1 GIVE YOUR CLIENTS A RAISE, LONG AFTER THEY RETIRE The executive retirement account A strategy using exempt life insurance.
2 Here s the story Robert, 45, is the owner-manager of ABC Manufacturing (ABC) and Susan, 45, is a key employee. To protect the business in case of a premature death, the company needs to own $1 million life insurance policies on each of them. For Robert, this would also help fund a buy-sell agreement. Robert s concerns: he wants more security for his investments, so he s considering holding some assets outside of his business to ensure they are protected from creditors, his non-indexed pension will lose buying power after he retires, and his current savings may not be enough for potential expensive health care later in life. Susan s concerns: her non-indexed company pension plan will lose purchasing power during retirement, and her retirement savings may not be enough for potential expensive health care later in life. Traditionally, the company would purchase term insurance on Robert s life and he would invest in a non-registered portfolio for retirement. Susan s plans to invest in a non-registered portfolio would give her additional income at retirement to supplement the company pension plan and registered retirement savings plan (RRSP). Is there a better way? The challenge The percentage of pre-retirement income that is funded from tax-preferred registered plans decreases as income increases. Let s take a look at some of the alternatives to such plans. Additional tax-preferred savings options: Tax shelters like real estate, film, oil and gas ventures, and limited partnerships have high risk and require careful selection and ongoing management. Growth equity funds, segregated funds and stocks also require careful selection and ongoing management. To realize maximum tax benefits, these funds assume significant risks. Exempt life insurance policies provide insurance coverage and a tax-preferred build up of funds within the policy. These savings can be used to fund retirement income. 2 The executive retirement account
3 Percentage of pre-retirement income replaced 70 Percentage of pre-retirement income $125,000 $150,000 $175,000 $200,000 $225,000 $250,000 Pre-retirement income RRSP contribution limit $22,000 $22,450 $22,970 Earned income $122,222 $124,722 $127,611 RPP money purchase limit $22,450 $22,970 $23,820 Pensionable earnings $124,722 $127,611 $132,333 RPP defined benefit limit $2,494 $2,552 $2,647 Pensionable earnings $124,722 $127,611 $132,333 (2 per cent benefit) Current limits on tax-preferred saving The 2012 RRSP contribution limit of 18 per cent of earned income to a maximum of $22,970 caps contributions for any individual with earned income greater than $127,611. These limits are scheduled to rise each year with inflation. The 2012 defined benefit registered pension plan (RPP) limit of $2,647 may be reached with pensionable earnings of $132,333 for plans with a maximum 2 per cent benefit formula. Again, these limits are scheduled to rise each year with inflation. The solution The executive retirement account (ERA) applies the insurance and investment components of a single SunUniversalLife insurance policy to meet the multiple and varied needs of each party. Both Susan and Robert can capitalize on this strategy to help meet their goals. The executive retirement account 3
4 Key employee or owner-manager buys SunUniversalLife policy and contributes to the fund. Company pays for costs of insurance according to the terms of an agreement with the key employee or owner-manager. Insured names the company as the irrevocable beneficiary for the face amount. Benefits of a SunUniversalLife Policy Face amount tax-free at death protects business against loss of executive Fund value grows tax-preferred available at retirement or death The result Susan, Robert and ABC Manufacturing (ABC) have different situations and goals. This approach is best suited to each of their specific circumstances and needs. Susan s case: Susan will own a SunUniversalLife insurance policy with an insurance amount plus fund death benefit, but she will designate ABC as the irrevocable beneficiary for the initial face amount, and her own heirs as revocable beneficiaries for the balance. If Susan dies, ABC will receive $1 million, while Susan s beneficiaries will receive an amount equal to the policy cash value at the time of death. Policy payments are projected to be $32,000 per year for 20 years. ABC will pay a policy payment approximately equal to the policy s cost of insurance (COI), $7,404, and Susan will pay the rest of the policy payment, approximately $24, Robert s case: Robert and ABC will share ownership of a SunUniversalLife insurance policy with an insurance amount plus fund death benefit. The initial death benefit will be $1 million plus an amount equal to the policy cash value on Robert s death. If Robert dies, ABC will receive $1 million, while Robert s beneficiaries will receive an amount equal to the policy cash value at the time of death. Policy payments are projected to be $32,000 per year for 20 years. Robert will pay approximately $23,266 each year in policy payments for 20 years, while ABC Manufacturing will pay approximately $8,734 2 each year for Robert s life, an amount approximately equal to the policy s cost of insurance (COI). Susan owns her policy, but signs a shared benefit agreement with ABC, while Robert signs a shared ownership agreement. The insurance company will not be a party to either agreement. The agreements specify the obligations of each party with respect to the insurance, along with provisions for terminating the agreement. 1 ABC Manufacturing s payments for insurance protection on Susan s life are similar to what it would pay for a SunUniversalLife insurance policy with minimum yearly policy payments. 2 The first year COI is $10,908. After deducting the COI discount, the COI starting in year two is approximately $8, The executive retirement account
