February 23, 2009, 6:00 am

Yep, Another Insurance Strategy to be Used as an Investment Vehicle – The Back-to-back

by: The Financial Blogger    Category: Financial Planning,Insurance,Investment, Market and Risk
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It’s funny how I used to be against most insurance agent and their products and that I am slowly changing my mind 😉 It is probably because I work with a smart insurance representative in my office 😉 He is showing me a bunch of great tips on ways you can use insurance for your benefit. Even thought, I still think that insurance products are being crafted in a dark tower by an evil scientist, I must admit that there are a tons of great strategy attached to them!

So today’s strategy is very interesting for your grand parents (the sweet spot is about 65 to 75 years old). In order to realize this strategy, you need two products offered by insurance companies:

– A life income fund

– A life insurance

So the mechanism is pretty easy:

Let say that you have 100K in a certificate deposit (CD), you will probably have a rate of 3% to 5% (more 3% to 4% these days 😉 ). Instead of making such low interest, you could use your 100K and by a life income fund from an insurance company. Since you are not getting any younger, the rate of distribution would be fairly appreciable (around 10% to 11%).

So let assume that you get 10K every year based on a 100K investment in a life income fund. The good news is that if you are 65 and you live up to 95, the insurance company will pay you a lot more than what you could have get from your 100K in a certificate deposit. However, the downside is that if you die at the age of 67, you would have received only 20K and your estate will be left with nothing of the original 100K (insurance companies have to make money somewhere, don’t they?).

This is why we insure your life with a life insurance. The insurance premium for a 65 year old (non-smokers 😉 ) would be quite high. It will probably be around 3,5K per year. However, at your death, your estate will still have the 100K while you had been able to enjoy the fruit of your money alive.

Let put everything back together:

– You purchase a life income fund for 100K

– You will receive 10K per year from it.

– Tax rate in Canada on life income fund is quite interesting. Therefore, you will only pay 2k of taxes on this income.

– Therefore, you will earn a net income of 8K per year.

– In order to protect your estate, you will purchase a life insurance for 3,5K per year.

– The insurance premium will be paid by your life income fund.

– Therefore, you will receive a guaranteed after tax amount of 4.5%

Wait, I could have made between 3% and 5% with my certificate deposit, so what’s the point of doing this whole thing for a guaranteed rate that I could get anyway?

The thing is that your 3% to 5% is before tax return. As interest income is fully taxable, chances are that you will pay a 30% tax on it (in Canada). Therefore, your after tax return will be between 2.1% and 3.5%…

As you can see, the maximum you can earn with a certificate deposit is 3.5% after tax. Considering our current economic situation, it will even be rough to get your 5% before tax interest rate.

Therefore, it could be a good idea to talk to an insurance agent in order to validate the strategy and make real calculation to make sure it is applicable to your situation. Keep in mind that by doing so, you will earn a better interest rate on your investment, but you will never be able to access your capital until your die. Therefore, if the strategy is suitable for your situation, I still suggest to not put all your money into this strategy.

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Really, that’s interesting!!! I didn’t think about this investment vehicle.

Insurance issues are interconnected with taxation, investment, an legal aspects. Because of this, relying solely on an insurance specialist is sometimes not enough, … just like relying on an accountant, a lawyer, or a financial adviser alone would not be hehehe 🙂

That sounds better than many insurance products, but if you rely on it for a long time inflation could become a problem.

Awesome strategy. TFB, would you generally recommend talking to a FA about such strategies or directly with the insurance seller?

Silicon Prairie,
your point is good. However, it is the very same problem with all the fixed income (read CD and bonds) strategy 😉

I would suggest you find someone who has done it before ;-0 a combination of a financial advisor and an insurance rep could be a good thing!