Personal Finance

Winnipeg Free Press - PRINT EDITION

Insured annuity offers choice

Weigh the pros and cons of investment vehicle

By: Terry McBride

Posted: 12/12/2009 1:00 AM | Comments: 0 (including replies)

WITH interest rates at historic lows, people who live off their GIC interest face cuts in spending levels. In many cases, they do not want to touch the principal. They want to leave the GIC principal to their children when they die.

How can you increase cash flow without getting into risky investments? As one solution consider an "insured annuity." This involves two insurance contracts.

"ö Prescribed annuity

The first contract is a prescribed life annuity. A simplified example: You have $100,000 to invest. Depending on your life expectancy, you would receive a fixed annual payment for the rest of your life. Suppose the annuity pays $8,000 per year. Each annual payment consists of a blend of $2,000 interest and $6,000 principal. When you die, the life annuity stops. The value at death is zero.

"ö Life insurance policy

The second contract is a Term-to-100 life insurance policy.

When you die the policy pays $100,000. Suppose the premiums are $3,300 a year. You would pay the premium using the cash from the $8,000 yearly annuity payments. That leaves $4,700 per year.

Because you are in a 35 per cent tax bracket, you pay $700 tax on your $2,000 interest component. That provides you with roughly $4,000 to spend per year.

"ö GIC

How does that compare to a GIC? Assuming you earn three per cent interest, you would receive $3,000 from your $100,000 GIC. After tax you'd have roughly $2,000 GIC interest left to spend per year.

Let's review the pros and cons of an insured annuity.

Pros -- You can receive more net cash flow with the insured annuity -- for two reasons. You receive a significant, regular return of capital. As well, taxable interest constitutes a smaller portion of each prescribed annuity payment.

Unlike a GIC that matures periodically, you have no re-investment decisions with an insured annuity.

As long as you keep paying your life insurance premiums, you guarantee your family will receive $100,000. Like the principal of the GIC, the life insurance death benefits are tax-free.

As a bonus, you avoid probate costs when death benefits from the life insurance bypass your estate to go directly to the beneficiaries that you designate. Even if your will is contested, the life insurance death benefit is paid to your designated beneficiaries without any fuss.

Cons -- You must pass a basic physical exam to be insurable. Poor health could mean you cannot obtain a life insurance contract at standard rates. Start with the life insurance application. After the insurance is approved, then buy the life annuity.

The main risk with insured annuities is an elderly policyholder could forget to pay the insurance premiums. Put a system in place to ensure insurance stays in force.

Your annuity capital is locked in for life, so you cannot withdraw lump sums. The purchasing power of fixed annuity payments is vulnerable to inflation.

Canada Revenue Agency could possibly view the insurance and annuity to be one bundled contract if they are underwritten together by the same life insurance company. You could lose favourable tax treatment, so buy the annuity and life insurance from two different insurance companies.

What if a life insurance company fails? Assuris (formerly known as the Canadian Life and Health Insurance Compensation Corp.) provides certain guarantees to protect you like CDIC does for GICs.

A risk-averse investor in good health with plenty of non-registered savings may wish to buy an insured annuity using a portion of those savings.

In the right circumstances the insured annuity can provide superior risk-free, after-tax cash flow compared to a GIC, while guaranteeing a legacy for heirs.

Terry McBride is a member of Advocis (The Financial Advisors Association of Canada). This article provides general information and should not be considered personal investment or tax planning advice.

-- Canwest News Service

Republished from the Winnipeg Free Press print edition December 12, 2009 B15

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