5 In Susan s case, she wants to own the policy after she leaves ABC, so it is best for her to own the policy from the beginning. If instead ABC owned the policy from the outset, transferring ownership of the policy from ABC to Susan at her retirement would create undesirable tax consequences for both Susan and the corporation. Also, after Susan leaves ABC, ABC will have no reason to have insurance on her life. In Robert s case, however, ABC will own the policy because it will continue to have a financial interest in Robert s life for as long as he owns shares in ABC. As a result, after 20 years, ABC will continue to pay at least the COI in order to keep the policy in force. Susan s SunUniversalLife policy is projected to have accumulated $878,239 of additional capital by the time she turns 65, tax-preferred. This is $146,701 more than the after-tax accumulation she may have had if she had invested in an alternate non-registered investment. 3 If Susan dies, before retirement, ABC will receive a tax-free $1 million death benefit, and Susan s beneficiaries will receive an amount equal to the cash value accumulation in the life insurance policy, also tax-free. Starting at Susan s retirement, the shared benefit agreement will end, Susan and ABC will stop paying policy payments, and ABC will release its interest in the death benefit. Over the next 10 years Susan will withdraw $70,727 each year after-tax from the insurance policy. Based on a 5 per cent assumed interest rate, the policy is projected to remain in force for Susan s life, and provide lifetime insurance coverage of more than $1 million for Susan s beneficiaries after she retires. Susan could also use the policy as collateral for a series of bank loans. Based on a life expectancy of 86 and a maximum loan of 75 per cent of the value of the policy, Susan could receive annual tax-free loans of $57,270. If she did this, and depending on how long she lives, Susan s beneficiaries could receive more money at her death than if she took income through withdrawals. However, the withdrawal scenario could produce more after-tax income for her and could avoid the risks associated with leveraging the policy. 4 $2,000,000 Estate benefit comparison In all years the life insurance policy death benefit is projected to be greater than the alternate investment amount. Estate benefit $1,500,000 $1,000,000 $500, Age ABC death benefit UL leveraging UL withdrawals Alternative investment 3 assumes annual rates of return of 5 per cent for a SunUniversalLife insurance policy with face amount plus fund death benefit; 5.15 per cent to age 65 and 4.7 per cent thereafter for Alternative Investment Balanced Fund; loan rate of 7 per cent. None of these rates or values is guaranteed or is an estimate of future rates or values. Actual results will vary and will be significantly different even with only a minor change in interest assumptions. You should review a SunUniversalLife product illustration to see how alternate interest rate scenarios may impact future values. 4 one of the most important risks is that the bank may require additional collateral, possibly at any time, but almost certainly if Susan lives beyond her projected life expectancy of age 86. If Susan cannot provide additional collateral, the bank may call its loan, and that may mean that Susan would have to surrender her policy with adverse tax consequences. Susan may guard against this risk by assuming a higher life expectancy than the age 86 used in this example, but income from leveraging will be less. See our guide, Leveraging a life insurance policy: A guide for lawyers, accountants and insurance advisors at for more details about the advantages and risks of leveraging and life insurance. The executive retirement account 5
6 At age 65, Robert will have accumulated $824,463 of additional capital in his SunUniversalLife policy in a tax-effective manner. This is $ 139,007 more than the after-tax accumulation he would have if he had invested in an alternative balanced fund. 5 If Robert dies, ABC will receive a tax-free $1 million death benefit, regardless of his age at death. Robert s personal beneficiaries will receive an amount equal to the cash value accumulation in the life insurance policy, also tax-free. Starting at retirement, Robert stops paying policy payments. Unlike the case with Susan, the shared ownership agreement remains in place because ABC will still need life insurance on Robert s life. Over the next 10 years, Robert withdraws $61,342 each year after-tax from the insurance policy. Based on an assumed 5 per cent interest rate, the policy is projected to remain in force for Robert s life, and provide lifetime insurance coverage of at least $1 million for ABC. Subject to the agreement, Robert could also use the policy as collateral for a series of bank loans. Based on a life expectancy of 82 and a maximum loan of 75 per cent of the value of the policy, Robert could receive annual tax-free loans of $56,175. The leveraging option could also produce a higher estate benefit for most of Robert s life, and is illustrated in the chart below. However, there are risks associated with leveraging the policy that Robert must be made aware of. 6 Estate benefit comparison $1,250,000 In all years the life insurance policy death benefit is projected to be greater than the alternate investment amount. Estate benefit $1,000,000 $750,000 $500,000 $250, Age ABC death benefit UL leveraging UL withdrawals Alternative investment In Susan s case, the lines representing the universal life (UL) policy