Life Insurance As An Asset Class

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Park
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Life Insurance As An Asset Class

Post by Park » 03 Apr 2015 00:08

I'm sceptical of insurance for investing purposes. However, the link below raises the possibility of using corporate owned life insurance as a fixed income alternative:

http://www.camagazine.com/archives/prin ... 73814.aspx

The second link is about personally owned life insurance as a fixed income alternative:

http://business.financialpost.com/inves ... educe-risk

Comments are appreciated.

Addendum:

The link below gives a dissenting view about corporate owned life insurance as a retirement vehicle:

http://issuu.com/justforcanadiandoctors ... 026e75cb7c

Go to page 21: the article is "Looking Into Life Policy" by Manfred Purtzki.
Last edited by Park on 03 Apr 2015 02:21, edited 1 time in total.

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Re: Corporate Owned Life Insurance

Post by DmDave » 03 Apr 2015 01:11

The thing you're talking about, I believe, is called universal life insurance. It has both an investment and insurance component.

I had one myself, when my mother didn't know any better and bought them for use when we were younger. We weren't very financially literate and fell for the salesperson's pitch of how this money will grow tax free, managed by Manulife MF advisor, and how I can withdraw the money out tax free through some voodoo accounting magic.

I've been paying it myself for about 4-5 years after I had it transferred into my corporation, and finally overcame my inertia, cashed out the policy last year and paid the tax bill. Like Purtzki said, it's a complicated product and not easily understood, and it's not for everyone. High networth individuals who don't have any RRSP, TFSA, or RESP room left and is looking for ways to defer tax may benefit from the tax-free nature of it. But there really is no point when you're just starting out your MD career.

The better option is to use the premium for said life insurance, buy a term life insurance policy and invest the rest in index funds/ETF's.

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Re: Life Insurance As An Asset Class

Post by Park » 03 Apr 2015 02:24

The more I did an internet search on this topic, the more I came to the conclusion that my question was really whether life insurance was an asset class. The link below says it is, and that life insurance can be an option for fixed income. I'm still sceptical.

http://www.advocis.ca/pdf/Forum/June201 ... -Class.pdf

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Re: Life Insurance As An Asset Class

Post by kcowan » 03 Apr 2015 06:41

Some old participating whole life policies paid cash dividends and would qualify. But any others are really illiquid fixed assets.

You can make a loan just like a reverse mortgage on a house. And you can recover cash value like selling a house. it can be counted as fixed for estate valuations just like a house. Just not in net worth calcs.
For the fun of it...Keith

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Re: Corporate Owned Life Insurance

Post by ghariton » 03 Apr 2015 11:41

DmDave wrote:The better option is to use the premium for said life insurance, buy a term life insurance policy and invest the rest in index funds/ETF's.
+ 1

I have long believed (ever since I worked three summers for Sun Life) that the insurance industry's administrative and sales expenses are excessive. Purchase what you need for them (insurance coverage) but no more. In particular don't let them invest for you.

That said, our tax laws favour life insurance payouts and so it may well have a place in estate planning. But I personally prefer giving my money away while I'm still alive.

George
The plural of anecdote is NOT data.

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Re: Life Insurance As An Asset Class

Post by Penquin007 » 04 May 2015 21:11

Permanent life insurance is popular investment strategy among incorporated doctors:
https://mdm.ca/wealth-management/insura ... imization/


It is also recommended as an alternative to fixed income inside taxable accounts by some advisors like Jamie Golombek:
http://lsminsurance.ca/life-insurance-c ... s-golombek
http://www.theglobeandmail.com/globe-in ... cle555062/

As a general rule, HNW (High Net Wotrh )clients don’t need life insurance as they most likely have more than enough wealth to satisfy any risk liability. That being said, I always bring up the topic of insurance with each HNW family as it’s a wonderful way to shelter annual investment income from annual taxation. Of course, I am referring to permanent insurance, generally universal or whole life, which is designed to last throughout the client’s life and often contains an investment component allowing the HNW client to build up cash values inside the policy in a tax-sheltered manner. The client also has the ability to surrender the policy prior to death to access its cash surrender value (CSV). The accumulation of wealth inside a nontaxable permanent insurance policy combined with the tax-free death benefit can produce far superior returns on an after-tax basis than nearly any fixed income portfolio, making this solution a primary recommendation for HNW clients with any bonds or other fixed-income investments in their portfolios.

