Case Studies

For incorporated physicians, the question is whether to invest using mostly their corporate account or in an RRSP and TFSA as well. Considering recently changed tax rules around corporate passive income, RRSPs and TFSAs have generally become more attractive for incorporated physicians.
To create RRSP contribution room, Dr. McCurdy would need to pay himself a salary (dividend income does not generate RRSP contribution room). Drawing a salary would also reduce his corporation’s net professional income, which would increase the corporation’s ability to earn investment income without consequence. Contributing to his RRSP would reduce the size of Dr. McCurdy’s corporate portfolio, thereby generating less passive income, which would make the corporation less likely to be affected by the passive income rules.

Dr. McCurdy could also invest in a TFSA. If he took the money out of the corporation to contribute to his TFSA, he would pay tax upfront. But once the money was in the TFSA, all income earned within it would be tax-free, making it a powerful savings tool.

Over the long term, the benefits of getting tax-free earnings from a TFSA will often be greater than the current tax savings that a physician would get from retaining money in their corporation. However, if he had to choose one over the other, Dr. McCurdy should likely go with the RRSP first.

After seeing their advisors, each decides to convert his or her $100,000 RRSP as follows:
John, who has always invested independently in order to have complete control over his investments, decides he also wants to manage his retirement savings. He converts his RRSP into an RRIF and elects to receive regular income for a period of 20 years.

Sandra wants to keep control over a portion of her savings to have a bit of flexibility and receive guaranteed regular income for life for security. She converts $50,000 of her RRSP into an RRIF and $50,000 into a life annuity with a guarantee period of 15 years. She will receive monthly income of $400 from her RRIF.

Mary wants guaranteed regular income until age 90. She converts her RRSP into a fixed-term annuity.
Here are the results of the three pensioners’ choices:

	John	Sandra	Mary
Retirement Income Process	RRIF 20 year period	RRIF Payments of $400/month	Life annuity with 15-year guarantee	Fixed-term annuity
Capital Invested	$100,000	$50,000	$50,000	$100,000
Monthly Income	$707/month for 20 years, after which RRIF will be depleted.	$400/month for 16 years and one month, after which RRIF will be depleted.	$316/month for life.	$589/month for 30 years, up to her 90th birthday.

James is a 25-year-old qualified carpenter who is a subcontractor to various builders. He is earning $70,000 gross but pays $20,000 in expenses, most which are fixed expenses ie a leased car and leased equipment. James rents an apartment and spends the rest of his earnings of $50,000 on living and entertainment expenses. James has little in the way of savings.

What if James doesn’t have insurance?

James has a car accident and is hospitalised for one month. He then faces a long and painful rehabilitation process of 12 months to try to regain the use of one of his arms. Even with private health insurance there are medical bills to be paid particularly for physiotherapy and rehabilitation sessions. John has no income for 13 months but must continue to pay his lease costs of $20,000 per annum. What little money Bob receives in disability payments from the government won’t cover his rental costs. Bob has to move back home and borrow money from his parents. If he doesn’t recover the use of his arm Bob will never be able to work as a carpenter again and will have to retrain into a potentially lower paid job.

What Insurances could James have taken out?

1. Income Protection
James could have taken out income protection for 75% of his net income of $50,000 which would provide him with a monthly benefit of $3,125.

As he had no sick leave or savings to fall back on ideally James should take out the shortest waiting period of 14 days, but this is also the most expensive. Other alternatives would be to take out a longer 30 day waiting period but include an accident option which would begin payments from day one if he suffered an accident or to take out a “Plus” product which includes a benefit payable within the waiting period if he is confined to bed.

Due to his youth James should ideally take out an age 65 benefit period as if his injury proved to be permanent and he could not work again in his own occupation he would be paid a benefit for the remaining 40 years of his income earning capacity. He should ensure that the policy is “own occupation” for the whole of the benefit period otherwise he could be forced to return to work in any other occupation he is suited to by his training, education or experience, even if lower paid.

2. Critical Illness / Life insurance
James could have taken out an amount of $250,000 of Critical Illness coverage so that if he was diagnosed with a life threatening illness OR totally and permanently disabled he would receive a lump sum to supplement his income protection payments. This could be used to pay medical expenses, home modifications and even to purchase a house of his own. Although he had no dependants yet to leave a death benefit to, taking out the same amount of life cover while he is healthy provides protection against an unforeseen event causing his health deteriorating in the future and making him uninsurable.

