Insurance Calculations

Transcription

1 Insurance Calculations You have learned many formulas and calculations throughout the LLQP course of study. This is an opportunity to review and practise what you have learned. Answers with detailed rationale are provided following all questions. It is imperative you answer the questions in this module correctly before proceeding to the Certification Exam. If your answers are incorrect, repeat the questions until you answer them correctly. REVIEW: Policy Benefits when Age Has Been Misstated REVIEW: Amount of Insurance Required: Human-Life Approach REVIEW: Amount of Insurance Required: Capital-Needs Approach (Capital-Retention Approach) REVIEW: Capital Gains and Capital Losses REVIEW: Residual Disability Benefits REVIEW: Coordination of Benefits REVIEW: Seg Fund Maturity and Death Benefit Guarantees REVIEW: Seg Fund Resets REVIEW: Seg Fund Withdrawals REVIEW: Market Value Adjustments to Annuities REVIEW: CPP with Early or Late Retirement Options REVIEW: RRSP Withdrawals REVIEW: RRSP Withdrawals for the Home Buyers Plan and Lifelong Learning Plan REVIEW: Pension Adjustments on RRSP Contribution Limits REVIEW: RRIF Withdrawals REVIEW: Splitting CPP Benefits ANSWERS Copyright 2011 Oliver Publishing Inc. All rights reserved. 371

2 LLQP REVIEW: Policy Benefits When Age Has Been Misstated Misstatement of the age of the insured (whether deliberate or not) does not allow the insurer to void the insurance contract. However, the liability of the insurer is adjusted so that the benefit in the policy is changed to the amount that would have been paid based on the premium received and the true age of the insured. The basic calculation is: Premium charged, divided by the premium that should have been charged, multiplied by the face value of the policy. Example: Jacques Bennie decided that, so far as the outside world is concerned, he would remain 39 forever. When he turned 42, he applied for and received a standard-rated $100,000 whole life insurance policy, in which he named his trusted employee, Rochester, as beneficiary. His application stated his age as 39. When Jacques died at age 70, the insurer became aware of the misstatement of age. When the policy was issued, Jacques, assessed as 39-year-old, was charged a premium of $25 per $1,000 of insurance. Had he been assessed as a 42-year-old, his premium would have been $27 per $1,000 of insurance. Therefore, Rochester will receive: x $100,000 = $92, Question: The premiums charged by ABC Insurers Inc. (ABC) for a single non-smoking female, aged 32 and 35 respectively, are $22 and $24 per thousand of insurance. Your client, Shanu, inadvertently misstated her age as 32, instead of her correct age of 35, when she purchased a $60,000 life policy from ABC. At her death, the insurer is made aware of the error, and the beneficiary of the policy wants to know the value of the insurance. What will the death benefit be? REVIEW: Amount of Insurance Required: Human-Life Approach The economic value of a human life depends on spending priorities, level of income, obligations to dependents, and the value judgements of the members of the family. However, the only value that the agent can predict with certainty is the level of income. If there is an estimate of the amount of income required by the family in the event of the death of the primary breadwinner, that value may be used instead. Therefore, the amount of annual income required by the family and the prevailing rate of interest form the basis on which this calculation is made. The value can be further refined by considering the effect of inflation. The basic calculation is: Amount of income required, divided by the prevailing rate of interest, equals amount of insurance needed. Example: If a family needs the $30,000 annual income of the primary wage earner, the total amount of insurance needed to replace the economic value of his or her life would be: $30, = $600,000. Therefore, $600,000 of life insurance is required. The basic calculation, including inflation: Determine the real rate of interest by assuming a nominal rate of interest and subtracting the long-term inflation rate to equal the real rate of interest. Example: The nominal rate of interest of 8% and the long-term inflation rate is 3%, therefore the real rate of interest is 8% 3% = 5%. 372 Copyright 2011 Oliver Publishing Inc. All rights reserved.

3 Insurance Calculations Question: How much life insurance is required for a family whose primary wage earner currently has a term life policy with a $200,000 death benefit? The annual income required by the family is $50,000. Assume a nominal interest rate of 7% and long-term inflation of 3%. REVIEW: Amount of Insurance Required: Capital-Needs Approach (Capital-Retention Approach) This type of needs analysis calculates the capital needed to provide sufficient annual cash requirements for the surviving members of the family unit. The process begins by determining the Final expenses-needed to meet the bills of the deceased to ensure that the remaining members of the family unit are not put to hardships. The final expenses needs is the difference between the assets of the family, less or minus final expenses. The next stage requires the calculation of the dependency-period needs of the remaining family members, which determines the amount of money that the family unit requires for annual living expenses. The dependency-period needs are shown in the difference between the continuing income sources of the family, less or minus the family s continuing expenses. Determining the total insurance needs of the family using this approach depends in part on the capitalization of the deceased s life; that is, valuing the amount of money that must be invested at an expected rate of return in order to earn the amount of money that the remaining family members require on an annual basis. Dividing the shortfall of the continuing income needs of the family by an expected rate of return, produces this figure. The final calculation of the insurance needs of the family is arrived at by adding the Final expense needs and the dependency-period needs. Example John and Nancy Weiss want to know the amount of insurance they require to provide for the family in the event of John s death. John s salary at the time is $65,000. Nancy is employed as a clerk in a flower shop. Her annual salary is $22,000. They have two children, ages 4 and 7. John is 35 years old, and Nancy is 31. John currently has life insurance from his work, covering one year s salary ($65,000). John is entitled to a CPP death benefit of $2,500. Copyright 2011 Oliver Publishing Inc. All rights reserved. 373