Jamie Golombek, Tax and Estate Planning For High Net Worth Clients
(https://www.mdrtstore.org/p/3986/tax-an ... th-clients)


It is also recommended by some advisors for Business Owners:

https://www.cibcwg.com/c/document_libra ... upId=93180
Last edited by Penquin007 on 05 May 2015 06:03, edited 1 time in total.

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Re: Life Insurance As An Asset Class

Post by Penquin007 » 05 May 2015 05:43

Corporate-owned permanent life insurance
If you need to hold fixed-income investments within your corporation, investing your corporate assets within a corporate-owned permanent life insurance policy
(such as a universal life insurance policy) can provide multiple benefits. First, the money invested within the policy is allowed to grow on a tax-deferred basis, rather than being subject to the high tax rates on corporate investment income. Second, you can pay the policy premiums using the corporation’s after-tax dollars, which is generally more cost effective than using your own personal after-tax dollars. Finally, the death benefit proceeds of the policy can eventually be paid out to your surviving shareholders with little or no tax—a very effective estate planning strategy.
Investing wisely in your corporation, MD Management
https://mdm.ca/multimedia/pdf/investing ... tion-e.pdf

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Re: Life Insurance As An Asset Class

Post by Park » 06 May 2015 08:32

Thanks for pointing this out Penquin. Although I'm very far from an insurance expert, life insurance as a fixed income asset class is intriguing.

From page 144 of Lifecycle Investing by Ayres and Nalebuff, "Few insurance products operate with less than 30% overhead and profit margin." When you look at segregated funds, their expenses are not low. Under those circumstances, the potential of life insurance to outperform conventional fixed income shows how significant taxation is on conventional fixed income.

You are taking on liquidity risk, when you use life insurance as fixed income. I've read about the buckets approach to retirement planning, and I see fixed income as a way to fund retirement during bad years of the stock market. As pointed out previously, if you use life insurance as fixed income, this is money that you intend to pass on as an inheritance. One could make the case that if that is the goal of the money, why not put it in stocks, where expected return would likely be greater and it's a more tax friendly asset? About the following, those who are more knowledgeable about insurance, please correct me. This type of life insurance makes more sense if you buy it when you're comparatively young. As an extreme example, I assume life insurance bought at 30 is much cheaper than life insurance bought at 80. If you buy life insurance at 80, fixed income may outperform stocks by the time your inheritors receive their money. But that's much less likely at age 30. Perhaps life insurance can also outperform stocks, although that would be more difficult.

You are taking on credit risk, when you use life insurance as fixed income. One view of fixed income is as the ballast of your portfolio, and I tend to agree with that. If you use life insurance as fixed income, you're assuming the credit risk of the insurance company. If the insurance company runs into financial trouble, insurance companies have a mechanism to deal with that.

http://lsminsurance.ca/life-insurance-c ... -insurance
https://www.retirementadvisor.ca/retadv ... u=articles

But this mechanism doesn't guarantee that all your money will be protected. And it's an industry mechanism, with no government backing. Finally, financial problems with life insurance companies are most likely going to occur around the same time that stock markets are doing poorly. Think AIG.

It may not be easy to diversify your credit risk.

The assumption of using life insurance as fixed income is that the tax advantages of life insurance will persist. Since life insurance as fixed income, looks like it's a long term investment, that becomes more uncertain with time. If the use of life insurance as fixed income becomes popular enough, the government may change the rules. Remember income trusts.

The information from CIBC Wood Gundy is interesting, but I sense it's goal is marketing, as there's only a discussion of the positives but not the negatives. Jamie Golombek implies that if you invest this way, you don't need income from the life insurance. The link from CIBC Woody Gundy shows that you can get income from this product, and it looks like you do it by taking a tax free loan advance. From what I can see, the calculations in the link assume a 4% interest rate on that advance. So if you use the life insurance as a source of income, you're taking on interest rate risk. The CIBC Woody Gundy publication looks like it's from 2014, when the highest rate for a margin loan from IB was 2.5%. Also, as you advance in years and take out more loan advances, you become more levered. Leverage is the equivalent of negative fixed income, so that would decrease overall fixed income exposure in your portfolio. Becoming more levered as one gets older in retirement doesn't sound like a good idea.

