Our content team reviewed the Financial Consumer Agency of Canada’s life-insurance guide, section 148 of the Income Tax Act, and the Canada Revenue Agency’s RRSP guidance to examine how IRPs work.
An IRP can use one of three ways to access the cash value of permanent life insurance contracts for supplemental retirement cash flow. An IRP is a strategy, not a registered plan; this guide explains:
- How they’re taxed as described in detail in the Income Tax Act
- How they compare to RRSPs, TFSAs and other strategies
- The plan and loan considerations that should be stress-tested before implementation.
Is An Insured Retirement Plan Right For You?
Generally speaking, an IRP should not be your first and only retirement strategy.
Consider an IRP and consult a specialist if you need permanent life insurance; have reliable excess cash flow to confidently fund long-term insurance premiums; have made appropriate use of your registered accounts; and can comfortably manage investment, policy, lender, and tax risks.
An IRP is a poor fit if you have a temporary life insurance need; the premium could strain your budget; you may need early access to the policy’s funds; the plan depends on favourable borrowing costs, insurance company dividends, or investment returns. A low premium alone is not the deciding factor.
How An Insured Retirement Plan (IRP) Works
- You buy a permanent life insurance policy because you have a permanent insurance need, not just because you want to save some money. Then, you fund the policy according to the terms of your contract.
- At retirement, you might be able to tap the policy’s value for retirement funds either via withdrawals, loans from the insurer, or third-party loans using your policy as collateral. All have their own risks.
- Upon your death, the insurer will pay the death benefit per your contract. Outstanding policy borrowing or a lender’s security interest can reduce what remains for beneficiaries.
- Different products have different charges, guarantees, dividends, investment options, etc. Non-guaranteed values may not match the illustration you were shown when you bought the product. Request updated, or in-force, illustrations to check whether the policy remains on track.
Read More: See How Whole Life Insurance Works
Three Ways To Access The Policy Value
| Access route | What happens | What you must verify |
|---|---|---|
| Withdrawal or partial surrender | Cash is removed from your policy, which can reduce policy values or coverage. | Be sure to verify any taxable policy gain, surrender charges, and the value(s) left in the policy and future premium needs. |
| Insurer policy loan | Accrued interest may be paid or added to the loan. Loans are made by the insurer according to the provisions of the contract. | Available amount, loan rate, adjusted cost basis, when the policy will lapse, reduced death proceeds. |
| Third-party collateral loan | The bank or other lender takes security over your policy and makes an independent loan to you. | Approval process/criteria; interest rate terms; renewal; collateral margins; terms of recourse; lenders’ rights on death. |
Generally speaking, a policy loan will be treated as a disposition of the policy, pursuant to Section 148 of the Income Tax Act, so taxable income can arise to the extent that the loan exceeds the policy’s adjusted cost basis.
A loan taken out using the collateral assignment will initially receive different tax treatment. However, this doesn’t make the full strategy guaranteed or cost-free.
Tax advice should be sought to determine the tax consequences of any action relating to a life insurance policy, as the consequences are policy-, ownership- and loan-route-specific.
Read More: See How Borrowing Against Life Insurance Works in Canada
IRP Vs RRSP And TFSA: What Is Actually Comparable?
| Feature | RRSP | TFSA | IRP strategy |
|---|---|---|---|
| Primary purpose | Its primary purpose is registered retirement saving. | Flexible tax-free saving | Involves permanent insurance coverage with the possibility of being able to access monies at a later date. |
| Contribution treatment | If within your deduction limit, a deduction may be taken under an RRSP. | Contributions made when there is TFSA contribution room available. Contributions are not tax deductible. | Premiums paid under an IRP strategy generally aren’t a personal tax deduction. |
| Access | Removing money from an RRSP is typically taxable. | Amounts that are eligible for withdrawal are not taxable and your TFSA contribution room will be reinstated on January 1 of the next calendar year. | Access depends on a withdrawal, policy loan or collateral loan. |
| Main risk | Investment and tax-on-withdrawal risk. | Involves investment risk. | Risks include policy performance; policy charges; tax implications; cost of borrowing; lapse risk; lender access. |
| Best comparison | Compare after-tax retirement income. | Compare after-tax accessible value. | Compare guaranteed and non-guaranteed policy values after premiums and loan costs. |
Although the answer to which of these financial planning accounts should come first varies from individual to individual, an IRP proposal should explain why an RRSP, workplace benefits, TFSA, or other regular investment account couldn’t accomplish the goal more simply.
Read More: Test Whole Life Insurance Against RRSP and TFSA Options
Personal And Corporate IRPs Are Not Interchangeable
While a corporation can own and fund life insurance policies, shifting policy ownership to a corporation can have significant tax, creditor protection, shareholder-benefit, accounting, and estate-planning implications.
Do not use a personal illustration as a corporate strategy. And don’t describe a corporate loan plan as equivalent without coordinated tax and legal advice.
Stress-Test The Loan Before Calling It Retirement Income
Take a quick example. Suppose you borrow $30,000 at the end of every year for 15 years and don’t pay the interest. At 4%, after 15 years, you’d owe about $600,700. At 6% interest, you’d owe about $698,300. And at 8%, you’d owe around $814,600. That’s the power of compounding.
This is only a loan-compounding example. We’ve ignored premiums, policy growth, charges and lender fees, taxes, changes to available collateral, etc.
Test your loan balances against the guaranteed policy values and death benefit in the same year. Stress-test by skipping premium payments, assuming lower-than-expected returns or dividend rates, or assuming you can’t get a renewal from your lender.
Read More: Compare an Insured Retirement Plan With Infinite Banking