4 LLQP Needs Analysis for Nancy and John Weiss, Readjustment Period Assets at Death Last or Final Expenses Death Benefit of life $ 65,000 Funeral $ 6,000 insurance Death Benefit of CPP 2,500 Legal and Accounting Fees 1,500 Investments 5,000 Income Tax and capital 500 gains tax Cash on Hand (bank 800 Debts (credit cards, car loan) 21,200 balances) Emergency Fund (based on 16,250 John s salary x 3 months) Mortgage 300,000 Total Assets $ 73,300 Total Final Expenses $ 345,450 Cash Need is the difference between assets and final expenses. Total Expenses Total Assets = $272,150 Dependency Period Continuing Income Continuing Expenses Nancy s Salary $ 22,000 Housing $ 15,000 Government Benefits 2,600 Food 4,500 Clothing 2,000 Telephone 800 Medical and Dental 2,000 Car (insurance, gas, 6,300 maintenance) Childcare 4,000 Entertainment and vacation 2,100 Education Fund (for both 6,000 children Total Income $ 24,600 Total Continuing Expenses $ 42,700 Dependency Need is the amount that will be needed to cover living expenses. (Total Continuing Expenses Total continuing Income) Rate of Return (given interest rate of 3.25%) = $556,923 Total Insurance Requirement is the combination of immediate and ongoing needs for the survivors. Cash Need + Dependency Need = $829,073 Question: Using the capital-needs approach, calculate the insurance needs of this family in the event of the death of the major income-earner. The major income-earner presently has a term life policy with a face value of $20,000. An examination of the affairs of the family reveals the following data: family assets total $200,000; final expenses are calculated at $250,000; continuing yearly income sources total $20,000, while continuing expenses are estimated at $35,000; and, the expected rate of return is 4%. 374 Copyright 2011 Oliver Publishing Inc. All rights reserved.

5 Insurance Calculations REVIEW: Capital Gains and Capital Losses Capital gains are incurred when investments classified as capital property are sold for more than their purchase price. The government taxes 50% of the increase of the value of the asset at the marginal tax rate of the owner. Some investments that produce capital gains are stocks, mutual funds, and segregated funds. Capital losses arise when the value of a capital property is worth less than its purchase price. They can be used to reduce capital gains. Capital losses may be applied against capital gains in the tax year in which they are received or in the three immediately prior tax years. They can also be carried forward indefinitely and used to reduce future taxable capital gains. The basic calculation is: Amount of capital gain, multiplied by 50%, multiplied by the taxpayer s marginal tax rate, equals the capital-gains tax. Example: John s marginal tax rate is 38%. If the price of shares he owned increased since he bought them, and he earned $1,000 more than he paid, he will have to pay tax on a taxable capital gain of $1000 x 50% = $500. Tax to be paid = $500 x 38% = $190. He will pay $190 in capital-gains tax. Question: When Prue Hubris was swept up into the high-tech stock-market boom three years ago, she bought 1,000 shares in Techie Dot Calm. When she finally sold these shares, she had a capital loss of $3,245. This year, she sold a portion of her bank stocks and realized a $5,250 capital gain. Prue wants to know what her tax liability will be on the sale of the bank stock, with or without factoring in the sale of the Techie Dot Calm stock. She is in the 30% marginal tax bracket. REVIEW: Residual Disability Benefits The residual disability benefit concept calculates the disability benefits required to make up the difference between the individual s total lost income and any partial income that can be earned while the individual is disabled. A residual benefit tops-up the income earned at work by a proportion of the full monthly benefit. The basic calculation to determine the percentage of the benefit that will be received is: Pre-disability income post-disability income pre-disability income Example Jack Drill, a dentist, earns an average income of $20,000 a month from his practice. His professional disability policy provides $10,000 as a monthly benefit. While on a ski trip, he falls and breaks both wrists: one is a clean break and the other is a multiple fracture. The clean break heals in eight weeks and Jack returns to his practice on a part-time basis, working about 60% of his pre-accident hours. Jack is able to earn $12,000 a month working part-time. The formula for his benefit is: 20,000 (pre-disability income) 12,000 (post-disability income) = 8,000 = 40% 20,000 (pre-disability income) 20,000 Since Jack s monthly benefit is $10,000, he will receive 40% of $10,000 = $4,000 as a residual benefit. Copyright 2011 Oliver Publishing Inc. All rights reserved. 375