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Re: Life Insurance As An Asset Class

Post by Penquin007 » 06 May 2015 20:10

The argument of using permanent insurance as Fixed Income alternative seems stronger for Business owner with excess funds, as a way to optimize their "after tax" total estate value:

https://www.sunnet.sunlife.com/files/ad ... 0-3968.pdf

https://www.sunnet.sunlife.com/files/ad ... helter.pdf

https://www.sunnet.sunlife.com/files/ad ... Part_I.pdf

https://www.sunnet.sunlife.com/files/ad ... xation.pdf

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Re: Life Insurance As An Asset Class

Post by Penquin007 » 06 May 2015 20:20

Borrowing against the policy’s cash value is an alternative to taking cash withdrawals. The corporation could take a policy loan or borrow money from a financial institution using the policy to secure the loan. Alternatively, the shareholder could borrow the money personally, and have the corporation pledge the policy as security for the loan. But these alternatives all create tax issues. Some or all of a policy loan will be taxable if the loan amount exceeds the policy’s adjusted cost basis, and the entire proceeds will be taxed as a dividend when paid to the shareholder. Third party loans are not treated as income to the borrower, but still raise tax issues. If the corporation borrows the money from a financial institution, the borrowed money will not be treated as income to the corporation or to the shareholder. But the corporation will only be able to pay the money to the shareholder as a taxable dividend. A shareholder can avoid the dividend issue by borrowing directly from the financial institution, using the corporation’s life insurance policy as collateral security for the loan. The borrowed money will not be treated as income for the shareholder. But unless the shareholder pays a reasonable guarantee fee to their corporation, the Canada Revenue Agency (CRA) will treat the corporation’s willingness to let its policy secure the shareholder’s loan as a taxable shareholder benefit.4 Shareholder benefits are taxed as income to the shareholder, with no deduction to the corporation.
Further drawbacks are that the right to borrow money may not be available until policy cash values have grown, interest will be payable on the borrowed money, and loan interest rates will usually exceed the policy cash value growth rate. Further, a loan from a third party financial institution will be a demand loan – repayment could be required at any time – and the interest rate may fluctuate. While policy loans are not subject to these drawbacks, over time, the tax cost of a policy loan could equal or outweigh the tax that would have been paid on a withdrawal. All in all, a shareholder should consider the CIS strategy only when they are sure that they or the corporation won't need any money from the policy during the shareholder’s lifetime.
https://www.sunnet.sunlife.com/files/ad ... helter.pdf

Park
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Re: Life Insurance As An Asset Class

Post by Park » 09 May 2015 19:41

http://www.advisor.ca/images/other/ae/a ... glight.pdf

Moshe Milevsky wrote the article above in 2004. My conclusion from that article is that he sees permanent insurance as an investment if the following conditions are met:
-the money would otherwise go in taxable fixed income
-if the top personal tax rate is relevant to you
-you've used up other tax shelters (RRSP, TFSA)
-you need the insurance

Under those circumstances, he implies that it would be acceptable not to keep the policy until death, although he prefers borrowing against it to cashing it in.
Last edited by Park on 09 May 2015 22:13, edited 1 time in total.

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Re: Life Insurance As An Asset Class

Post by Park » 09 May 2015 21:59

Insurance Logic by Moshe Milevsky and Aron Gottesman 2002

p. 26-34 is relevant
makes a case for insurance as an alternative to taxable fixed income
should be in top personal tax rate
should have used up RRSP, RESP, TFSA etc.
appears to believe taking a loan against the policy is OK - tax free income, on the assumption that the interest rate on the loan is less than or equal to the rate at which your assets are growing inside the insurance policy

"You might be inclined to buy a lot of whole life insurance that you don't really need for protecting your human capital, just to gain access to the tax-free inside build-up. And we can't really argue with that. On a pre-tax basis it would be silly, but on an after-tax basis - especially if you are paying close to 50% on each additional dollar you earn - this strategy can be a godsend....We certainly consider them as a viable savings strategy."

"Life insurance is one of the last remaining tax shelters and might be even more powerful than an RRSP in building tax-favoured wealth. Therefore, even people who don't have the motive of human capital protection for purchasing life insurance might do so for tax purposes."

"When you are buying an insurance policy for tax reasons, make sure an expert has gone through the numbers carefully so that you will not lose in commissions and fees anything you might gain in tax savings. And do make sure to compare the returns you are getting - on an after-tax basis - to a low-cost index fund."

There's a list of questions to ask when purchasing life insurance, and the following is relevant to this topic:

"Do I have a guarantee that I can borrow against the cash value of the life insurance policy at a reasonable rate?"

P.S. The interest on the loan backed up by the policy is not tax deductible.

P.P.S. About tax free income from a policy, it will avoid benefit clawbacks.
Last edited by Park on 10 May 2015 00:22, edited 1 time in total.

