As a new year begins, many of us refocus our financial goals. This may be an opportune time to assess insurance needs to help protect loved ones. For high-net-worth (HNW) investors, consider the opportunity to use life insurance as part of a broader investment strategy.

With rising rates, there has been increased attention to low-risk, fixed- income investments like Guaranteed Investment Certificates (GICs). Yet, insurance may provide an alternative that can produce a more favourable financial result after factoring in the potential tax implications. Consider the potential tax implications for a GIC returning four percent held in a non-registered account: after tax, this would yield two percent for an investor with a marginal tax rate of 50 percent.

At a basic level, many permanent life insurance products have fixed premiums and a guaranteed payout at death. As such, it is possible to calculate a rate of return (IRR) on the premiums. Since proceeds upon death are paid tax free, the only variable is the age of death. Take, for example, a whole life policy for a non-smoking, healthy 50-year-old male who pays an annual premium of $14,000 for a $1 million policy:

Insurance: Complement a Portfolio’s Fixed Income Component

Permanent life insurance may be a way to achieve fixed-income exposure. A participating whole life insurance policy (or “par policy”) allows you to share in the potential surplus earnings of the insurer. Your premiums go into a broader “participating account” that is professionally managed by the insurance company, which is used to pay insurance claims, expenses, taxes and other costs. The majority of the assets in the account are typically longer-term debt instruments, such as public and private fixed-income investments, bonds and mortgages. The account may include real estate or equity holdings. This provides the policy owner with access to a low-cost, widely diversified portfolio that is often difficult to replicate for individual investors.

The Par Policy: Additional Benefits for HNW Investors

In addition to the traditional benefit of supporting loved ones in the untimely death of an income earner, there may be additional benefits. The participating investment account is tax-sheltered for the policy owner, compared to a fixed-income portfolio of investments that would be taxable. Based on the account’s performance, annual “policy dividends” are often issued to policyholders. These can be used to purchase additional paid-up insurance that would increase the policy’s death benefit coverage, which the beneficiary will receive tax free upon the death of the insured. This provides the policy with the potential to outperform the after-tax fixed-income component of a traditional balanced portfolio.

In the event of a premature death, the par policy would have a high probability of outperforming the fixed-income component of a traditional investment portfolio (i.e., the increasing IRR at a lower age depicted in the chart). The estate value may also be higher, as income and any growth would be earned on a tax-free basis inside the policy. Death benefits paid from the policy may not be subject to probate where the policy is owned outside of a corporation and certain specific beneficiaries have been named, such as a spouse or children (in provinces where applicable).

For business owners, there may be additional tax benefits through the use of the company’s capital dividend account, further enhancing the value of the estate. Corporations with active business income may also be able to offset the tax that can result from the passive income rules.

Be aware that funds must be committed to this strategy, so sufficient assets must be available after premiums are paid to cover lifestyle and other needs annually. If premium payments stop, the policy could lapse; or, if the policy is surrendered, the policy owner would be entitled to a surrender value. If funds are required, the cash value may be withdrawn or borrowed against. Annual policy dividends are not guaranteed, though many of the large life insurance companies have paid these on a regular basis. Policy premium rates will vary by age and health; a medical is often required to determine premium payments.

If you are interested in learning more, please contact the office.