What Is an Insured Retirement Plan?
Insurance is a tool for someone to protect them self against uncertain risks. The policy owner pays a relatively small sum (the engineered premium) every year to an insurance company, which is contractually obligated to cover his loss if the worst comes to pass. You can insure for just about anything, from car accidents, medical treatments, cancelled flights and death itself. Isn’t it funny how someone will insure their luggage on a 4-hour flight to Mexico one way, where the likelihood of bags going missing is minimal, but won’t insure the one thing they know will happen…death. That is why life insurance exists.
Life insurance comes in two forms (i) Permanent or (ii) Term. Think of permanent as being insured for your entire lifetime (to age 100), whereas term would otherwise be “temporary” (i.e. 10, 20, 30 years). Your choice should be based primarily on your objectives. That being said, you cannot solve a permanent problem with a temporary solution. It is crucial to work with a licensed Advisor who is thoroughly familiar with both.
- Canadians are increasingly leaning more toward permanent life insurance (i.e. dividend-paying participating whole life) coverage for several reasons, primarily;
The contractual guarantees. - Ease of access to a growing pool of financial cash value that cannot go down, cannot be repossessed and is not tied to any stock market.
- Co-ownership of the Life Insurance Company itself.
- The contractual authority to collaterally assign cash values in exchange for access to money for things like retirement, property, automobiles, appliances, education, and more.
At its core, life insurance involves an “insured” who pays a premium while He/She is alive in exchange for a contractually binding promise that the “insurer” will pay out a named beneficiary or an estate a death benefit after He/She dies. The purpose primarily is to replace the lost income and to pay off all outstanding debts. When utilized for this purpose, it is essential to have a proper “needs analysis” completed by a life-licensed advisor who can derive the adequate amount of death benefit coverage required to fulfill those objectives.
Another form of life insurance is named Universal Life or “UL”. Some refer to this type of insurance policy as a slot machine with a death benefit attached to the investment component. The essence of UL is to transfer the investment risk away from the life insurer to the life insured.
In contrast, dividend-paying participating whole life, a staple of savings in Canada since 1847, backed by legally binding contractual guarantees, is a product where the life insurer assumes 100% of the risk and the life insured’s a sole obligation is to pay a premium. The Life Carriers in Canada who provide these policies to the general public have satisfied their contractual obligations to policy owners since 1847 (or the past 174 years since this article was written). This policy is a unilateral contract, and one element of the contract is cash value which is guaranteed to rise daily and must match the total death benefit by Age 100 of the Person who is the life insured.
With all that background knowledge out of the way, we can finally answer the question. An insured retirement plan (IRP) is simply a process combined with a product. The product is a dividend-paying participating whole life insurance contract or a system of contracts. The process involves collaterally assigning the daily increasing cash values in exchange for a loan or operating line of credit to supplement your retirement needs financially with a never-ending stream of tax-free money. And when the life insured passes away, the insurance company writes two checks (i) to pay off the loan or operating line of credit, (ii) to pay the remaining balance to a named beneficiary income tax free. *Note* Corporate-owned life insurance has additional steps and nuances to achieve the same IRP objective. We recommend that you consult with a Chartered Life Underwriter (CLU) in concert with a CPA to review.
How Do Insured Retirement Plans Work?
You can only implement the process if you have the product. And so, step 1 is to get the right policy in place. The most critical items to address are how much money you need and how long will you need it? That will help the Advisor atAscendant Financial determine how much premium needs to be deposited into the policy and for how long. Second, you need to know how to implement the process. That requires a good coach, meaning someone thoroughly familiar with IRP implementation.
A dividend-paying participating whole life contract is the most commonly used contract to implement this strategy.
The contract has two vital components:
- Coverage: The starting estate value or death benefit. This is what determines the exempt room available for you to put more tax-advantaged savings deposits into the contract and the basic or minimum premium required to cover the actuarial cost of insurance.
- Cash Value: The daily growing pile of financial value that the policy owner has total and complete control over.
Once the policy owner reaches retirement age and their policy has accumulated a large sum of total cash value, it’s time to implement the process. To do this, the policy owner applies for a secured loan (or operating line of credit) and the life insurance policy is assigned as collateral. A bank will lend a minimum of ninety (90) percent of the ever-increasing total cash value, expecting no repayment until either the life insured passes away or the policy is surrendered.
What does that say to you about the strength of the policy as an asset?
Insured Retirement Plan Pro and Cons
Cash value accumulation: Because the policy owner is borrowing against the total cash value, the daily growth continues uninterrupted. The policy owner enjoys ready access to money from the bank while the total sum of cash value rises daily inside His / Her policy.