Park
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Re: Life Insurance As An Asset Class

Post by Park » 10 May 2015 00:04

http://www.cibcwg.com/c/document_librar ... ersion=1.0

Some of the above link is relevant to the question of insurance as an investment

http://www.theglobeandmail.com/globe-in ... e21798724/

Tim Cestnick, a small section of getting life insurance on your children/grandchildren.

http://www.waterstreet.ca/data/tim-cesn ... ck-209.pdf

A Cestnick article from 2001 on getting life insurance on your children/grandchildren ("cascading insurance").

http://www.waterstreet.ca/data/tim-cesn ... ck-687.pdf

http://www.waterstreet.ca/data/tim-cesn ... ck-689.pdf

http://www.waterstreet.ca/data/tim-cesn ... ck-585.pdf

http://www.waterstreet.ca/data/tim-cesn ... ick-80.pdf

http://www.waterstreet.ca/data/tim-cesn ... ick-97.pdf

http://www.waterstreet.ca/data/tim-cesn ... ck-495.pdf

http://www.waterstreet.ca/data/tim-cesn ... ck-873.pdf

Some other links from Tim Cestnick on insurance.

https://www.sunlife.ca/files/plan/engli ... 0-2882.pdf

p 20-22 has some relevant information on accounting and taxation of corporate owned life insurance.

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Re: Life Insurance As An Asset Class

Post by Park » 10 May 2015 21:01

I have come to the conclusion that permanent life insurance can be an effective estate planning tool to increase the amount you leave to your children, grandchildren or charity.

It is reasonable under the following circumstances:
-you have used up other tax shelters, such as TFSAs, RRSPs etc.
-the money paid for insurance would otherwise go in taxable fixed income
-the top marginal tax rate is relevant to you
-you do not intend to use the life insurance policy in the future to income

You are taking advantage of the tax sheltered growth inside permanent life insurance, and the tax free nature of a death benefit.

A joint last to die policy probably makes most sense.

As for insurance on children, such as cascading insurance, it could be considered if the need for tax sheltering is great.

As to whether permanent life insurance should be held by the individual or corporation, there are pros and cons.

Life insurance paid by a corporation will cost less.

OTOH, life insurance held by a corporation will not have creditor protection, may be more difficult to generate income from, might adversely effect the small business deduction for very large corporations, and might have a potentially negative impact on the lifetime capital gains exemption. Finally, the corporation will have to pay capital gains tax on the cash surrender value of the permanent life insurance policy at the time of death. From what I can see, what is written in the last sentence does not apply to individuals holding permanent life insurance.

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Re: Life Insurance As An Asset Class

Post by Penquin007 » 11 May 2015 21:52

Park wrote:Insurance Logic by Moshe Milevsky and Aron Gottesman 2002
(...).
@Park: Do you have a link for this article from M. Milevsky and A. Gottesman?

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Re: Life Insurance As An Asset Class

Post by Park » 12 May 2015 01:17

Penquin007 wrote:
Park wrote:Insurance Logic by Moshe Milevsky and Aron Gottesman 2002
(...).
@Park: Do you have a link for this article from M. Milevsky and A. Gottesman?
It's a book.

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Re: Corporate Owned Life Insurance

Post by Park » 12 May 2015 02:08

ghariton wrote:That said, our tax laws favour life insurance payouts and so it may well have a place in estate planning. But I personally prefer giving my money away while I'm still alive.

George
The more I think about it, the more sense it makes to give your money away while alive. A death benefit is tax free to the recipient, but so is a gift. The gift may not be tax free to the giver, unlike insurance, but this is less of an issue with charity donations. Even with gifts to family members, there are ways to minimize tax on money that is given. Investments can grow tax free in permanent insurance, but such investments also have a 30% headwind. With money that you intend to give, there are ways to invest which may not be tax free, but are tax efficient. Until you give the money, income from that money is much easier than with insurance. If you give from a corporation, there's no cap gains tax on the CSV when you die. There's much greater liquidity with a gift strategy. And credit risk can be much less of an issue.

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Re: Life Insurance As An Asset Class

Post by Park » 12 May 2015 08:20

About life insurance as an asset class, it has two purposes: it can provide income during retirement and it can increase the amount you give to others. .

About the goal of income, the following is from Sun Life:

"A shareholder who anticipates needing money from their holding company may want their own company to own taxable investments instead of life insurance...All in all, a shareholder should consider the CIS strategy only when they are sure that they or the corporation won't need any money from the policy during the shareholder’s lifetime."

https://www.sunnet.sunlife.com/files/ad ... helter.pdf

Such statements, from a leading insurance company, should make an individual think carefully before using life insurance to provide income.

