Managing Risk with Insurance

2017-06-01

As part of a financial plan, insurance is typically thought of as a solution employed to protect against the risk of future financial loss. While this is a very important application of insurance, additional innovative solutions are being used to safeguard the value of investors’ assets in a tax-efficient manner and to ensure that one has enough to cover healthcare expenses as one ages.

Protecting Income

Insurance can play a key role in one’s financial plan earlier in life than one may think. You are working hard to earn income to give your children an education, to build a strong investment portfolio, and to create the lifestyle you want to live. What if that employment income stream was suddenly not available?

At a minimum, every sound financial plan for any investor with a family or other dependents should include Term Life Insurance. This type of coverage will safeguard your family from the future loss of income during the years after your death, and from the risk of financial struggles. Term Life Insurance is quite affordable, especially for the younger investor.

The risk of becoming disabled for a significant period of time before 65 is actually higher than the risk of dying before 65. A Disability Insurance policy pays a monthly benefit (replacing a portion of your income, depending on the level of coverage chosen) while the policy’s definition of disability is being satisfied. There is normally a waiting period of 30 days to two years before payment and benefits are typically paid for a period of two years, five years, 10 years or “to age 65”.

Although many investors are already covered by a group plan at work, there are some limitations to a corporate disability policy that you should be aware of:

  • Your employer owns the plan and may cancel it or make changes to it at any time
  • Coverage is often terminated if the employee leaves the employer
  • The definition of disability is usually “regular occupation” (the inability to perform the duties of your own specific occupation) for a short period (one or two years) after which it reverts to an “any occupation” definition (the inability to perform the duties of any job for which your education and training qualify you). This may limit your ability to make a claim and may force you into a role that you do not want to take
  • Benefits may be capped
  • Benefits are taxable if the employer pays the premiums (unless the premiums are a taxable benefit to the employee, in which case the benefits would be tax-free)

If you already have group disability coverage, you may wish to consider supplementing that plan with your own individual policy.
Protecting Assets against Taxation

You spend great efforts creating your financial plan and building your investment portfolio; it is worth protecting it from the eroding effects of taxation. This is especially critical for registered investments like RRSPs and RRIFs that become fully taxable on the death of a surviving spouse. Taxation concerns extend beyond your retirement assets; other investments or valuables, such as the family cottage, may be subject to capital gains tax.

The funds received from the payout of an insurance policy are tax-free. Tax-free insurance proceeds are immediately available on death and provide the funds to pay taxes at that time. In the absence of using tax-free insurance, beneficiaries may have to consider either selling the estate assets or borrowing funds necessary to pay taxes owing on the estate.

Creating a Tax-Free Wealth Transfer

Once you have a financial plan that ensures preservation of your income and addresses your investment goals, you may want to consider shifting a portion of your assets to a tax-exempt environment. With a Tax-Exempt Insurance policy, you can maximize the value of your estate and the value of your assets at death since the assets accumulate within a contract, free of annual accrual taxation. Part of the policy premium will pay for the cost of the insurance and the rest will be invested, allowing the policy’s ultimate benefit to grow through the years. Tax-exempt life insurance shares certain characteristics with other types of investments, however no other asset allows for all of the following:

  • Tax-deferred growth, much like within your registered pool of capital
  • Potential for tax-free income during retirement
  • Tax-free distribution on death
  • The Cost of Longevity

Many Canadian investors are retiring earlier and living longer than in previous generations. Although a longer retirement is appealing when thinking of all that you want to do and accomplish, a longer retirement adds to the risk that, at some point, you will need major financial resources to maintain your health and quality of life. Fortunately, there are two insurance solutions that can help.

Critical Illness (CI) insurance can provide you with a tax-free lump sum if you are diagnosed with a covered medical condition, such as heart attack, stroke, or cancer, among others. Premiums are reasonable, and this type of coverage could prove invaluable if a serious illness strikes.

Long Term Care (LTC) insurance specifically addresses the costs associated with receiving care at home or in a facility. With facility-based long-term health care costs across Canada ranging from about $15,000 per year to over $65,000 per year and financial support from governments shrinking, this type of protection can ensure quality care without placing undue pressure on family members.
Reducing the Risk

Although risk is an inevitable part of investing and life, much of that risk can be minimized through employing insurance solutions as integral components in your financial plan – by protecting income, minimizing taxes, preserving estates, and caring for your health.