place.

A critical illness event without proper coverage often forces individuals to dip into their RRSPs, triggering significant financial consequences. Withdrawals are taxed at one’s marginal rate—up to 53.53% in Ontario—meaning $2.15 may need to be withdrawn for every $1 needed. Additionally, if the illness prevents ongoing contributions, it can derail long-term retirement plans, making recovery—financial and otherwise—much harder.

This is where critical illness insurance steps in as a vital safety net. It can provide a one-time lump-sum payment upon diagnosis of a covered condition, allowing you to recover on your own terms. This benefit serves to protect your retirement savings by providing the necessary funds without forcing you to liquidate investments or incur tax penalties from RRSP withdrawals.

Adding a critical illness sensitivity analysis to a retirement plan is a simple yet powerful way to "crash test" a client’s future income against the impact of a major health event. It shows how unexpected medical costs can erode both registered and non-registered assets, helping to quantify the timing and amount of potential withdrawals. Ultimately, it highlights the difference between preserving retirement savings and having to spend them on healthcare.

The "crash test” step works by simulating various scenarios to demonstrate the benefit of having critical illness insurance. It compares retirement income amounts under four distinct possibilities:

• If you stay healthy and don't have critical illness insurance coverage.

• If you become ill and don't have insurance coverage, showing the financial setback.

• If you experience a covered critical condition and are protected by critical illness insurance.

• If you stay healthy and are protected by critical illness insurance (reinvesting the return of premium back into the retirement plan)

This comparative analysis makes the financial benefits of critical illness insurance clear.

Case Study: 

A 45-year-old male has $1,000,000 in registered investments and plans to contribute $25,000 annually, earning 6% until retiring at 65. He expects to live to age 85.

Ask your client:

“Imagine you’re 55 and diagnosed with cancer. Your doctor tells you there’s an excellent chance of recovery—but the treatment costs $250,000. Would you hesitate to pull that from your RRSP if it meant saving your life?”

Follow up with:

“Could a critical illness cost you your retirement?”

“What would happen if you had to stop contributing to your RRSP for two years?”

“How would your long-term plans change if your savings took a major hit in your 50s?”

Using a “crash test” scenario, we model the impact of a critical illness at age 55, requiring $250,000 (after-tax) and a two-year pause in RRSP contributions. The results:

• Healthy, no insurance: Monthly retirement income of $29,961.

• Critically ill, no insurance: He would need to withdraw $537,981 from his RRSP to net $250,000 after tax, reducing his retirement income to $21,681 per month.

• *Critically ill, with $250,000 CI insurance: Monthly income drops only slightly to $28,806.

• *Healthy, with return of premium at 65: Monthly income of $29,140, nearly matching the no-insurance healthy scenario.

Beyond the purely financial figures, critical illness insurance provides immense peace of mind, allowing individuals to focus on getting better rather than worrying about derailing their retirement plans. All policies offer a lump-sum benefit for covered conditions, additional long-term care protection, benefits for early stages of illnesses, and fast access to money with a Recovery Benefit. Most policies also feature a return-of-premium option at retirement, which adds another layer of potential benefit.

Therefore, the importance of "crash testing" a financial plan for a critical illness event cannot be overstated. While no one wants to contemplate suffering a serious illness, its potential financial impact can be devastating. By proactively putting protection in place through critical illness insurance, you are effectively safeguarding your income and savings, ensuring your future financial security.

In conclusion, "crash testing" your financial plan against the risk of critical illness is a fundamental step in comprehensive retirement planning. It ensures that your retirement savings remain intact for your future, not to cover medical bills. This vital exercise provides a clear understanding of potential vulnerabilities and empowers your clients to implement the best solution to protect both themselves and their family from the financial consequences of a serious health event.

* Male age 45 n/s for $250,000 CI coverage, annual premium: $6442.69/yr. Canada Life LifeAdvance (Level Premium to age 75 with Return of premium at withdrawal year 15 (or expiry), Loss of independence and premium reduction.