6 LLQP Question: Your client, Joan, is a policy owner of a disability policy that provides a monthly benefit of $3,000. Her monthly income is $8,000. After being disabled, Joan returns to work and earns 50% of her pre-disability income. How much money will she receive as a residual benefit now that she is back to work at 50% capacity? REVIEW: Coordination of Benefits Coordination of Benefits coordinates extended health care and dental benefits paid under group plans to ensure that benefits do not exceed total eligible expenses. In other words, an insured with multiple plans will not show a profit through multiple claims for the same expenses. The primary carrier is the insurer of the plan that determines the benefits first and then calculates the benefits as though duplicate coverage does not exist. The secondary carrier is the insurer of the plan that determines the benefits second, and then limits its benefits coverage to the lesser of: the amount that it would have paid had it been the primary carrier, or 100% of all eligible expenses reduced by all other benefits payable for the same expenses by the primary carrier. A plan that has no coordination-of-benefits provision, either in the contract or in the plan document, is the plan that determines benefits first (the primary carrier). For plans that contain coordination-of-benefit provisions, priority is determined by the relationship of the claimant to the plan. The primary carrier is the plan where the claimant is a member/employee, and the secondary carrier is the plan where the claimant is a spouse or a dependent child. Example: Amita Saenz suffers from a variety of skin ailments that require numerous prescriptions. Each month she files her prescription receipts, together with the necessary paperwork, with her employer to forward to their group plan insurer. She has an extended health plan that has a $25 annual deductible and a co-insurance factor that pays 80%. Her husband s plan has a $100 annual deductible and no coinsurance factor. Here is what she is reimbursed over the first three months of the year: January: Receipts $ Amita s plan $185 submitted $25 deductible Plan pays 80% x (185 25)= $128 paid $32 co-insurance Husband s plan $185 submitted $100 deductible $85 could be paid, but since $128 was already paid under Amita s plan, husband s plan will pay $57 ($185 $128) February: Receipts $ Amita s plan $185 submitted $0 deductible Plan pays 80% x $185 = $148 paid 376 Copyright 2011 Oliver Publishing Inc. All rights reserved.

7 Insurance Calculations Husband s plan $185 submitted $0 deductible $185 could be paid, but since $148 was already paid under Amita s plan, husband s plan will pay $37 ($185 $148) March receipts $185.00; payments will be the same as February, since deductibles are already paid. Question: Jack is a diabetic who self-administers insulin on a daily basis as needed. He is a member of a group extended health care and prescription drug plan through his employer. The plan has a $100 annual deductible, and a co-insurance factor of 80%. Jack submits monthly receipts to his employer for reimbursement in the following amounts: month 1 - $235; month 2 - $285; and month three - $135. His wife, Jill, is also a member of a group extended health care and prescription drug plan that has a $75 annual deductible, but no co-insurance factor. Jack is covered under Jill s plan, as a dependent spouse. Jill has two group dental plans; both pay 80% of eligible expenses. Plan A does not contain any co-ordination-of-benefits provisions, while Plan B covers orthodontic procedures with a maximum annual benefit of $2,500, and co-insurance factor of 60% for orthodontic work only. Jill has eligible dental expenses of $ and orthodontics bill of $4,500. Calculate the amount that will be reimbursed by Jack s group plan in month 1, and the amount that will be reimbursed by Jill s group plan in month 1. REVIEW: Seg Fund Maturity and Death-Benefit Guarantees The maturity guarantee provides for the return of, 75% at least of the initial deposit, less any withdrawals, either: 10 years after the date on which the contract is signed by the investor; or 10 years after the end of the year for deposits made during each year. Some companies offer up to a 100% guarantee. Thus, if the value of the contract is less than the initial deposit, the investor receives the guaranteed amount. If the value of the contract is greater than the guarantee, the investor receives whatever that greater amount is. Withdrawals reduce the guaranteed amount. The death benefit specifies that the beneficiary of the contract will receive, at a minimum, the amount specified as the maturity guarantee. The basic calculation is: deposit, multiplied by 75% or whatever is the guarantee percentage, equals the minimum amount received on maturity. Copyright 2011 Oliver Publishing Inc. All rights reserved. 377

8 LLQP Question: What is the minimum amount that an investor will receive on a seg fund contract with a 75% guarantee, purchased with a deposit of $20,000, when the value of the fund on maturity is $14,345? REVIEW: Seg Fund Resets Some segregated funds allow their values to be locked in. This is called the reset feature. The investor tells the insurer that he or she wants to reset (some companies will accept verbal instructions; others need these instructions in writing) and the investor gets the end-of-day close price on the day the reset request was received. The number of resets is limited; two to four a year is usual. The reset feature sets the new guaranteed value at a higher level, based on the higher market value of the contract. As the fund continues to grow, the reset feature allows the investor to increase the guaranteed value at death or maturity. When the contract is reset, the maturity date is adjusted to 10 years from the reset date. The death and maturity guarantee benefits will immediately be based on the reset amount, and so will be higher than when the contract was purchased. There is no calculation required to determine the reset; it is simply the value of the contract as of the date of reset. Example: A client opened an account on June 1, 1995, with $100,000 and a 100% maturity guarantee. On November 2, 1998, she saw that the account value was $125,000, and she chose to reset. The maturity date of the contract changed from June 1, 2005, to November 2, The maturity guarantee changed from $100,000 to $125,000. Question: Alf Little opened a seg-fund account on January 1, 2010, with $50,000, and a maturity guarantee of 75%. Alf tracked its decline to a low of $47,200 by June of that year, and then its recovery and rise to a value of $51,500 by the fall. On November 17, 2011, relieved at the recovery, and nervous about the future, Alf reset his fund. When will the fund mature? What will be the value of the death benefit, and the maturity guarantee on that date? REVIEW: Seg-Fund Withdrawals When a withdrawal is made from a seg fund, the maturity and death-benefit guarantees must be adjusted accordingly, since the value of the contract has been reduced. This adjustment is made by either the linear-reduction method (which reduces the principal by the dollar amount withdrawn) or the proportional-reduction method (which reduces proportionally the principal and the growth in the account according to the number of units surrendered compared to the number of units in the contract prior to withdrawal. The proportional method thus considers that Fair Market Value (FMV) of the contract at the time of withdrawal). The basic calculation is: deposit, multiplied by 75% or whatever is the guarantee percentage multiplied by the percentage that represents the amount of withdrawal, equals the amount received on maturity. 378 Copyright 2011 Oliver Publishing Inc. All rights reserved.

