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Life insurance can pay the final tax bill on your registered assets, allowing you to pass the full value on to your heirs.
If you're like many Canadians, your RSP has become the major source of asset accumulation during your lifetime. Through the magic of compound interest and tax deferral, your RRSP may become the largest asset you hold.
However, at death, your RRSP or RRIF could be your most significant estate asset, and also your most significant tax liability; without proper planning, almost half the value of the registered assets in the estate will go to taxes.
Upon death, the spousal rollover option enables registered assets to pass tax-free to the surviving spouse. However, on the death of the surviving spouse, the Canada Customs and Revenue Agency (CCRA) consider the entire value of the RRSP or RRIF as taxable income. These funds are added to other sources of income earned during the year and will almost certainly push even those who had modest incomes while living, into the maximum tax bracket for their final tax year.
Passing on the Full Value of Your RRIF to Your Heirs
How can you pass on the full value of your RSP or RRIF to your heirs? Investing in life insurance can ensure that your beneficiaries will receive the full benefit of the RSP or RRIF assets held in your estate. Through this technique, you are effectively redirecting money that you do not require for living or lifestyle expenses to an insurance contract.
The insurance then pays your estate taxes, greatly reducing the tax burden on your estate and your heirs. The most cost-effective insurance policy is one that covers both you and your spouse, where the death benefit is only payable when the second death occurs, which is when the tax liability becomes due. The cost for this "second to die" insurance is usually 1% to 2% of the death benefit, annually, and will depend on your age, gender, smoking status and overall health.
Buying tax protector life insurance can be a sound investment. Because life insurance proceeds at death are not taxable, the asset generated for your beneficiaries is generally significantly higher than you could have accumulated by investing the life insurance premium into a non-registered investment.
Case Study Example
For example, a couple, both 65 years of age, have RRSPs currently worth $450,000 in total. They will withdraw their RRIF minimum income beginning at age 71 and they have assumed rate of growth of 4% on their investments. At life expectancy (age 87), the couple's RRSPs will be worth approximately $210,000. The tax payable will be $110,000 based on a 46.41% tax rate.
If no planning is done, the couple's estate will be responsible for paying a tax bill of $110,000. This means that their heirs will inherit a greatly reduced estate from what they expected. If the assets are insured, the annual cost to the couple is $1,553, and the full value of the estate is preserved.
Through effective planning, the tax on these registered assets can be immediately funded for an annual payment of less than 2% of the potential $110,000 tax bill.
Every Situation is Different
Every individual situation is different and professional advice should be sought before any final decisions are made, but there are some general ideas and techniques that are extremely effective. Rates of return will vary by situation, and are dependent on such factors as age, spouse's age, health, and the amount of insurance needed.
You are encouraged to consult your tax advisor to discuss the suitability of this approach to your particular situation.
All insurance products are sold through ScotiaMcLeod Financial Services* companies. ScotiaMcLeod Financial Services companies are the insurance subsidiaries of Scotia Capital Inc., a member of the Scotiabank Group. When discussing life insurance products, ScotiaMcLeod Investment Executives are acting as Life Underwriters (Financial security advisors in Quebec) representing ScotiaMcLeod Financial Services.
ScotiaMcLeod Financial Services includes:
* ScotiaMcLeod Financial Services (Ontario) Inc.
* ScotiaMcLeod Financial Services (Quebec) Inc.
* ScotiaMcLeod Financial Services Inc.
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