Tax-free money to use as a source of income: Because no withdrawals are occurring within the policy itself, no taxable event is triggered. If the policy owner elected to withdraw money from his insurance policy, any amount is withdrawn above the adjusted cost basis (ACB) would be taxable. But with an IRP process, the policy owner does not trigger a taxable event because the asset (the policy) is collaterally assigned. The money is a loan coming from the bank, not the policy. We recommend consulting with a Chartered Accountant for any questions regarding your specific circumstances.
Deferred interest payment: The policy owner is not required to pay monthly interest payments on his loan. The interest is capitalized and deducted from his tax-free death benefit along with the principal loan balance. The remaining balance of the death benefit is paid out to named beneficiaries. When structured properly, the amount passed on to the surviving family can be far more than the total premiums deposited. We refer to that as “replenishing” the asset back to the family. All that being said, the borrower (policy owner) can repay the bank, partially or in full, at any time while He / She is alive and release the collateral assignment.
The benefit of having a participating whole life insurance policy is primarily certainty. No matter what happens, the policy owner is guaranteed a fixed sum and a simple, secured way to provide guaranteed retirement income. The downside of Insured Retirement Plans, and the policies they depend on, is that by taking an advance on the future death benefit so you can use it while you are alive, less is available to pass on. However, this strategy is typically arranged with this intention in mind. Another downside is that a policy owner must work with a 3rd party lender rather than the insurance company they co-own. Anyone familiar with the Austrian School of Economics typically does not support business with commercial banks who fractionalize the money supply. That being said, the policy owner understands they do have options.
Here are some of the worst-case scenarios of Insured Retirement Plans:
Loan Interest Rates: The interest portion on the IRP loan may be perfectly affordable at first. But interest rates may rise in the future. And the longer the loan duration, the greater that repayment could become. It might even reach a point where the interest equals the cash value. However, the cash value accumulation and dividends of the participating contracts often perform in tandem with interest rates on a lagging scale. If loan rates rise, the life company can earn more, which increases the death benefit and cash values of the policy owner correspondingly to mitigate this risk. If this scenario was to arise, the lender would simply stop providing credit. If a loan exceeded the cash value, they would have to pledge another asset as collateral, or the policy would effectively end to pay off the loan. Hence the policy owner’s behaviour and understanding while using this method are critical. They must keep a prudent relationship between the loan balance, cash values and their annual spending.
Reduced death benefit: Having access to a lump sum of tax-free cash to spend is too much for most to handle. It’s tempting to live largely and spend it all just because you can. However, if that does happen, then the policy owner would leave significantly less money for his family upon death. Doesn’t that defeat the purpose of life insurance in the first place? Again, this is subjective and really a moving target as the policy owner’s life shifts and changes over time. What may have been necessary at the onset of the policy and their life in retirement 25 years later may adjust decision making. The key is to have the power and control to do so, which this method allows.
IRP definition
It’s simple, IRP is the acronym for Insured Retirement plan. This is also referred to by a few other names commonly in Canada. It is sometimes known as a “preferred retirement solution” or a preferred retirement account. Every life insurance company in the nation has its own spin or label to attach to this concept with their marketing departments.
Insurance Retirement Planning Guide
To summarize, here is a simple step-by-step guide to how this works.
- Identify your objective, i.e. how much money do I require and for how long.
- Work with someone thoroughly familiar with how to properly design your policy.
- Apply for the policy
- Capitalize your policy by paying the premium on time, all the time.
- Make sure that your Executor or Individual entrusted with handling your final affairs is aware that you have this policy in force and what your intentions are for its use while you’re alive and when you pass away.
When you’re ready to begin implementing your IRP, work with a licensed professional who can help guide you through the implementation phase. Monitor and adjust as appropriate throughout your retirement years.
The result looks like this:
- The policy owners get back all the premium deposits they made during their lifetime as tax-free income plus more.
- The beneficiaries still receive tax-free money that they can use to pay the final tax bill, among other things.
- The insurance company itself guarantees the collateral.
- The lender will lend 90% (or more) of the total cash value asset with minimal questions asked in most case and does not require repayments.
- The policy owner has peace of mind, the certainty of money in retirement, security, control, WITHOUT market risk or tax risk. Isn’t that good?
New Training from Jayson Lowe
Insured Retirement Plan Expert
We have expert financial advisors and coaches that can help you Implement the Insured Retirement Plan Strategy into your financial life. Access the On demand webinar to learn more.