9 Insurance Calculations Example of Proportional Reduction: Client A begins an IVIC contract on January 15, 2002, with a deposit of $10,000. If the deposit guarantee is 75%, on January 15, 2012, the client will receive a minimum of $7,500. If the client had withdrawn $1,000 prior to that date, when the value in the contract was $12,000, the new guarantee by the proportional method would be calculated as (FMV Withdrawal)/FMV multiplied by the original guarantee. Thus the new guarantee after the withdrawal will be calculated as: New Guarantee = (FMV Withdrawal amount) x Original Guarantee FMV = (12,000 1,000) x 7,500 = 11,000 x 7,500 = $6,875 12,000 12,000 Example of Linear and Proportional Reduction: Sarah bought 500 units in a seg fund with a guarantee of 100% at $20 per unit, for a total value of $10,000. Two years later, the value of the units has increased to $25 per unit; the total value of her investment has increased to $12,500. She withdraws $1,000 by surrendering 40 units ($1,000 $25 = 40). The balance of units in the fund is reduced to 460 ( = 460). The proportional-reduction method indicates that the value in the fund on which the guarantee is based is reduced by 8% to $9,200 ( = 0.92; $10,000 x 0.92 = $9,200). Or Proportional Method (Alternate to calculation by units using FMV and withdrawal amount) New Guarantee = (FMV Withdrawal amount) x Original Guarantee FMV = (12, ) x 10,000 = 11,500 x 10,000 = $9,200 12,500 12,500 If the guarantee in her contract calls for 100% return of her initial deposit, the linear-reduction method indicates a new balance in her contract of $9,000 ($10,000 $1,000 = $9,000.) So the new guarantee is $9,000. Alternate method (Linear Method) New Guarantee = (Original Investment Withdrawal amount) x Original Guarantee Original Investment = (10,000 1,000) x 10,000 = 9,000 x 10,000 = $9,000 1,000 10,000 Copyright 2011 Oliver Publishing Inc. All rights reserved. 379

10 LLQP All policy withdrawals are deemed to be partial dispositions with tax consequences, and they will decrease the ACB of the contract. The withdrawal must be reported for tax purposes and tax paid on it when appropriate. Example: Jan s policy has a fair market value of $150,000 and an ACB of $140,000. She withdraws $30,000; thus she is deemed to have disposed of 20% of the contract ($30,000 $150,000 = 20%). She must therefore report a capital gain of 20% on the difference between the ACB and the fair market value of the policy of $2,000 ($150,000 $140,000 =$10,000 x 20% = $2,000). Question: Danny Warbachs bought 1,200 units in a seg fund at $30 per unit. The fund guarantees a 75% return on the initial deposit. In less than two full years, the increase on a per-unit basis in the seg fund was $8.00. Following the increase, Danny withdrew $15,200 from the contract. a) How many units in the fund did Danny surrender to make the withdrawal? b) Using the linear-reduction method, what is the value of the guarantee in the contract following the withdrawal? c) Using the proportional-reduction method, what is the value of the guarantee in the contract following the withdrawal? d) Assuming the ACB of the contract was $36,000, what capital gain, if any, must Danny report as a result of his withdrawal of funds from the contract? REVIEW: Market Value Adjustments to Annuities When an annuity contract is surrendered, or an early withdrawal is made, an adjustment will be made to the interest rate on which the annuity is based. This is termed a market value adjustment. The calculation will be one of three possible adjustments: 1. The interest rate credited to the premium is changed to the rate that would have applied for the number of years of the annuity. Example: A 10-year annuity with an interest rate of 5.7%, which was withdrawn three years early, would have its original interest rate changed to 5.2%, the interest rate that would have applied had the contract been for seven years. 2. The interest rate credited to the deposit may be changed as a result of a change in interest rates from the date of the premium and the date of the early withdrawal. Example: If interest rates are higher (e.g., 7%) on withdrawal than on deposit (e.g., 5%), the policy owner might have to pay an additional penalty (e.g., $150) for the early withdrawal in order to reflect current market conditions. 3. The interest rate used to calculate either of the two changes above may be reduced by an additional amount (e.g., ¼ of 1%) as a penalty for early withdrawal. Example: A 10-year annuity with an interest rate of 5.7%, which was withdrawn three years early, would have its original interest rate changed to 5.2%, the interest rate that would have applied had the contract been for seven years, and further reduced to 4.9% as a result of the penalty. 380 Copyright 2011 Oliver Publishing Inc. All rights reserved.

