How To Use Life Insurance For Retirement

One of the biggest advantages of owning your own company is the ability to deduct business expenses so you are paying those expenses with pre-tax dollars. But what many entrepreneurs don’t realize is that although there are many things that are not deductible, there is still a big advantage if you buy them in your corporation.

So instead of buying life insurance with your personal (after-tax) income, you can purchase it through your corporation with (after-tax) income which has been taxed at a much lower rate. 

Should you use life insurance as an investment vehicle and a retirement tool? In this article, we share some insights to help you arrive at a conclusion. 

Benefits Of Using Life Insurance As A Retirement Tool 

There are two main situations when life insurance is a powerful tax-efficient investment tool:

  •  Life insurance is a tax-efficient way to shelter some money

In 2018, a new passive income rule came out that may have caused you to have to pay more income taxes in your business. But life insurance is not taxed like other investment tools, you can have investments growing inside your life insurance policy at a tax-deferred rate. 

  •  Life insurance allows you to take money out of your corporation tax-free

There is something called the Capital Dividend Account or CDA. It is a notional account in our accounting system that allows business owners to take money out of their corporation tax-free. There are two ways to accredit the CDA account: through capital gains investments, and through life insurance. 

How To Build A Retirement Fund Inside Your Life Insurance 

You can build a retirement fund inside your life insurance through Cash Value Policies. In Canada, there are two types of Cash Value Policies: Universal Life and Whole Life

The great thing about these cash value policies is that they allow for tax-deferred growth, which means that any money grown inside these life insurance policies is tax-free. 

At Ocean 6, we have a proprietary process called the Blueprint, which helps business owners and incorporated professionals get clarity and confidence in their financial plan. In Step 5 of this Blueprint process, we deep dive into how to invent your retirement plan, using tools like life insurance, to create an effective retirement plan for you. 

Three Ways To Access Cash From Life Insurance For Your Retirement Income

1. Through a direct withdrawal

This is the very first thing that you can do – to take out your cash by withdrawal. However, this is the most tax-inefficient way to take money out of your life insurance policy. Remember, money grows in a tax-free fashion but cannot be withdrawn tax-free. It means that you and your corporation will be taxed if you take out the money. At Ocean 6, we do not recommend this to our clients.

2. Through a policy loan

This is when you take out your policy and collateral against it with the life insurance company. One of the biggest benefits of doing this is you do not have to go through financial underwriting. There may be some financial questions that they may ask you, but generally speaking, these types of loans are not difficult to obtain. The disadvantage though is that it is at a much higher interest rate than the third option…

3. Through a collateral loan from a private bank 

This is the most effective way to lend money out of your life insurance. When you collateralize the cash value to a bank, you can negotiate for a much lower interest rate. You do have to go through some financial underwriting, but if you have the financial means to do so, you will win with a much lower interest rate. Another benefit of doing this is it will work as a line of credit. This way, you only pull out what you need to spend, rather than the whole thing and paying interest on the entire collateral loan. 

Other options available from banks include the Immediate Financing Agreement (IFA) and the Insurer Retirement Plan (IRP). Both of these options utilize the same concept: collateralizing your cash value to a bank to take back the advantage of the money that is inside your policy. 

These are effective ways of accessing your cash because instead of paying income tax, you pay a little bit of interest. But in general, you will still win because the interest rates are far less than the tax rates that you will pay in Canada. 

How To Assess Your Life Insurance Needs

If you don’t yet have any life insurance or are wondering if you’re utilizing your current life insurance policy to its full benefit, here are some questions to ask yourself:

1. Start by reviewing your current financial plan and ask yourself if there is a need and a benefit for having life insurance. 

2. Take a look at your current life insurance policies. See if you can take advantage of the things that you have already built. Maybe you already have in your portfolio a whole life or universal life but have not realized that it can be used as a retirement fund. 

3. Take a look at your company. See if there is any investment capital that is sitting on and not being utilized. Take the time to review those and start putting the money towards your retirement plan. 

Life insurance, when used properly, can be the most tax-efficient tool that you have in your corporation. It is almost like having your tax-free savings account inside the corporation. 

If you want to learn how to use life insurance as an investment vehicle and a retirement tool, book a call and we’d be happy to run you through our full financial Blueprint process.

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