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Maxed out RRSP? Try a life-insurance strategy

The financial debate these days is whether to put money in an RRSP or a tax free savings account.

But what if you discovered another way – a strategy to invest a set amount every year (that you can comfortably afford) that would be guaranteed to double your money over time and most likely provide a return around 8 per cent, after tax, annually?

With this strategy, in your late working years or early retirement you would receive a tax free payout. This investment does not move up and down with the stock market or real estate market.

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Here is how it works:

•You have maxed out your RRSPs. This could be because your income is high and you have good savings, or you have a sizable pension contribution, or as a self-employed individual who receives dividends you have very little RRSP room to use, and your TFSA is maxed out.

•You have a parent or in-law, aunt or uncle, who is in reasonably good health for his or her age, and is somewhere between 60 and 80. Reasonably good health means no recent or current cancer, heart attacks or strokes or other major diseases.

•You take out a permanent insurance contract on this individual. With permanent insurance, if it is held until death, it is guaranteed to provide a payout.

For example, if someone puts in $12,000 a year for 15 years, that totals $180,000. The insurance policy might pay out $360,000 in 15 years. This is different from a "term 10" or "term 20" insurance policy that covers only a fixed time period, and usually has a return of negative 100 per cent. Permanent insurance allows you to know the payout on the investment. The only unknown is when the payout will occur.

•To implement the strategy, you would need to search the market for the best permanent insurance solution given the age and health status of the individual. That will require an insurance broker who has access to the full market, focuses on estate planning and understands the strategy.

Now how does this become an RRSP or TFSA alternative?

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If you are making $200,000-plus a year, and you are maxing out your RRSP contribution and TFSA contribution, over time you are probably left with savings held in non-registered investments or in a second property. Both of these are being taxed and subject to the variability of the markets.

If you are middle aged and you have a parent in his or her 60s or 70s, and in decent health, he or she will certainly qualify for permanent life insurance. By funding this insurance with money that would otherwise be taxed in some way, and getting a payout around retirement, this meets the objective of retirement planning perfectly.

Many people respond: "Isn't life insurance very expensive at that age?" The answer is that the rate of return can be very good. This return is not tied to any investments held within the insurance policy. It is based on the dollars put in over the years, held within the plan using a guaranteed minimum return, and the insurance payout at the end.

If you want more tax sheltering than you are allowed with RRSPs and TFSAs, an alternative is to pay for the life insurance on your parent. In some cases the return is so good and the other benefits are so strong, you would want to do this instead of some of your RRSP and TFSA contributions.

If you are self-employed, earning good money but not earning a salary, you simply don't have much or any RRSP contribution room. This type of strategy is a great alternative. You get the best of both worlds in terms of tax efficient income, and you still can benefit from a tax sheltered retirement strategy – without any hard limit on contributions.

An even better option for self-employed individuals is to buy the insurance policy within their company.

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Remember that the named beneficiary of an insurance policy can be quite flexible. In some cases, parents are more comfortable with the process if they know that the grandchildren are also named as beneficiaries on the policy.

Among other benefits of this strategy, the insurance policy is creditor proof, and the death benefit is not considered family assets in the event of marriage breakdown (unlike the RRSP and TFSA).

Some might suggest that it seems odd to financially benefit from a relative's death. While one can understand the point of view, it is really no different than anyone who is likely to receive an inheritance. It is simply helping your family to do smart financial planning.

An example

We have an imaginary investor – let's call him Joe.

Joe is 41. His yearly income is $200,000, and he has no more room in his RRSP or TFSA. He has $150,000 in non-registered investment assets. If Joe had more RRSP room he would put more money in.

Joe's mother, Susan, is 70. Other than a prescription for high cholesterol and a bad knee, she is in decent health.

Joe's insurance broker has searched the market to find the best return for a permanent policy for a 70-year-old woman. Joe deposits $12,000 a year for 15 years and the policy is fully paid up – a unique feature of this particular product. This policy also has a return of premium. It essentially adds one dollar of payout for every dollar Joe puts in.

After one year, Joe has put in $12,000. If Susan passed away, the insurance payout would be $193,000, for a return of 1,508 per cent.

Every year Joe puts in $12,000, the payout goes up $12,000. In year five, Joe would have put in $60,000 and the insurance payout would be worth $241,000.

In 15 years, Joe has put in $180,000. In this case, the policy is now fully paid, and Joe doesn't need to pay another dollar. The payout figure does not continue growing past this point.

As it turns out, Susan passes away shortly after, at age 85. Joe is now 56 years old. The insurance policy pays out $361,000 to the beneficiaries. In this case, Joe is the sole beneficiary.

If Joe had put the same $12,000 a year for 15 years into a non-registered GIC, to have the same after-tax return as this strategy (assuming Joe pays a 46 per cent marginal tax rate), he would have to find a GIC paying 15.35 per cent.

Not only did this strategy provide Joe with extra tax shelter, but it guaranteed he would at least double his money, tax free, whether Susan lived to age 71 or age 95.

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Source: TriDelta Financial

Read more of Globe Investor's 29 Ways in 29 Days to be a better investor

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