As they age, more and more Canadians are withdrawing money from their RRSPs to cover expenses incurred by critical and long-term illnesses, incurring heavy tax penalties and damaging their long-term retirement savings.
"We are seeing a trend among people to dip into their RRSP savings to cover costs or replace income that they might lose because of a serious injury or illness," says James McKeown, a senior insurance specialist with Edward Jones.
"Early withdrawal of money from your RRSP can have a number of consequences. Once the money is out you have to start over again to save it and you also lose the compounding growth that you would have gotten if it had stayed in."
As well, the government taxes early withdrawals very heavily. If you withdraw up to $5,000 you pay a 21 per cent withholding tax in Quebec and 10 per cent in all other provinces. Withdrawals between $5,001 and $15,000 are taxed at 26 per cent in Quebec and 20 per cent in other provinces and early withdrawals over $15,000 are taxed at 31 per cent in Quebec and 30 per cent in all other provinces.
And there's another penalty. Once you've withdrawn the money it is removed from the contribution room available to you and you cannot re-contribute it later. If you've got $30,000 contribution room and take out $15,000, you're left with only $15,000 of contribution room.
Many aging Canadians are turning to critical illness, disability and long term care insurance as an alternative way to protect themselves from the financial impact of a serious illness or disability.
"A diagnosis of a serious disease like cancer can have a devastating impact on the individual and their family," says Mr. McKeown. "In times like this you want to spend all your efforts on getting the right treatment and getting well again. The last thing you want to be worried about is finances."
Critical illness insurance is designed to provide a lump sum payment of cash upon medical diagnosis of a specific condition. The number of conditions covered varies depending on the insurance company, but could be as high as 24. Most claims, however, are made for cancer, stroke and heart attacks, the three most common illnesses in North America.
A typical $100,000 policy for a non-smoking 50-year-old male would cost $101 a month and $86 a month for a non-smoking 50-year-old woman. The average policy is for $100,000 which is paid in a lump sum 30 days after diagnosis.
Complementing critical illness insurance are disability and long-term care (LTC) insurance, which also provide benefits while you are alive.
Disability insurance is designed to replace a portion of your income if you are unable to work for an extended period due either to an accident or sickness.
LTC insurance provides an income based on a person's cognitive impairment or inability to perform daily living activities such as eating, bathing or toileting.
According to the Council on Aging, more than 40 per cent of people over the age of 65 will at some point in their remaining years require long term care and spend time in a nursing home or long term care facility for an average of three to four years.
Twenty per cent will stay more than five years and for a couple over 65 there is a 66 per cent chance that at least one of them will enter a long term care facility at some point in their lives.
Some synergy policies combine all three types of plans in one.
"Statistics Canada estimates that $1.2-trillion will be needed to fund the health care needs of boomers over the next 25 years, and it is estimated that one in three Canadians will suffer a life-altering condition in their lifetime," Mr. McKeown says. "So the risks and costs are real and more and more people are seeing this kind of coverage as a permanent need in their retirement planning."
People who may not be able to qualify for critical, disability or LTC insurance – a medical examination is required – have the option to use their Tax Free Savings Account as a source of money, which can be withdrawn tax-free and put back in later.
"It makes sense to keep invested in your RRSP and shift the risk to these types of insurance policies," Mr. McKeown says.