Over the last few years, annuities and life insurance haven’t received the attention they deserve, as rising stock and real estate prices captured investors’ attention. Now, inflation and rising interest rates are eroding purchasing power, while recession worries weigh on stocks, bonds and real estate.
It’s no wonder, then, that more investors are focusing on protecting what they’ve built. Here are four ways life insurance and annuities can help you do so.
1. Avoid these two life insurance “traps”
Life insurance generally comes in two varieties: term policies, which pay a fixed amount to your named beneficiaries if you die within the policy’s term, and permanent policies, which pay out no matter when you die. In addition, permanent policies devote part of your premiums to building a cash reserve that grows on a tax-deferred basis and can pay dividends, as well.
No matter which type of you choose, one “trap” you should avoid is going with an arbitrary number when deciding how much insurance you need. Andre Guillemette, Wealth Protection Specialist at BlueShore Financial, often hears from people who pick, say, a million dollars’ worth of coverage because it’s a round figure they may have heard from the media, or friends and family.
“For most people, that’s not enough,” says Guillemette. “Vancouver’s cost of living is high, of course, and if you want to replace your income over a period of years, a million dollars doesn’t go as far as it used to. In my view, 10 to 20 times annual income is a good starting point, but you should discuss your unique needs with a financial advisor.”
Another mistake people often make is assuming the remaining spouse will simply go back to work and carry on as before – but that’s unlikely, given the emotional toll of losing a spouse and the burden of running a household alone.
“For example, if the remaining spouse has a three-year-old and a five-year-old, they likely won’t be able to work the same amount as they did before, or may have to hire help,” says Guillemette.
In addition, Guillemette says people often overlook the emotional toll: “Imagine your partner just passed. Are you really going to go back to work like nothing happened? Most people don’t think about that. You just don’t know how you’d react to a situation like that.”
2. Combine life and mortgage insurance for broader coverage at low cost
Most people who’ve bought a home are familiar with mortgage insurance**, which is designed to pay off the balance of your mortgage upon your death. There are also components of most mortgage-insurance policies that cover your payments for a set period of time if you’re ill or injured and can’t work, or if you suffer a job loss.
One thing to bear in mind is that this type of insurance loses value over time, as premiums are set when you first take out your mortgage, so you’re essentially paying the same premium to cover a shrinking liability as you pay it down. That could make a term life insurance policy for the initial value of the mortgage a better option. But life insurance doesn’t cover you if you’re injured and can’t work.
A good strategy could be to combine the two. For example, many mortgage insurance plans require you to take the mortgage-life insurance component of the policy up to a minimum amount in order to access the disability and job-loss features. The good news is that this minimum is typically very low.
So it could be possible to take the minimum amount of mortgage-life insurance to get the disability and job-loss features. Then you could add a fixed amount of separate term life insurance, say up to the original balance of the mortgage.
This way, you’ll still be able to access your mortgage-insurance policy’s disability and job-loss coverage. And in the event of your death, the term policy’s payout flows to your beneficiary tax-free, and it doesn’t decline in value with the mortgage, either.
3. Consider a cash-refund annuity as interest rates rise
With an annuity, you simply deposit a fixed amount of money with an insurance company, and they provide you with a fixed payment at a regular interval (monthly, quarterly, every six months or annually) either for the rest of your life or a specified term. This payout consists of your money being handed back to you and interest on your original deposit. Annuities have become more popular in recent months, as rates have risen.
The risk with a traditional annuity is if you die early in the term, the financial institution keeps the funds that haven’t yet been paid out to you. But another type of annuity – the “cash-refund annuity” – avoids this risk.
Under a cash-refund annuity, if you die before the annuity expires, the balance transfers to a named beneficiary and avoids probate, much like a life-insurance policy’s payout. The disadvantage: this increased safety comes at the cost of higher fees.
Nonetheless, cash-refund annuities could be a good option if you want to generate an income stream in retirement – to pay for home care or a senior-care facility, say – and still leave a legacy for your loved ones. Today’s elevated interest rates also add appeal, as they increase your monthly payouts, helping offset cash-refund annuities’ higher fees.
4. Use this tax-efficient life-insurance strategy to access money in your corporation
If you’ve owned a business for a number of years, you may have accumulated a large amount of excess earnings within the company. The problem, as you no doubt know, is that accessing these funds yourself will likely trigger a big tax bill. If you’re in the top tax bracket, for example, tapping this cash as part of your salary could result in it being taxed at your highest marginal rate (53.5% in British Columbia).
Here’s where a life insurance–based strategy comes in. There are a number of steps here, so you should work closely with your financial advisor, as well as your accountant, when following this plan. But essentially, you’d use some of the money in your company to buy permanent insurance on your life, while naming the company as the beneficiary. Over time, the company would devote money to the policy, boosting its cash value.
At retirement, you could take a loan from a bank for the equivalent of the life-insurance policy’s cash value, using that value as collateral (most banks will allow you to borrow against up to 90% of the policy’s value). You would then use the loan to fund your retirement. When you die, the policy’s payout would go to your corporation, which could then pay it to your estate to pay off the loan balance.
Your financial advisor can help design the best wealth-protection plan for you
The above strategies can all be highly effective at protecting your wealth from economic upheaval, unexpected changes in your life or even your death.
But this article is only an introduction – to get more information and find the best strategies for you, speak with your financial advisor. They will work with you (as well as your accountants, lawyers and other professionals) to fully assess your financial situation and make sure you have the right plan in place. Make an appointment today. DISCLAIMERS CUMIS ARTICLE GENERAL INSURANCE