Other desirable features:
Future guaranteed insurability – by including this option James will be able to increase the cover on the occurrence on certain life events eg marriage, taking out a mortgage, having children even if his health has deteriorated.

Own Occupation TPD – a more expensive option than Any Occupation TPD but would still pay a lump sum benefit if James could no longer be a carpenter but could return to work in a lower paid job.

What if James had these insurance plans?
If James’s policy had a 30 day waiting period he would be entitled to receive payments starting 30 days after his injury (or later depending on insurer processing dates) and so he would might have to draw down on savings or seek support from his family for this period. However also after 30 days he may have the ability to claim on his Critical Illness benefit. Furthermore if James were to pass away unexpectedly, the life insurance benefit would be able to cover any of James’s liabilities and final expenses.

Mary and John are aged 30 and are both working in professional occupations earning $80,000 each. They have saved $50,000 which is earmarked for a deposit on the house they wish to buy together and start a family. In the meantime they pay rent and living expenses and try to save as much as possible.

What if Mary and John don’t have insurance?
Mary is diagnosed with breast cancer and undergoes surgery and a 6 month period of intensive chemotherapy. Mary is unable to work during this time and incurs considerable medical expenses. Mary is told that she has made a complete recovery but there is still a lingering concern that the cancer will resurface. Mary and John’s home ownership dreams are fading as they have spent most of their savings on Mary’s medical expenses. They face a dilemma in that Mary has been told that she should try to have a family as soon as possible but it will be hard for them to save for their deposit from one income.

What insurances could Mary and John have taken out?
1. Critical Illness Insurance
Mary and John could have taken out $100,000 of critical illness coverage each. They may have based this amount on covering income for a period of six to twelve months in the event of a serious illness and to pay medical bills not covered by their health cover.
Desirable Features:
• 25 covered conditions (major 3 are heart attack, cancer, stroke)
• 15% or up to $50,000 could be paid out if a covered non-life-threatening illness occurred.
• Return of Premium (ROP) option available where if the individual was never diagnosed with anything, they would be refunded up to 100% of the premiums paid.

2. Life Insurance
Mary and John could have taken out life insurance coverage so that if one of them died their partner could still realise their dream of home ownership. If they were anticipating taking out a mortgage of $500,000 then if they had insured for this amount the surviving partner would be able to purchase a home outright while they continued to work themselves. This is important because banks are unlikely to lend as much to a single income earner as to a two-income family and the burden of servicing a loan from one income is also difficult.

3. Disability Insurance
When both incomes are important for the achievement of the family’s goals both incomes should be protected. Mary and John could both have taken out disability insurance coverage with a monthly benefit of $5000 per month (eg 75% of their $80,000 income per annum) with a benefit period to age 65 to protect them against both temporary and permanent sickness and injury.

What if Mary and John had these insurances?
While Mary was unable to work while having surgery and being treated for her breast cancer her disability insurance benefit would have paid, after the waiting period, a monthly benefit of $5000. These ongoing payments would allow the couple’s finances to remain in good shape and their saving program to continue.
In addition, when her malignant cancer was diagnosed Mary would have received a payout of $100,000 under her critical illness policy. This money could have been used to pay medical bills and top up Mary’s income. Importantly this could give Mary the ability to take discretionary time off work after receiving the all clear (e.g. leave without pay) to ensure that her recovery was complete – which may not have been possible if the couple were under financial stress.
While the life insurance coverage would of course not have been claimed upon, if Mary and John had deferred taking out life insurance they would have found that after her breast cancer Mary was no longer insurable. Putting life insurance coverage in place while both partners are healthy is important as once in place this coverage is guaranteed by the insurer if your health deteriorates.

A successful entrepreneur required a substantial amount of life insurance for estate planning purposes but was unwilling to extract money from his business to fund the premiums. The entrepreneur was earning approximately 25% of the funds used in his business and understandably didn’t want to reduce his earnings to buy life insurance.

The result was that the client proceeded with sufficient life insurance coupled with an IFA strategy that covered 100% of his insurance premiums. He continues to retain and reinvest his earnings in his company, not insurance premiums. The client’s effective net cost of his life insurance (while factoring in the tax-deductible interest cost) amounts to paying less than 4% of the true premium out-of-pocket.