11 Insurance Calculations Question: Annuities Anonymous Inc. (AA) charges a 0.6% penalty in addition to its standard policy of interest adjustment for early withdrawal from all annuities that it sells. When Robert Cratchet bought a 10-year annuity, the interest rate on it was 5.2%, while 3- year annuities had an interest rate payable at 4.1%; 4-year annuities paid 4.25%; and 5- year annuities paid 4.65%. Robert cancelled the annuity in its third year to pay the medical bills for his son Tim. What interest rate will AA pay? REVIEW: CPP with Early or Late Retirement Options A CPP recipient can elect to begin receiving his or her pension as early as age 60 and as late as age 70. For an early entitlement, the pension is reduced by 0.5% for each month the recipient is younger than age 65. The recipient must prove that he or she is no longer employed or has employment income lower than the amount of CPP that would be received. When the pension is delayed, it is increased by 0.5% for each month the recipient is above the age of 65. Benefits are capped at age 70. The basic calculation for early retirement is: benefit payable, minus no. of months of early retirement multiplied by 0.5%, equals early retirement benefit. The basic calculation for late retirement is: benefit payable, plus no. of months of late retirement multiplied by 0.5%, equals late retirement benefit. Example: If James Brown retires at age 65, his benefit payable is $875. However, if he retires at age 64, his benefit payable is reduced by 0.5% per month (12 months x 0.5% = 6%). His benefit payable at age 64 is therefore $875 6% = $ If he decides to retire at age 66, his benefit payable is increased by 0.5% per month. His benefit payable at age 66 is therefore $ % = $ Question: Lois Lane s benefit payable at age 65 is $650. What will she receive as a pension if she retires at age 63, or at age 68? REVIEW: Registered Retirement Savings Plan (RRSP) Withdrawals There are four ways in which funds may be removed from an RRSP: As cash, subject to a withholding tax (details below); Transferred to an annuity; Transferred to a Registered Retirement Income Fund (RRIF); Transferred to another RRSP, as long as this is done prior to December 31 of the year in which the plan holder turns 71 years of age. At age 71, the RRSP must be converted to one of the above options. All funds must be either withdrawn or transferred from the RRSP by the end of the calendar year in which the plan owner reaches the age of 71. Copyright 2011 Oliver Publishing Inc. All rights reserved. 381

12 LLQP When funds are withdrawn, the financial institution is required to deduct a withholding tax on the amount withdrawn. The withholding tax for residents of Canada is as follows: Withdrawals All provinces except Quebec Quebec up to $5,000 10% 21% $5,001 to $15,000 20% 26% $15, % 31% The gross amount withdrawn (including the amount of the withholding tax) is added to the plan holder s taxable income for that tax year, and is taxed at the individual s marginal tax rate. Double taxation is avoided, since the plan holder gets credit for the tax that was withheld when the withdrawal was originally made. The basic calculation is: amount of withdrawal, minus withholding tax, equals funds received by plan holder. Example: Vijay, a resident of Calgary, wants to withdraw $7,000 from his bank, the administrator of his RRSP. The bank will be obliged to deduct a 20% withholding fee before advancing the balance of the funds. Vijay will receive the sum of $5,600 ($7,000 $1,400), and must declare $7,000 as taxable income for the year of the withdrawal, but will receive a tax credit in the amount of the funds held back ($1,400). Question: Amy Dextrous needs cash immediately in the amount of $6,000, to take advantage of a once-in-a- lifetime deal on a diamond ring. She currently has $18,000 in an RRSP from which to draw the funds. What amount of income must she declare in the year in which she takes the money from her RRSP? What tax credit, if any, will she receive in the same year? REVIEW: RRSP Withdrawals for the Home Buyers Plan and Lifelong Learning Plan Home Buyers Plan The Home Buyers Plan allows an RRSP plan holder to withdraw up to $25,000 from his or her RRSP to buy or build a qualifying home if neither spouse has been a homeowner for five years, including the year of withdrawal. This condition will be waived for disabled persons. The home must be in Canada, can be new or used, and the purchaser must occupy it as his or her principal residence by October 1 of the year after the withdrawal is made. If both spouses have RRSPs, they can borrow up to $25,000 each, provided they take joint ownership of the property. The funds withdrawn are not taxable, but must be repaid in equal annual instalments over a 15-year period. If the amount repaid exceeds the minimum annual amount, the amount payable in subsequent years is reduced. If an amount less than the minimum is repaid, the shortfall must be included in the plan holder s taxable income for that year. Since repayment cannot be made after the year the plan holder reaches 71 years of age, any remaining payments must be included in the plan holder s income in each year they become due. There is no interest charged on the loan. 382 Copyright 2011 Oliver Publishing Inc. All rights reserved.

