insurance

So you and your spouse have saved for retirement. Your financial picture is in order, and you have both decided to retire at age 60 with dreams of a long retirement.

If one of you passes away at age 70 instead of living to age 90, would you believe that it could cost your family \$580,000? You might think that dying younger would leave more for your family, but in many cases, the opposite is true.

This scenario takes place all the time, especially when the husband is several years older than the wife.

To see how and why this takes place, here is a fairly reasonable scenario for a newly retired couple with no company pensions:

Scenario 1 - Couple retires at age 60, and both live to age 90

Own a home worth \$600,000.

They have joint non-registered investments of \$150,000.

They each have a \$350,000 RRSPs and \$15,000 in TFSAs.

They are both taking CPP early, but are eligible for full CPP as they worked for many years.

They have no debt, and spend \$50,000 a year.

They have 2 children, and a first grandchild on the way.

Estate value of \$2.48-million, and total lifetime taxes of \$758,000 - based on 6 per cent annual investment returns, 4 per cent real estate returns, and 2.5 per cent inflation.

Scenario 2 - Same scenario as above, except the husband dies at age 70

We have lowered the annual expenses by 15 per cent - considering most expenses will still be in place, but there will be a deduction for food and clothing.

Estate of \$1.90-million, and total lifetime taxes of \$918,000.

So, how is it that if the husband dies at age 70, they end up paying \$160,000 more in taxes and leaving \$580,000 less to their estate?

Three Reasons:

1) With both spouses qualifying for full CPP, other than a small one-time survivors' payout (maximum \$2,500), there is no ongoing lift to CPP or OAS for this couple. Essentially, despite paying into it for so many years, there is simply a loss of \$15,000+ a year (after age 65). This has a large impact on the overall financial picture.

2) No ability to split income. When the RRSP rolls over, the minimum withdrawal all goes to one person. This loss of an ability to split income raises the tax bill every year. As an example, if a single person has an income of \$80,000, the tax bill will be almost \$9,000 higher than if a couple have \$40,000 income each - even though the household income is exactly the same.

3) Expenses don't get cut in half. While every situation is different, in most of these cases, the only expenses that really drop are food, some utilities and clothing. If the survivor stays in the same house, and ultimately leads an active retirement, the overall expenses usually will look similar to the 15-per-cent decline noted above.

Now that you understand this huge gap, what can you do? There are two possibilities.

The first is to send articles like this to your MP and MPP and ask for greater tax fairness for single seniors. The wonderful ability to split pension income means nothing to someone who has no one to split the income with. There could also be changes for those who receive no top up to OAS or CPP after a spouse passes away.

The second is to see if you can benefit regardless of the scenario. In the example above, if the 60-year-old couple decided to take out a permanent insurance policy that is "joint last to die," they would effectively eliminate this \$580,000 gap.

Here is an example of the effect.

The 60-year-old couple take out \$1-million of permanent insurance. They pay \$9,800 a year.

Because of their particular financial situation, the \$9,800 a year is easily covered without ever affecting their standard of living.

In the case of the husband passing away in 10 years, and the wife living another 30 years, we have the following:

With insurance:

Estate of \$2.37-million, and total lifetime taxes of \$737,000.

With no insurance:

Estate of \$1.90-million, and total lifetime taxes of \$918,000.

This is including the cost of insurance.

There is a \$470,000 larger estate, and \$181,000 less paid in tax.

What if we compare it to the initial ideal scenario where they both live to age 90:

Estate value of \$2.48-million, and total lifetime taxes of \$758,000

By using the insurance, you make up most of the \$580,000 gap outlined at the top.

This of course begs the question: What if you took out the insurance, and it turns out that you both live a long time, passing away at age 90?

With insurance:

Estate of \$3-million, and total lifetime taxes of \$543,000.

With no insurance:

Estate of \$2.48-million, and total lifetime taxes of \$758,000.

The couple ends up more than \$500,000 ahead, with significant tax savings. The reason is that they still benefit from the payout on the insurance (they put \$294,000 in and it pays out \$1-million), and they still are able to benefit from the government pensions and income splitting for all of those years.

By looking at this type of insurance policy, you can beat the government and its current system of financially punishing a family if a retiree passes away early.

Everyone must keep in mind their goals. For most people, the key goal is to ensure that they won't run out of money or be forced to meaningfully lower their standard of living. You may want to do a detailed financial plan to help show that this key goal is essentially covered for you (to do a high-level check to see if this goal is likely covered for you, use a retirement calculator. If that first goal is easily covered, then you move toward getting the most out of your other goals. These might be related to spending more on yourselves, giving more to others, minimizing taxes and/or leaving more for your kids or grandkids.

Depending on which of these are a priority for you, the insurance solution may be ideal. Like all planning, the time to ask these questions is now, hopefully before you face the significant financial and personal hit of spending your retirement as a widow or widower.