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Advocates of 'buy term and invest the difference
take note: a Universal Life insurance policy can simultaneously
satisfy your need for low cost life insurance protection and
comprehensive investment options - all in one policy. The available
investment options run the gamut from fixed interest accounts
providing competitive interest rates, to interest accounts to
linking to the leading markets in the world, to funds mirroring
the returns of top performing investment funds.
Over and above the life insurance protection
a Universal Life policy provides, one of the greatest advantages
this type of policy offers over ordinary investment funds is
that it is recognized as tax-exempt, as prescribed under the
Income Tax Act (Canada). If you have a Universal Life policy,
your investments can grow on a tax-deferred basis (within limits),
similar to an RRSP or an RPP. As a result, your cash accumulation
can be higher than in an outside non-registered investment-even
with the cost of insurance included! Universal Life is one of
the few remaining tax shelters left in the Income Tax Act.
There are seven different ways to access
the cash value in your Universal Life policy. However, keep in
mind that if you want to use the following features to your full
advantage, you must be prepared to invest as much as possible
in the policy as is permitted for a tax-exempt insurance policy
under the Income Tax Act, (Canada).
1. Withdrawal-You may withdraw a portion
of the cash value in your policy at any time, subject to a surrender
charge typically applicable for the first nine years of your
policy. The Income Tax Act (Canada) allows a credit of the Adjusted
Cost Base (ACB) of the policy to be applied against the withdrawal
so that only the net amount becomes taxable. The ACB is typically
higher in the early years of the policy and is maybe eliminated
after about 25 to 30 years. This credit can be a tax advantage
over other registered investments (RRSPs, RRIFs, and RPPs), where
you have to pay tax on the full amount of the withdrawal.
2. Use of Pre-Tax Dollars-Universal Life
allows you to pay your policy's monthly charges with cash already
accumulated in your investment interest account(s), without considering
this to be a withdrawal for tax purposes. Since insurance premiums
are usually not tax deductible and are paid with after-tax dollars,
it is a definite tax advantage to be able to use pre-tax dollars
to pay the charges. In contrast, money withdrawn from an RRSP
to pay for term insurance would be fully taxable.
3. Tax-Free Payout on First Death-If the
option to receive a payout of a policy's account value on the
first death is elected at issue on a joint last to die Universal
Life policy, typically anywhere from 25% to 100% of the cash
value of the policy can be withdrawn by the named beneficiary
on a taxfree basis upon the first death of the lives insured.
As long as it is elected at the time of application, the Canadian
Customs and Revenue Agency (CCRA) currently treats this option
as an advance on the death benefit, rather than as a taxable
withdrawal. On the other hand, with an RRSP, if there were no
surviving spouse to whom to rollover the RRSP, the proceeds would
be fully taxable upon death.
4. Tax-Free Payout on Disability-Upon satisfaction
of the definition of disability given in the policy, up to 50%
of the cash value of the policy typically may be withdrawn on
a tax-free basis per year. Other registered investments offer
no comparable feature, and this would be considered a taxable
withdrawal from an RRSP or a RRIF.
5. Policy Loan-If you require a short-term
loan, a Universal Life policy allows you to borrow up to 90%
of the value of your investments in Guaranteed Deposit Accounts
at a very reasonable rate of interest without having to go through
any credit checks or approvals. This is a terrific feature to
use when borrowing to buy an RRSP, instead of going to the bank
for a loan. If you take your resulting tax refund (if applicable)
and use it to pay down the policy loan, you will be left with
a much smaller balance to pay off. This gives you the added advantage
of having two separate tax shelters working for you-the RRSP,
and the investments within your Universal Life policy.
Keep in mind that under the Income Tax
Act (Canada), the loan is deemed as income in the year it is
taken out; however, you are allowed to deduct any payments made
on the loan before the end of the year so that in essence, it
becomes a tax-free loan if the loan is repaid in full in that
tax year. The remaining loan balance not repaid will be included
as income and will be taxed. In addition, there is no pressure
to repay the loan if you are prepared to pay the tax on it. However,
if the loan balance plus interest owing exceeds the accumulated
cash value in the policy, this may cause the policy to lapse
which would then require either a cash infusion or loan repayment
into the policy to correct the situation.
6. Supplementary Retirement Income-If you
have longer-term borrowing needs, your Universal Life plan, as
a cash value life insurance policy, may be used as collateral
with your bank to secure a loan. If there is substantial cash
value in the policy, you may take it to your bank and request
to receive a series of annual loans for up to 90% of the value
in the Guaranteed Deposit Accounts or up to 50% of the value
of equity based investments. Provided your lending institution
is willing to capitalize the interest and wait to be paid out
of the death benefit upon death of the life insured, no loan
repayments would be required. It is important to note that there
are banks that specialize in this program.
The loans are received tax-free from the
bank and there is no actual withdrawal from the policy, which
allows the cash value to continue growing on a tax-deferred basis
within the policy. In this way, a sufficient amount of money
should always be available to pay off the bank loan when due
while maintaining a death benefit for your beneficiaries. This
is an excellent way to supplement your retirement income and
use the accumulated cash value in your universal life policy
without paying tax on it.
7. Death Benefit-Upon the death of the
life insured, all of the cash value accumulated in the policy
is paid out, together with the death benefit to a designated
beneficiary, on a tax-free basis.
So by taking a previously taxable investment,
investing it in a Universal Life policy where it can grow tax
deferred and be passed tax-free on death to your beneficiaries,
you can satisfy your need for life insurance, enjoy easy access
to your cash, avoid probate taxes with a beneficiary other than
your estate, and prevent the cash from becoming tied up in estate
administration.
Within limits prescribed under the current
Income Tax Act (Canada), tax-free* growth, tax-free* income,
and taxfree* transfer of estate can be yours with Universal Life.
To take full advantage of the features available to you from
a Universal Life Insurance plan you must be prepared to take
full advantage of the savings room by depositing in the form
of a premium up to the maximum annual amount allowed under your
policy to remain tax exempt.
If you do not deposit greater than the minimum required premium,
then there will be little or no cash value to access and your
policy may lapse. Universal Life might be your answer to "Buy
Term and Invest the Difference". See your Financial Advisor
for a plan that is right for you!
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