13 Insurance Calculations Plan holders may be restricted from deducting their contribution to an RRSP if the same funds are withdrawn within 90 days. If a contribution is made in excess of that to be withdrawn, only the amount of contribution greater than the withdrawal is deductible. If the plan holder dies within this period, the outstanding amount of the loan is taxed. The basic calculation is: amount of withdrawal, divided by 15, equals minimum annual repayment. Example: Ozzie and Harriet, both aged 59, have been contributing to their RRSPs for years. Ozzie has $46,000 in his, while Harriet has amassed $62,000. Content with apartment living and travelling, in December they found a dream ski chalet, within easy commute to the city, and although they have $15,000 in cash, it is insufficient for the $53,000 down payment they need. What can they do to raise the cash and close the deal? Since neither has been a house owner for the past five years, including the year of withdrawal, they can each borrow $25,000 from their respective RRSPs as long as certain conditions are met. They must move into the chalet by October of next year, and treat the chalet as their principal residence. They must structure the repayment of the loans over a period of 12 years, not 15, since at age 71 they must terminate their RRSPs. Question: In December of this year, 59-year-old Bonnie, and Clyde, age 44, her husband of three years, decided to buy a house. Although this would be a first (house and marriage) for Bonnie, Clyde had both a previous wife, from whom he separated and then divorced, and a home, his interest in which he conveyed to his ex-wife three years ago. Clyde has $17,500 in his RRSP, while Bonnie just topped hers up to $23,000 when she deposited a bonus cheque of $5,000 into her account on December 15. How much can each withdraw from their respective RRSPs for a down payment on the house, what limitations, if any, will apply to Bonnie s contribution, when must the loan(s) be repaid to avoid taxation, and what is the latest date on which they should close on the house and take possession? Lifelong Learning Plan A Lifelong Learning Plan withdrawal can be made by an individual, or his or her spouse or common-law partner, if the individual or his or her spouse is enrolled in a qualifying educational program at a designated educational institution on a full-time basis. A RRSP plan holder may withdraw a maximum of $10,000 per year, to an individual limit of $20,000 over a maximum period of four years. The loan must be repaid over a period no longer than 10 years. Each year, a minimum of 10% of the total loan must be repaid. No interest is charged on the loan. If the plan holder dies within this period, the outstanding amount of the loan is taxed. The basic calculation is: amount of withdrawal, divided by 10%, equals the minimum amount of repayment. Example: John Dough has borrowed a total of $18,000 from his RRSP to pay tuition for the three-year funeral director s course at Mortal Community College. The course is approved and the college designated within the meaning of the plan. John withdrew $9,000 His loan repayment in year one is Copyright 2011 Oliver Publishing Inc. All rights reserved. 383

14 LLQP $1,800 per year for 10 years beginning the earlier of the year after he completes his studies or the fifth year after the loan was initially taken. Question: Paul Bunion enrolled in a forest-management program (an approved course), at Timberlane College (a designated educational institution). He borrowed a total of $17,000 from his RRSP for the three-year program, and had made four minimum annual payments allowable under the Lifelong Learning Plan when he was struck and killed by a falling tree. How much of the loan had Paul repaid at the time of his death, and how is the balance of the outstanding loan treated for tax purposes? REVIEW: Pension Adjustments on RRSP Contribution Limits There are three factors that determine how much can be contributed annually to an RRSP: 1. The lesser of a dollar limit, or an annual deduction limit of 18% of the previous year s earned income 2. A pension adjustment, which represents the value of benefits accruing in the company-sponsored Registered Pension Plan (RPP) or a Deferred Profit-Sharing Plan (DPSP). The pension adjustment for any current year must be deducted when calculating the allowable RRSP contribution for the subsequent year. 3. A past service pension adjustment when contributions are made to an employee s pension plan for the years the employee worked for the employer previously, either because he was not a member of the plan during those years or because the plan was upgraded and the plan permits current members to make additional contributions for previous years of service. will also reduce the amount of RRSP contribution. RRSP contributions are carefully monitored by the CRA, so that an individual does not exceed his or her annual contribution maximum. Both pension adjustments (the value of benefits accruing in the companysponsored plan) and past service pension adjustments (contribution by the employer to a defined benefit plan for the years of employment prior to the implementation of the company plan) will affect the RRSP contribution, but in slightly different ways. Example: Robert s income and pension adjustments look like this: Income $52,400 $55,000 $58,675 Pension adjustment $1,200 $2,200 $3,200 Past service pension adjustment $500 $1,000 $1,500 To calculate his maximum RRSP contribution for the year 2010, CRA calculates: Robert s income for 2009 x 0.18 $9,900 (lesser of 18% of previous years salary or Dollar limit for 2010 which is $22,000) pension adjustment for ,200 past service pension adjustment for ,500 Robert s limit for 2010 $6, Copyright 2011 Oliver Publishing Inc. All rights reserved.

15 Insurance Calculations Question: Bill Bailey s income, pension adjustment, and past service pension adjustment for the year 2009 are respectively: $58,500, $2,200, and $1,300. In 2010, his income is $62,750, his pension adjustment is $3,000 and his past service pension adjustment is $3,600. Calculate Bill s maximum RRSP contribution for the year REVIEW: Registered Retirement Income Fund (RRIF) Withdrawals A RRIF has an annual minimum withdrawal requirement. It is determined by the age of the plan holder, the date on which the RRIF was established, and other factors, such as whether the plan has been changed since it was first established. These factors are reflected in a table from the CRA that shows the minimum withdrawals as a percentage of the value of the plan. The plan holder may withdraw more than the minimum, in which case a graduated withholding tax (similar to that for RRSP withdrawals) will apply. The basic calculation is: From age 71, the CRA table applies to the RRIF plan holder or his or her spouse onward. If the plan holder or spouse is 70 or younger, the minimum withdrawal is calculated as: the value of the plan at the first of the year, divided by 90 minus the age of the plan holder or spouse. Example up to age 70: Rhonda, at age 67, has a plan valued at $100,000 at the beginning of the year. She wishes to make the minimum withdrawal allowed, and is uncertain what this amount is. The minimum amount is $100,000 (90 67) = $4, Example age 71 and older: Roger Elder is 70 years old. He established a RRIF in 1995 that has a current value of $200,000. He needs to know what the minimum withdrawal will be. Minimum RRIF withdrawals for those aged 71 or older are determined by a schedule in the Income Tax Act that lists the minimum withdrawal amount. The following illustrates how much Roger would receive at various ages according to the type of plan he might have. For the sake of simplicity, it bases the yearly calculation on $200,000; in actual fact, the $200,000 value of the plan would be reduced by the withdrawals, but would be increased by interest or investment income. Roger s Age Pre-March 1986 plan Qualifying plan All other RRIFs 71 $10,520 (5.26%) $10,520 (5.26%) $14,760 (7.38%) 72 $11,120 (5.56%) $11,120 (5.56%) $14,960 (7.48%) 73 $11,760 (5.88%) $11,760 (5.88%) $15,180 (7.59%) 74 $12,500 (6.25%) $12,500 (6.25%) $15,420 (7.71%) 75 $13,340 (6.67%) $13,340 (6.67%) $15,700 (7.85%) 80 $20,000 (10.00%) $17,500 (8.75%) $17,500 (8.75%) 84 $33,340 (16.67%) $19,860 (9.93%) $19,860 (9.93%) 89 $200,000 (100%) $25,420 (12.71%) $25,420 (12.71%) 90 0 (0%) $27,240 (13.62%) $27,240 (13.62%) 91 0 (0%) $29,460 (14.73%) $29,460 (14.73%) 92 0 (0%) $32,240 (16.12%) $32,240 (16.12%) 93 0 (0%) $35,840 (17.92%) $35,840 (17.92%) (0%) $40,000 (20.00%) $40,000 (20.00%) Copyright 2011 Oliver Publishing Inc. All rights reserved. 385

