It could mystify you almost as much as a Luc Langevin number. The concept: use a life insurance policy to generate tax-free retirement income.
Yes, life insurance can sometimes help a retiree to make ends meet.
Please note: the product is not originally designed for this purpose. Beware if an advisor pushes this argument, because if you’re looking to save for retirement, there’s a whole lot better than insurance.
Surrender value as collateral
This strategy involves whole life insurance with a cash value attached to it. Everything revolves around it. This option makes it possible to recover before his death a more or less significant part of the money paid over time into the policy. As soon as it is invoked, the insurance is cancelled.
The surrender value is only accessible after several years, and its withdrawal is generally accompanied by a tax bill (it will depend on the moment chosen to recover your money).
The strategy in question is not to cash it in, but to borrow up to 90% of the cash value from the bank, offering it as collateral. The financial institution will reimburse itself with the death benefit of the life insurance, once the client has left for his final resting place.
It’s somewhat the same principle as with the home equity line of credit that we use to finance some retirement projects. In this case, you borrow against the mortgage-free value of your property (which serves as collateral), and the lender will get back your money and the interest when the house is sold.
But where is the problem with insurance?
Your need for insurance
Unlike real estate that provides accommodation, permanent life insurance meets a specific need: estate optimization. We should not subscribe to it without first having the certainty of dying with well-stocked bank accounts. It is a niche product for the wealthy.
If you’re being offered whole life insurance for use in retirement, that’s questionable. You must first have an estate need, so have a lot of money. And if so, the use of insurance during retirement should be unnecessary.
The strategy therefore results from poor planning at the start or from a reversal of fortune.
“Borrowing on the cash value is at best a plan C or D. We will use it to help a client carry out a project, for example the acquisition of a recreational vehicle. Before, we will explore other possibilities, “explains Caroline Désy, financial security advisor at BGY, integrated financial services.
It is that the approach is not without risk. In certain circumstances (interest rate hike, loan approaching the value of the guarantee, in particular), the financial institution can recall the loan. Without the cash to repay, the client must then cash out the cash value, which comes with a tax bill and ends the insurance policy.
The pensioner then comes out the loser. Caroline Désy rules out this strategy if the policyholder does not already have sufficient resources to settle the loan without having to use the surrender value.
So it’s a plan C or D for people of means. Not plan A for the average person.
REAL INSURANCE NEEDS
- 95 % life insurance needs are met by term life insurance, which is much less expensive.
- The term life insurance death benefit is used to replace the loss of income resulting from the death of a breadwinner.
- In certain circumstances, permanent life insurance can be used to pay taxes at death on illiquid assets in which capital gains have accrued, such as a cottage or income property.