Life insurance can increase the amount of money that you can give to others. However, life insurance will not increase what you can give before you pass away, but only after you pass away. There are tax advantages to using life insurance, but there are increased costs and decreased flexibility. Even those who advocate life insurance as a way to increase what you give, consider it a fixed income substitute. If you have a more than a 10 year time horizon and are an astute investor, stocks will very likely be a better choice than fixed income. As a fixed income substitute, life insurance makes the most sense in the last 10 years of your life. But permanent life insurance in the last 10 years of your life won't be cheap.


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Re: Life Insurance As An Asset Class

Post by Feddar » 15 Jan 2016 07:50

Park wrote: the following is from Sun Life:

"A shareholder who anticipates needing money from their holding company may want their own company to own taxable investments instead of life insurance...All in all, a shareholder should consider the CIS strategy only when they are sure that they or the corporation won't need any money from the policy during the shareholder’s lifetime."

https://www.sunnet.sunlife.com/files/ad ... helter.pdf
This totally contradicts the salesmen I have been speaking with. In fact, it goes against the very reason for my interest in this product. I find this rather disturbing. I will give this to them to respond to.

Thanks.

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Re: Life Insurance As An Asset Class

Post by OptsyEagle » 16 Jan 2016 14:30

What did the salesman say to you?

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Re: Life Insurance As An Asset Class

Post by Feddar » 17 Jan 2016 08:13

He said he would get their tax lawyer to call me. I'll keep you posted.

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Re: Life Insurance As An Asset Class

Post by Feddar » 28 Jan 2016 21:32

So, one salesman just kept on sending me advertising and ignored the question entirely. He's out!

The other gave me a good explanation. He said that you can take out the amount deposited into the policy above the premium, tax-free. Beyond that, you have to pay taxes. But because the money was in there, compounding tax-free, the increase in value would be better, in the end, than if you had paid taxes initially, and then compounded with taxable returns.

It makes sense, and I agree with that. But I still don't understand why Sun Life would make the statement "All in all, a shareholder should consider the CIS strategy only when they are sure that they or the corporation won't need any money from the policy during the shareholder's lifetime".

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Re: Life Insurance As An Asset Class

Post by brucecohen » 29 Jan 2016 09:56

Feddar wrote: The other gave me a good explanation.
No he didn't. He just gave you bafflegab. Here is a Canada Life brochure that you might find useful and here is an FP article you might find cautionary. In a nutshell, you get to withdraw tax-free an amount earmarked to pay for the underlying insurance -- and if not done carefully such a withdrawal can reduce the life insurance coverage. FWIW, permanent life does tax-shelter until death interest that would otherwise be taxed if earned outside. So there is a value from tax-sheltered compounding -- theoretically. The problem is that in today's low-rate environment it's possible or even likely that the higher MER and any other fees can offset the value of that compounding. Meanwhile, remember that an equity investment held outside an insurance policy can compound "tax-free" until you sell it.
But I still don't understand why Sun Life would make the statement "All in all, a shareholder should consider the CIS strategy only when they are sure that they or the corporation won't need any money from the policy during the shareholder's lifetime".
Have you read this and this? In a nutshell, the only time that money earned inside a life insurance policy can be withdrawn tax-free is when the insured dies and the earnings become part of the tax-free death benefit.

FWIW, if you own an incorporated company you have an accountant. This insurance proposal is entirely tax-driven. So if your accountant can't understand the proposal, relate it to your own situation and explain the pros and cons, why would you bother considering it? Remember that the insurance agent has a vested interest in selling the plan; your accountant has a vested interest in meeting your ongoing needs.

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Re: Life Insurance As An Asset Class

Post by SLeazebag » 29 Jan 2016 10:50

"FWIW, permanent life does tax-shelter until death interest that would otherwise be taxed if earned outside. So there is a value from tax-sheltered compounding -- theoretically. The problem is that in today's low-rate environment it's possible or even likely that the higher MER and any other fees can offset the value of that compounding. Meanwhile, remember that an equity investment held outside an insurance policy can compound "tax-free" until you sell it. "

It's funny that the life insurance salespeople and the life insurers themselves don't typically mention the 15% investment income tax that the life insurer must pay annually on the investment income build-up deemed to occur within a life insurance policy. :roll: The life insurer charges this tax back to the policyholder in one way or the other. So the compounding shelter within a life insurance policy is not really "tax free". There is a tax being paid annually albeit at a lower tax rate than what the policyholder would otherwise be subject to if the interest were instead to be earned outside the policy.

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