The Insurance Retirement Plan (IRP): A Tax-Efficient Way to Create Guaranteed Retirement Income in Canada

“If you knew, at passive income time, that you would be getting back everything that you paid into a system – tax free – would you object to putting more money in it?”

Planning for retirement in today’s world is not as simple as it used to be. People are living longer, cost of living is increasing and inflation keeps compounding. Much like interest, inflation is a compounding statistic, which means that the rate of inflation becomes exponential as time goes on. The question needs to be asked then, will I need access to more money when I start my retirement, or later on in my retirement?

The answer is, your need for money will likely increase over time throughout your retirement to keep up with inflation and the cost-of-living increases. Then there are costs associated with healthcare and assisted living to consider as well.

The number one fear of retirees is running out of money. The reason this is a concern is because conventional retirement portfolios are created around the idea that you are going to draw down your investments and assets as time goes on.

As you draw down investments, you are interrupting their growth, and you are exposed to increased market risk. Your need to draw money does not decrease when the markets are down. Withdrawing when markets are down only increases the risk of you outliving your money.

So what is a good alternative?

There are many different ways to plan for retirement. Which one best suits your needs is very relevant to where you live and what you want retirement to look like. However, we all have a need for money in retirement.

One piece that is often overlooked as a means for retirement income is the strategic use of life insurance.

There is something called the Insurance Retirement Plan (IRP) which uses a whole life insurance product to supplement income during retirement. What this plan does is combine the need for current protection, estate planning, and retirement income into one product. But, the most important factor is we can leverage against the value of our policy to access money in retirement without withdrawing funds from it.

How we design the policy, and which type of policy we use will have a very large impact on our ability to use it as a source of income during retirement. I always recommend a Participating Whole Life Policy over any other type of whole life because of the ability to plan off of guarantees rather than projections.

A quick note on Universal Life. We don’t recommend Universal Life because of the way the insurance portion is calculated. Universal life attempts to de-link the insurance and investment portion of your premium payment. How it works is essentially the cost of insurance per year is equivalent to a 1 year term contract. This means that while you are younger, the cost of insurance per year is very cheap. However, as you age, when you need the protection the most, the cost of the insurance sky rockets.

As the risk of the life insured passing away increases over time, so too does the cost of the insurance. This means the longer you live, the higher the cost of your insurance premiums will be. Meaning the longer you live, the quicker your cash reserves diminish. This is the exact opposite of what we want in the IRP.

With a whole life policy, the cost of insurance remains level throughout the life of the policy. The cost of the insurance based off the average life expectancy is averaged throughout the life of the policy rather than changing and increasing year to year as the risk increases.

How we design the whole life policy has a major impact on the amount we have access to in retirement. The three most common ways of accessing money from your policy in retirement are:

1.Take the dividends as a cash payment;

2.Take policy loans to fund your retirement; and

3.Annuitize the policy with a commercial bank.

The first option will have tax consequences on every dividend paid. The second will have tax consequences once the adjusted cost basis of the policy has been surpassed (roughly equivalent to once you take a loan greater than the total amount of money you have put into the policy), but the third option provides tax free income.

However, its important to note that the growth that occurs within these policies is tax free. There are no capital gains taxes because this is not an investment, its life insurance.

Regardless of the option you choose, the design of the policy will matter greatly when it comes to how much money you can access. The goal with an IRP policy is to maximize the amount of premium we can pay. Now this may seem counterintuitive, but stay with me.

When designing these policies, we want to maximize the use of the Exelerator Deposit Option (EDO) and the use of dividends to buy Paid-up Additions (PUA). The EDO is used to buy additional death benefit. It is flexible premium that you have the option of paying each year to purchase additional coverage. Paid-up additions are the same principle, but are purchased through the dividends the policy receives each year.

When maximizing the use of both of these tools, we are contributing more and more money to the policy each year. That money is increasing the death benefit on the policy which in turn increases the amount of cash value in the policy.

In the policy contract, the cash value (I refer to this as the equity in the policy) must equal the death benefit at the life insured’s age of 100. So, as we increase the death benefit, contractually the cash value must increase as well. The cash value is the amount we have access to when it comes to accessing money in retirement.

If we have been consistent with our EDO payments throughout the life of the policy, we have created a scenario where the death benefit has grown substantially throughout the life of the contract. This, in turn, has increased the dividends, which again increases the death benefit.

It also has created a situation where the cash value needs to start sprinting to catch up to the death benefit. What it looks like on a graph is almost exponential growth of our cash value. Remember, the cash value must equal the death benefit at the life insured’s age of 100. Therefore, we know for certain what the cash value is going to equal at the end of the policy. Fluctuations in the market won’t affect this number. We are planning off guarantees.

The magic happens because the money we use to buy EDO gives us a greater than 1:1 return. Meaning for every dollar of EDO we spend; we get greater than $1 of death benefit. It can be as high as $4-5 for every 1$ dollar spent. This is where all of that accelerated growth comes from.

When it comes time to access money, we will know for certain how much will be available to us every single year. Plus, we don’t have to draw down any investments to access money. Meaning we never interrupt that tax free growth, and we never outlive our money.

This is why the IRP is so attractive. It allows us to plan with certainty in an extremely tax efficient way.