16 LLQP Roger decides to withdraw $15,000 from his qualifying plan when he is 71, which in addition to his other income will put his marginal tax rate at 23%. What are the immediate and yearly tax implications attributable to this withdrawal? The minimum withdrawal is $10,520. A withholding tax applies to withdrawals in excess of the minimum withdrawal. Since Roger s withdrawal is $4,480 above the minimum, a withholding tax of 10% will be withheld on the additional amount. Therefore, Roger receives $14,552 ($4,480 x 10% = $448; $15,000 $448 = $14,552). As Roger s marginal tax rate is 23%, the amount of tax payable on the total withdrawal is calculated as: $15,000 x 23% = $3,450. However, the $448 that was withheld when the funds were withdrawn, must be deducted: $3,450 $448 = $3,002. Therefore, Roger s tax liability for his withdrawal is $3,450, of which $448 has been deducted at source. Question: Rhoda at age 70, has a plan valued at $200,000 at the beginning of the year. She wishes to withdraw only $12,000. Does this sum meet the minimum withdrawal that is required, and assuming a withholding tax of 10% on the first $5,000 in excess of the minimum amount, what is the actual cash that Rhoda will receive when making the withdrawal? REVIEW: Splitting CPP Benefits As a strategy for tax saving through income-splitting, the higher-income spouse can direct up to 50% of his or her CPP benefits to the lower-income-earning spouse.. This may be done provided both spouses are over age 60. However, if this is done, a portion of the recipient spouse s CPP is automatically transferred back to the first spouse. If the transferring spouse has high CPP benefits and the recipient spouse has low, or no, CPP benefits, the assignment can effectively transfer up to half of the CPP income to the lower-income spouse. The amount that can be transferred, up to a maximum of 50%, depends on the length of time the spouses lived together as a proportion of their total contributory period. Example: Andrew and Sylvia, aged 64 and 62 respectively, have retired from show business and are receiving CPP benefits. Andrew, whose benefits are $4,800 per year, is taxed at the rate of 23%, while Sylvia, taxed at the rate of 39%, has yearly CPP benefits of $6,560. They decide to consider splitting their income by assigning 50% of their CPP benefits to the other. What, if any, tax benefits will arise from this strategy? Andrew s tax liability on his pre-split benefit ($4,800 x 23%) = $1,104 Sylvia s tax liability on her pre-split benefit ($6,560 x 39%) = 2,558 Total tax payable $3,662 Total benefits $11, Individual benefit after splitting ($11,360 2) 5, Andrew s tax liability on split benefit ($5,680 x 23%) 1, Copyright 2011 Oliver Publishing Inc. All rights reserved.

17 Insurance Calculations Sylvia s tax liability on split benefit ($5,680 x 39%) 2, Total tax payable $3, Tax savings ($3,662 $3,521.60) $ Splitting their income through the assignment of 50% of their CPP benefits will save them $ in taxes. Question: Brenda and Marty, aged 63 and 64, have been married for 35 years. Marty, taxed at the rate of 36%, has CPP benefits of $6,700 per year, while Brenda, taxed at the rate of 21%, has CPP benefits of $4,800 per year. Assuming that they can and do split 50% of their CPP benefits, calculate their combined tax savings, if any. Copyright 2011 Oliver Publishing Inc. All rights reserved. 387

