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Insured Annuities: Are they back?

For many Canadians entering their retirement years, their focus tends to switch from accumulating wealth to preserving wealth for themselves and their estates. Their portfolios often tend to include more weighting in fixed-income investments, such as bonds, and GICs. These clients typically rely only on the interest earned on these portfolios to supplement their retirement income while preserving the capital for their estates (i.e. kids, charity, etc.). They often tend to seek out opportunities to maximize this stable source of income as their investments come up for renewal. A strategy worth exploring is an INSURED ANNUITY (or back-to-back annuity). The ‘insured annuity’ is a strategy designed to give you increased income while you’re alive while ensuring you have funds available to leave a legacy when you die.


Here’s how it works.

An insured annuity is made of two contracts: a life annuity (either single life or joint life) and a permanent life insurance policy (either single or joint last to die) The combination of these two products creates the equivalent of a locked-in, fixed-income investment. The end goal is to provide a better return on investment than a traditional fixed-income investment while preserving capital (see example case study below). To implement the insured annuity strategy, you would liquidate some or all your fixed-income investments and use the proceeds to purchase a “prescribed life annuity” with you as the annuitant (or jointly with your spouse). As a prescribed annuity, each guaranteed payment consists of a level tax-free amount and a level taxable amount that doesn’t change for the life of the annuity contract. The ‘taxable portion’ is treated as regular income, like the interest earned on your alternative fixed-income investment. The type of life annuity purchased usually has little to no guaranteed period. Designing the annuity in such a way is important to maximize the cash flow available during the annuitant's lifetime. The after-tax cash flow is then used to pay premiums on a permanent life insurance plan that matches (and replaces) the amount of the fixed-income investment liquidated to purchase the life annuity. To maximize after-tax cash flow, the type of permanent plan most suitable is a low-cost permanent option (i.e. minimum funded UL Level COI or a T100). The ‘net annuity payment’ (after taxes and after payment of life insurance premiums) may provide you with a higher after-tax income than you otherwise would have received on your traditional fixed-income investment (i.e. bonds, GICs)


Who’s it for?

This strategy is designed for affluent individuals who are Canadian-resident taxpayers, with capital that exceeds lifestyle requirements who are above age 60, and in good health. They tend to have portfolios that include conservative, liquid investments such as GICs, bonds, and bank accounts. Interest income earned is used to enhance or supplement lifestyle goals during retirement, and leaving a legacy at death is a high priority. So, if you have clients that are only living off the income of their fixed-income portfolios they may be a candidate for this strategy.


The benefits of an Insured Annuity:

  • Increased guaranteed cash flow for life.

  • Preferential tax treatment of annuity income which provides the potential to reduce tax payable on investment income.

  • Estate preservation through life insurance proceeds paid tax-free to beneficiaries at death.

  • Creditor protection on both annuity and life insurance contracts (when naming beneficiaries in the protected class or as irrevocable).

  • Elimination of probate fees (or estate administrative fees) when naming a beneficiary other than the estate on the life insurance policy (not applicable in Quebec).


Case Study:

Let’s meet Zach and Tara both 65 yrs. old. Over the years they’ve been very prudent with their money and have been successful in building up a sizeable retirement nest egg. Leading up to their retirement date, they’ve decided to take less risk with their investments and started to shift more of it into conservative type investments, like GICs. Currently, 40% of their investment portfolio is made up of fixed-income investments. Based on a recent financial plan they plan to use the interest earned on their GIC portion of their portfolio to supplement their retirement income and preserve the capital as a gift to their kids. After meeting with their financial advisor, they heard about an Insured annuity strategy that piqued their interest. They’ve decided to carve out $1mill. of their GIC portfolio to explore how this would work.

Next steps: We liquidate $1mill. of their GIC portfolio which was anticipated to earn 4% on average over their lifetime. We use this to purchase a prescribed joint life annuity with no guarantee period to maximize the cash flow available during their lifetime. This produces a guaranteed income of $58,972 for the life of Zach and Tara, of which $20,658 is taxable each year. Assuming a 50% tax rate, they’re left with $48,643 after tax. To preserve their initial $1mill. for their kids, they need to purchase a life insurance policy. We then purchase a low-cost permanent joint last-to-die policy for $1Mill. (minimum funded universal life with level cost of insurance). The premiums for this policy are $19,438. After subtracting the cost of insurance, they are left with an annual net cash flow of $29,206. Now, compared to the GIC alternative which produces an annual net cash flow of only $20,000...that’s an annual increase in after-tax cash flow of $9,206 or a 46% increase. The equivalent pre-tax rate of return required on the GIC to match the Insured annuity output would be 5.84% each year for life. Zach and Tara can also decide if they don’t need the extra cash flow (of $9,206) they can increase their gift to their kids by purchasing an insurance policy worth $1,475,000 instead of $1,000,000.


A word about Corporate-insured annuities:

If an incorporated business owner finds themselves in a similar situation as the scenario above, they may also decide to explore an Insured Annuity strategy. In this case, since funds are held corporately, and not personally, the only available annuity contracts to a corporate owner are “accrual annuities” not “prescribed annuities.” Unlike the prescribed annuities where the taxable portion is level throughout, the taxable portion of the guaranteed payments of the accrual annuities decreases as the client gets older (specified in the annuity contract). Therefore, in the earlier years, the taxable portion of the guaranteed payments make up a substantial percentage of the overall payment. The after-tax advantage may be smaller in the early years but grow bigger as the years progress. The bigger advantage lies in the difference in net estate values. With the Corporate Life Insured Annuity strategy, the net estate values will be significantly greater than the GIC since most if not all the life insurance proceeds are allowed to flow out tax-free to the estate due to the CDA credit created. This is not the case for the GIC investment. The proceeds of the corporate GIC investment would be paid out as a taxable dividend to the estate. Leaving less money to the estate after tax.

Although the results can be quite favorable, implementing an Insured Annuity strategy should not be undertaken unless the following areas are addressed:

  • Will the strategy be suitable to ensure current and future needs are met?

  • Will you qualify for life insurance (preferably at standard rates)? This should be explored before purchasing a life annuity product.

  • Will the lack of liquidity be a problem? Both the life annuity contract and the type of low-cost permanent life insurance plans implemented, provide no liquidity.

  • Will the assets being liquidated produce a capital gain or forgo interest payments?


For older individuals looking for long-term, guaranteed returns while preserving capital for their estate, an annuity combined with a life insurance policy can be an extremely attractive solution.







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