James is the sole shareholder of a private Canadian company. He is a healthy, 43-year-old non-smoker. Paul requires $1,000,000 of life insurance and will also need a retirement income supplement from age 65 to 83. His company will deposit $27,730 into the life insurance policy for 20 years. At retirement, his company will borrow against the cash value of the life insurance policy and use the borrowed funds to pay him a taxable dividend.

The Assumptions		The Benefits
Current Insurance Required:	$1,000,000	Cash surrender value at age 83:	$1,900,147
Annual deposit (2o years):	$27,730	Death benefit at age 83:	$2,329,662
Personal Tax Rate:	45%	Capital dividend account credit at age 83:	$2,329,662
Personal dividend rate:	35%	Annual loan advances to company from age 65 to 83:	$55,000
Corporate tax rate on investment income:	47%	After-tax dividend to shareholder:	$35,750
Life expectancy:	83	Repayment of loan balance at age 83:	$1,699,811
Policy dividend yield:	6.25%	Funds available to beneficiaries at death:	$629,851
Loan rate:	6%
Loan rate after factoring in tax deductibility:	3.18%

The net result for James is that he will contribute $27,730 into the plan for 20 years before withdrawing $55,000 ($35,370 post tax) for 18 years while still leaving $629,851 to his beneficiaries/ estate which in itself is more than James contributed to the plan. James will protect his estate while adding an additional source of income during retirement.

Client Details
Andy is 45 years old and is a business owner of AndyCo. After completing a needs analysis assessment, Andy realizes that his corporation needs permanent insurance protection on his life. Andy has $250,000 of surplus invested in passive assets in his company that is currently being taxed at 50% and would like to find a more tax effective method to deploy that surplus. He also would like a portion of those funds to be accessible in a tax efficient manner should they be required in the future.

Solution: Corporate Insured Retirement Plan
Insurance details:

• Planned deposits: $25,000 for 10 years (reallocated from his corporate surplus)
• Insured life: Andy
• Owner of policy: AndyCo
• Beneficiary: AndyCo
• Product: Participating (Whole Life) Insurance Plan

Other details:

• Projected values illustrated at:
  • 6% dividend yield (current annual yield) for the life of the policy
  • 5.2% net return4 before-tax on an Alternative Investment
  • 5.75% annual interest expense on a third-party line of credit with the policy assigned as collateral.
• Andy’s personal tax rate: 50% on income, 45% on ineligible dividends

After 20 years, Andy’s corporate-owned policy may be used as collateral for a loan which could provide him with a source of income in one of two ways:

Collateral	Borrower	Projected Annual Loan	After-Tax Funds for Andy (based on use of annual loan)
Corporate Owned Insurance	Andy	$23,837 for 20 years (age 65 to 84)	Personal Borrowing $23,837
	AndyCo		Corporate Borrowing (Dividend paid to Andy) $13,110

Using the insurance solution and the personal loan approach, when Andy’s interest in the corporation is realized as part of his estate, the insurance solution is projected to provide better value compared to investing the surplus in an alternative taxable investment.

Outcome

• Over a period of ten years, $250,000 of passive assets in AndyCo (net of charges) will grow tax-deferred within the policy, reducing Andy’s corporate tax bill.
• If Andy leverages the corporate-owned policy as collateral to fund personal income, he would receive $23,837  (after-tax) each year from age 65 to 84. This does not reflect costs that may be incurred to address potential taxable benefit/shareholder benefit issues.
• At age 85, there would still be $258,099 left to his estate even after the outstanding balance of the loan is paid-off.
• With the alternative investment, if the same deposits are made and the same after-tax income distributed, Andy would only be able to receive the income from age 65 to age 76 (plus a remaining withdrawal of $23,127 at age 77) after which time the value of the portfolio would be depleted, leaving nothing for his estate

Comparison of Values Corporate Insured Retirement Plan with Empire Life corporate leveraging and personal loan versus an Alternative Investment
	Empire Life Insurance Whole Life Plan	Alternative Investment (Fixed Income portfolio projected at a 5.25% net annual rate of return)
Annual Deposits	$25,000 for 10 years	$25,000 for 10 years
After-Tax Funds	$23,837 (assumes annual bank loans from  age 65 to 84)	$23,837 (assumes withdrawals from the portfolio from age 65 to 76 with a final withdrawal of $23,127 at age 77). See note below.
Gross Estate Value	$1,172,922	$0
Accumulated bank loan	$914,823	$0
Net After-Tax Estate Value (net of bank loan)	$258,099	$0