18 LLQP Answers Policy Benefits when Age Has Been Misstated Premium charged premium that should have been charged x face value of the policy is: x $60,000 = $55,000 Insurance needs: Human-Life Approach Real interest rate is 7 3 = 4% Amount of insurance required = $50, = $1,250,000 Insurance in place 200,000 Additional requirement 1,050,000 Insurance needs: Capital-Needs Approach The family will require additional insurance on the major income earner in the amount of $405,000 Cash needs: assets final expenses $200,000 $250,000 = ($50,000) shortfall. Continuing income needs as yearly income sources yearly income needs $20,000 $35,000 = ($15,000) shortfall. Capitalized value of deceased s life as continuing income needs shortfall divided by the expected rate of return $15,000 4% = $375,000 Add to his shortfall of cash needs $375,000 + $50,000 = $425,000 Death benefit of term policy $20,000 Additional insurance $405,000 Capital Gains and Losses Tax liability without factoring in the capital loss on the Techie stock is: Capital gain of $5,250 x 50% = $2,625 is the taxable gain on the sale, which when, taxed at her marginal rate of 30%, means a tax liability of $2,625 x.30 = $ Tax liability when factoring in the capital loss on the Techie stock is: Net Capital Gain = Capital gains on the sale of the bank stock, less capital losses on the Techie stock $5,250 $3,245 = $2,005. Taxable Capital gain of $2,005 x 50% = $1,002.50, when taxed at her marginal tax rate of 30%, means a tax liability of $1, x 0.30 = $ Residual Disability Benefits 8,000 (pre-disability income) 4,000 (post-disability income) = 4,000 = 50% 8,000 (pre-disability income) 8,000 Joan s monthly benefit under the policy is $3,000; she will receive 50% of $3,000 = $1,500 as a residual benefit. Coordination of Benefits $108 will be reimbursed by Jack s group plan in the first month because: $235 submitted less $100 deductible co-insurance $135 x 0.8 = $ Copyright 2011 Oliver Publishing Inc. All rights reserved.

19 Insurance Calculations $127 will be reimbursed by Jill s group plan in the first month, because Jack is covered by more than one plan for his expenses. Since he is a dependent spouse under Jill s plan, her plan is second in priority. It therefore pays the lesser of what it would have paid had it been the primary carrier, or 100% of the eligible expenses, reduced by the benefits paid for the same expenses by the primary carrier. $235 submitted less $75 deductible $160 would have been paid if Jill s plan was the primary carrier, but since Jack s plan already paid $108, Jill s plan will pay the lesser of ($160 or $235 $108) = $127 Seg Fund Maturity and Death Benefit Guarantees The guarantee on the original deposit was $20,000 x 0.75 = $15,000. The maturity guarantee will provide a benefit of $655 (the difference between the value of the fund at maturity and the maturity guarantee) to provide the investor with $15,000. Seg Fund Resets The fund will mature on November 17, 2021, with a death benefit and a maturity guarantee of $38,625 ($51,500 x 75% = $38,625) Seg Fund Withdrawals Danny surrendered 400 units from the fund ($15,200 $38 = 400) Using the linear method of reduction, the new guaranteed value in his contract is: $36,000 $15,200 = $20,800 x 0.75 = $15,600 Using the proportional method of reduction, the new guaranteed value in his contract is the balance of units in the fund which is reduced to 800 (1, ). The value in the fund is reduced to $24,000 (800 1,200 x $36,000). The guarantee is therefore $24,000 x 75% = $18,000. Alternate Method (Proportional): Original Guarantee = 75% x 36,000 = 27,000 FMV of fund at withdrawal = $38 x 1,200 = 45,600 New Guarantee = (FMV Withdrawal amount) x Original Guarantee FMV = (45,600 15,200) x 27,000 = 30,400 x 27,000 = $18,000 45,600 45,600 Since Danny disposed of one-third of the contract ($15,200 $45,600 = 0.333), he must report a capital gain of $3,196.80, which is one-third of the difference between the ACB of the contract and its market value at the time of the withdrawal [($45,600 $36,000) x = $3,196.80]. Market Value Adjustment to Annuities His annuity rate will be reduced to the three-year rate of 4.1%, and further reduced by the penalty of 0.6% to 3.5%. CPP with Early or Late Retirement Options At age 63, her pension will be reduced by 0.5% x 24 months = 12%. Benefit payable is therefore $650 12% = $572. At age 68, her pension will be increased by 0.5% x 36 months = 18%. The benefit payable is therefore $ % = $767. Copyright 2011 Oliver Publishing Inc. All rights reserved. 389

20 LLQP RRSP Withdrawals A one-time withdrawal from her RRSP sufficient to net $6,000 would need to be $7,500 because of the 20% holdback on the funds ($7,500 20% = $6,000). She must declare $7,500 as her income and she will get a credit of $1,500. RRSP Home Buyers Plan Withdrawal Neither Clyde nor Bonnie can make a withdrawal under HBP as Clyde owned a home within the last four years. RRSP Lifelong Learning Plan Withdrawal Paul had repaid $6,800 at the time of his death (4 x $17, = $6,800). The outstanding amount of the loan ($10,200) is taxed as income to Paul in the year in which he died. Pension Adjustments on RRSP Contribution Limits 2009 income $58,500 x 0.18 $10,530 Pension adjustment for 2009 $2,200 Past service pension adjustment for 2010 $3,600 Maximum contribution is $4,730, which is the lesser of $22,000 or $4,730. RRIF Withdrawals Minimum amount required is $200,000 (90 70) = $10,000. The additional $2,000 is subject to a 10% withholding tax of $200. The net amount that Rhoda will receive is $11,800 ($10,000 + $1,800). Splitting CPP Benefits Marty s pre-split tax liability on the CPP income $6,700 x 36% = $2,412 Brenda s pre-split tax liability on the CPP income $4,800 x 21% = $1,008 Total tax payable by both: $3,420 Post-split benefits $6,700 + $4,800 2 = $5,750 each Marty s post-split tax liability on CPP income $5,750 x 36% = $2,070 Brenda s post-split tax liability on CPP income $5,750 x 21% = $1, Total tax payable by both: $3, Tax saved $3,420 $3, = $ Copyright 2011 Oliver Publishing Inc. All rights reserved.