leveraging and withdrawals also represent the death benefit that the policy is projected to pay, and are always above the alternate investment line. So it s easy to understand that the projected death benefit is greater than the alternate investment. Here, if you apply the same reasoning, it s easy to see that the alternate investment crosses the UL leveraging and withdrawal lines, so it may look like the alternate investment outperforms the life insurance policy. But when you consider the fact that the projected death benefit is always greater than the alternate investment you can see that s not the case. 6 The executive retirement account 5 assumes annual rates of return of 5 per cent for a SunUniversalLife insurance policy with face amount plus fund death benefit; 5.15 per cent to age 65 and 4.7 per cent thereafter for Alternative Investment Balanced Fund; loan rate of 7.0 per cent. None of these rates or values is guaranteed or is an estimate of future rates or values. Actual results will vary and will be significantly different even with only a minor change in interest assumptions. You should review a SunUniversalLife product illustration to see how alternate interest rate scenarios may impact future values. 6 The first year COI is $10,860. After deducting the COI discount and adding premium tax, the COI starting in year two is approximately $8,746. See footnote 5, above, for a discussion of some of the risks of leveraging. See our guide, Leveraging a life insurance policy: A guide for lawyers, accountants and insurance advisors at for more details about the advantages and risks of leveraging and life insurance.
7 MAKING IT EASY Our goal is very simple to make it as easy as possible for you to sell and service our products. By providing your clients with a concrete summary of the issues that face them, you will be better positioned to help them structure an effective financial solution. That s why we offer the following tools that you can use to explain the benefits of the ERA strategy to your clients: Executive Retirement Account STRATEGY TOOLS ERA illustrations: Clearly demonstrate how your clients differing objectives can be met with this unique approach. Using your clients actual financial data, you can easily compare the costs and benefits of the insurance solution versus those of taxable investments. Our powerful Eos software can do all of the income calculations for you, or you can customize income streams from the insurance policy and alternative investment. Client reports: The ERA client report provides a powerful presentation of your clients problems and our solutions. The client report shows your clients, clearly and simply, how the ERA strategy can enhance their income and their estate. Outline of a sample ERA agreement: Your clients lawyers may find our outline of a sample ERA agreement helpful when drafting an effective insurance-sharing agreement. A copy of the agreement can be found on The executive retirement account 7
8 Sharing interests in a life insurance policy lawyers and accountants: This comprehensive guide explores the tax and legal issues that you will need to consider in drafting the insurance sharing agreement needed to implement the ERA strategy. Guide to leveraging a life insurance policy: A guide for lawyers, accountants and insurance advisors, this booklet reviews several methods of accessing cash value of an exempt life insurance policy, including a number of third party leverage structures, with a balanced discussion of benefits and risks. SunUniversalLife tools: For further information about the versatility of SunUniversalLife, our client guide, advisor guide, and investment account options booklet can provide you and your clients with full details about the product s features and benefits. SunUniversalLife CLIENT guide SunUniversalLife provides permanent life insurance protection to meet your long-term needs plus the opportunity for tax-preferred growth in savings. It s designed for people like you who want security, diversified investment opportunities, guarantees and greater flexibility. This flexibility allows you to customize your policy at issue and adjust it as your needs change in the future. What s inside How your SunUniversalLife policy works Types of coverage Custom-design your policy What s the bright idea? SunUniversalLife The bright idea behind the ERA strategy is SunUniversalLife. Besides providing your clients with a flexible financial planning tool, SunUniversalLife gives you the confidence to deliver: optimal tax growth, competitive, guaranteed level cost of insurance, a bonus option that combines a guaranteed investment bonus starting in year two with a unique cost of insurance discount controlled by the client, or a no-bonus option that provides lower management fees on investment account options, a large selection of competitive tax-preferred investment options, including three exclusive Financial Post Index (FPX*) accounts and seven institutional managed accounts, tax-free access to policy funds if required in future as a result of disability. * FPX is a trademark of The National Post Company. 8 The executive retirement account
9 We re here to help We ve been a trusted and reliable company for over 145 years. As a leading international financial services organization, we continue to build on that strong foundation with a focus on market-leading products, expert advice and innovative solutions. Our team of insurance- and investment-focused sales directors, living benefits specialists, and advanced tax and estate planning specialists understand your needs and work with you to help you make the best decisions. Contact your sales director or visit today. Life s brighter under the sun Sun Life Assurance Company of Canada,