Pitfalls of The Insured Retirement Strategy

Back in mid-1990's the insurance industry came out with a new concept called the Insured Retirement Strategy.   The idea is that you build tax-deferred investment values inside a life insurance policy during your earning years.  Upon retirement, rather than withdrawing funds from the insurance policy (which would trigger taxes)  you instead use the policy as collateral for a bank loan.  In other words, you get your cash from the loan instead of the policy, thus minimizing taxes. The loan simply accumulates and is paid off by the proceeds of the life insurance policy when you pass away.

Here's an example.

You purchase a Universal Life Insurance policy at age 45.  Over the next 20 years you accumulate $1,000,000 inside the policy, tax sheltered.  Upon retirement, you use this million dollars as collateral to withdraw $50,000 every year.  The $50,000 is of course tax free (because it's a loan).  The loan accumulates with interest and when you pass away your $1,000,000 insurance policy pays the bank off for the loan.

The pitfalls of the Insured Retirement Strategy

If you are being pitched with this concept, it's important that you assess the risks.  The insurance industry will provide you with lots of information on the benefits of this strategy so I'll skip that. Insteat lets look at some of the risks and pitfalls that you should consider.

  1. High MER's and DSC:  The life insurance policy investments used in this strategy can have much higher MER's (expenses) than comparable investments outside an insurance policy. They also frequently have deferred sales charges (DSC). In layman's terms that means you make less money and have less flexibility.   
  2. RRSP's and pensions are better: Insurance industry brochures will suggest that Insured Retirement is suitable for those who have maximized their RRSPs.  The corollary to that is that you should only consider Insured Retirement strategy after you've ensured your RRSPs, TFSAs and pensions are all brimming full.  To put it another way, Insured Retirement should not be a pillar of your retirement planning it should only be a secondary or additional option.
  3. CRA Risk:  The strategy works because you're accumulating funds inside a tax sheltered investment and then effectively accessing them without triggering taxes.  The CRA has some stringent rules about doing stuff that takes advantages of tax loop holes. The insurance industry suggests you can mitigate this risk by ensuring you have an actual need for the life insurance. Still, the CRA could change the regulations in the years between now and when you retire and prevent you from using the insurance policy as collateral.  How likely is that?  There's no way to measure, however it may be worth noting that you can't use an RRSP as collateral on a loan.
  4. Interest rate risk:  It's clear to most of us that there's some risk inherent in the investments as they grow.  But what about the interest rate on the loan upon retirement?  The banks will only let your loan grow to a specific percentage of your collateral. With a high interest rate on the loan at retirement, the amount of the loan could outstrip the value of the insurance policy, forcing the bank to call the loan.  Now instead of taking a tax-free annual payment, you're stuck coming up with a huge chunk of money to pay off the loan early – probably requiring you to cancel the policy and pay the taxes on all that money you've been sheltering.
  5. Bank risk:  You diligently build the investments over 20 years,  then hop into the bank to take your first loan.  The bank informs you that the rules have changed – and not in your favour. Perhaps instead of letting you take a loan of 75-90% of the value of the policy they now cap it at a maximum of 50%.  Or maybe they've been burned at some point and simply refuse to use a policy as collateral.  Either way, what's going to happen with taxation, banks, and insurance in 20 years is unknowable, and that brings some risk into the process.

In the end, Insured Retirement Strategy can look attractive for the right investor.  But be careful that you have the financial wherewithal to weather the storm if things change to your detriment.  If you're looking at the strategy, remember this should only be considered as a secondary strategy after RRSP's and TFSA's.  And always do a worst case scenario check – what happens if none of this comes about as projected?

Written by Glenn Cooke

Glenn Cooke is a life insurance broker in Canada and president of Life Insurance Canada. He has more information about life insurance on his website.

12 Responses to Pitfalls of The Insured Retirement Strategy

  1. Great analysis, its very true that the only people who should consider this will have already maximized their other retirement investments. Typically these people have the financial smarts to see that there are other alternatives with lower costs (MER etc) that offer similar benefits.

  2. Very well explained.

    The sad part is some insurance brokerages sell this product through multi-level marketing. The new immigrants/ financially uneducated esp the Filipinos are being sold by this product.

    They are told by the insurance agent that if they will sell this product to their friends and family they will have a huge commission for a $200/mos premium they will receive $2500.

    Clients and prospect clients are being promise of 18% or 8% return of their investment and told that these return are guarantees.

    I wonder how to stop these unethical and misleading practices.

    • Hi! I am an advisor from the MGA you are referring to, and yes I’m here to get some facts straight (some because, well, we dont really have much space here)

      First of all, an MLM’s model is to pay a percentage of a recruit’s sales towards his/her ‘upline’. FYI our commission is 100% ours, whether you are a seasoned advisor or someone who just started. Instead of getting a percentage from our downline’s sales, we are given bonuses. (Sweet!)

      Second, we NEVER promise an 18% return of investments (is that even legal??)
      We follow protocols from the companies we represent who are VERY STRICT in making sure that we do not overpromise to our clients.
      (our represented companies have huge reputations at stake after all)
      We do stress tests and show them worst case scenarios (the reason why our client’s policy explanation takes TWO GLORIOUS HOURS!),
      show then RORs of 6% and lower, and yes, we also let them know that bank loan policies may change in the future (that may, of course, affect their retirement income. Duh.)

