Most of us view insurance as a “necessary evil,” but what if I could show you that not only is insurance a good thing to have in case of your death, that it could also provide you with a way to grow and use money Tax-Free. RRSPs can shelter your money and let it grow within the RRSP, without any tax liabilities until you begin to take the money out. Usually at age 71 in the form of a RRIF.
Hopefully, by that time you will be in a lower tax bracket and therefore get to pay the tax at a lower rate. However, Life Insurance Tax Shelters (LITS) offer another option that will not only permit your money to grow Tax-Free but if structured properly, will permit you to access the funds without tax ramifications. So instead of just a Tax Deferral you can have Tax-Free money. Why are these plans better than other non-sheltered investments?
1. They permit your money invested in the plan to grow Tax-Free.
2. The annual maintenance fee for the plan is considerably less than the tax that would have to be paid on earnings on the investments that were not sheltered.
This illustration may help. Although the numbers will not be the same for you, it should give you a good idea of the benefits of such a plan. Suppose your investments are earning a rate of 10% annually and each year you deposit $10,000 into a non-sheltered investment of some kind with your tax rate at 40%. At the end of 20 years you would have $630,025 in the plan, but if you had to pay the tax of these investment earnings each year, you would have also paid a total of about $172,010 in tax. If you are able to shelter that money in an LITS, those earnings will be the same but because the funds are growing within the plan there are not tax liabilities. Over 20 years the administrative fees for the plan will probably be somewhere slightly over $20,000, so by participating in the plan you saved an additional $150,000 in tax .
The second option is what makes LITS the GREAT Tax Shelter available in Canada. Instead of withdrawing the money, visit your bank (your insurance company may also do this for you) and borrow money using the policy as the security. Generally, do not borrow the full amount all at one time, but annually as you have need of it. The arrangement you make for the loan is that no repayment will ever be made on it, but at the time of your dealth the funds from the LITS will be used to cover the total owing. This permits you to access the earnings from this money Tax-Free.
The lending company will feel comfortable with this arrangement because they know that their loan is well secured (by the balance you have in the fund plus the insurance) and that funds are continuing to grow. So everyone is happy.
If you choose the second option- and borrow against the funds rather than withdraw them, here is what could happen. You could take your first loan of $50,000 and then each year you increase it by3% to account for inflation. Even doing that it will take you 24 years to borrow the total amount accumulated.
Remember that this money is flowing into your hands Tax-Free and in addition, in the event that you do not survive as long as the money does, because it is an insurance policy the balance remaining plus the insurance benefit moves into the hands of your beneficiaries Tax-Free. Now you see why we say it is the best tax shelter.