      The commission is sure big (it’s not actually $2,500. It’s even more;) BUT we never ask them to pay anything upfront until after the policy delivery. Because if, after stating all the benefits of IRP and the client decides it’s not for him, he can definitely decline the plan.
      It’s his money after all.
      If he does like it then great! But while most advisors disappear after a done deal we are REQUIRED to make at least an annual visit to explain our clients’ statements. We face them (yep. Including those times when the market is low) because that’s how advisors are supposed to do it. It’s a way for us to assess whether they need to make some adjustments with their monthly premiums. Or if the need is greater. Or referrals! (Yay!)

      I will not claim that I am an expert in every financial matter but Insured Retirement Plan is definitely my specialization. We’re not here to replace RRSP and TFSA. Rather, we want to show everyone another choice for their future money planning. Compare them, and then let THEM choose.
      And of course, to somehow educate the financially uneducated.

      We don’t force our clients to get IRP, besides, not everyone is qualified to have one. As I said, it’s the client’s money anyway. That is why we always encourage our clients to do their due diligence. (Which I hope the writer did before coming up with this article)
      I mean, he does have great points. But only to his level of understanding (well this has been a few years ago, I sure do hope he knows more now)

      But because he didnt do his research and apparently the balls to maybe ask us and get as much information as he should have then he should have known why the cash value would not be ‘eaten up’ by the cost of insurance. (and why there is a lot of Filipino clients).

      It’s a shame to assume something you have not much information (and worse, publish it!)

      All you had to do is simply ASK and you shall receive (thy answers!)

          • Great response Elle B, this poor guy really doesn’t know much about a Corporate Insured Retirement Program at all! It is sad that people forget (or neglect)to do their homework before they complete such articles. There should be several compliance issues with the article he wrote.

            You forgot several benefits however, if Whole Life Insurance, such a Manulife PAR is inside Corporation, using 60 cent dollars to build wealth, as the business owner would be using pre-taxed Corporate dollars, which at death the majority can be paid out through the Capital Dividend Account tax free on death based on CDA Credit in policy. The Manulife PAR product’s current Dividend is 6.25% (recently announced remaining same Sept 2019 to Sept 2020). We illustrate at Current minus 1.0% (or 5.25% currently. Not sure where 18% came from?

            Of coarse there is interest to pay to Manulife Bank, or whatever Bank chosen and terms can change, but in a low interest, low growth environment, the dividend is great and interest rates should remain, tame, this is however a risk to consider. The great thing about Manulife Bank, is the interest can capitalize over time and be paid off by the Beneficiary at time of death, with the majority, if not all being tax free proceeds. In most cases, a policy of the size the writer is speaking of, there is normally a much larger death benefit than what is owing on the loan at the end, providing a boost to their estate.

  3. Thanks Elle ,
    I am joining Greatway financial. You have done a good job. Most people have negative attitude and write negative without proper information. i do not find anything wrong with IRP. I was with other financial company—i am not expert but know–if we compare with other products–this is the best. Where there is an investment–risk is always there but here ,it is a calculated risk. Even in the worst case-nothing to loose. But everything is not for everyone–IRP is given to those persons, who are eligible and they need it. Thanks

  4. Leave me a good and honest answer. Most of the big banks would only offer this to those people that have excess cash. They would also note that people who have not maximixed their RSP and TFSA are not really a potential client. People they are targeting are high net worth client. Why are they not offering this to ordinary people like me? are they wrong in their study that IRP should also be offerred to ordinary people like me? Can you please enlighten me on this matter.

    • Hi Phil, in the bank they would offer this to someone who can save $20k annually for 15 years( just an example). And who can only do that,rich!
      Thats why insurance company offers this to people who can only put $600 minimum and above annually ( depends on their age)…
      Even if the bank says we cant accept it as a collateral or even the government put tax on it ( because of its growth capability) and also, for me its still better to have something than having nothing! …
      Every financial product in the market is amazing. Cant compare them apple to apple they have their own feature. Determine your financial goal then check which one would one would benefit you most.

      IRP is RISKY ( but how risky is Risky, numbers doesnt lie!) and NOT guaranteed ( guaranteed investment only guarantees capped potential growth!). Ex. Which ine is better guaranteed 8% ROR from 1950 till 2018 or risky and not guaranteed( s&p 500) numbers doesnt lie.

      $ money under your pillow 20 years less buying power.

      $ inside savings in the bank 72 years before it will double.

      $ in TFSA no tax but how about the growth plus inflation.

      $ in RRSP tax on withrawal but you can put it in RIFF( but what is the max allowable withrawal). Plus clawback with your CPP. And hows the growth capability.

      $ IRP is RISKY and NOT guaranteed!
      But always remember this NUMBERS doesnt LIE! I can explain more about this if you are willing to listen🙂…

      So choose above which one will you benefit most in relation with your financial goal. Thank you.

  5. I came across your article and gave me some important insights about IRP. Thank you. It’s true that brokers would most likely to emphasize only the good side of this strategy which I understand is mainly its tax sheltered environment. Bottomline, if an Advisor is only motivated to sell/endorse this product; or at the first analysis goes on to talk about IRP and present a UL right away, because of the high commission attach to it, then they are doing a disservice to their clients. Sad but this happens a lot.

  6. Im getting confused.. I was offered an IRP and the offer is good though I found it too good to be true.. I’m not really aware of this IRP and other insurance but I’m in doubt of investing and if the deal will really happen after 20 years..

  7. Insurance is not an Investment that’s it. Insurance needs to an Insurance Investment needs to be an Investment never ever combined the two or you will loose one!

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