Yeah me neither... In retirement a lot of people are looking for ways to get at their money while paying the smallest amount of tax possible. Income streams are king in retirement, if you can pay less taxes you get more income. Drawing an income from an RRSP or RRIF has a heavy tax burden but is the only option for most people. If you are a business owner you have a strategy available to you that most people don’t have. It takes time to implement so you might want to start now.
Many business owners will retain earnings in their company as a natural tax shelter. Getting the money out can be difficult as it needs to come out in salary or dividends which means lots of tax is payable. Another issue with retained earnings is that once you have $400,000 of retained earnings in your company you have to start paying a “passive income tax” of 50% on that amount. Rather than pay this passive tax we start to deposit retained earnings into a Universal Life policy, the policy provides Key Person insurance which is probably needed, as well as holds a tax sheltered account exempt from the passive income tax.
Let’s assume a business owner shuffles $15,000 a year for 10 years into a universal life policy. At the end of 10 years, the policy has a death benefit of $319,333 and a cash value of $187,699.
Red is your cash, yellow is the growth of your cash, blue is the combination of the life insurance, deposits and growth.
The business owner goes to a bank and asks to borrow $187,699 in the form of a Line of Credit. The bank says it needs collateral, no problem the businessman has exactly $187,699 in his corporate life insurance policy. The company, which he owns, will even sign as a guarantor for the loan. The bank is happy and agrees to the loan. The bank stipulates it will call the loan if it is 90% of the value held in the life insurance policy. Since the investments in the life insurance policy will continue to grow the bank will often agree to extend further credit in the future. Interest on the Line of Credit is capitalized, rather than paid, it is added to the balance of the Line of Credit. You never need to pay an interest payment until the end of the loan.
Now I have fancy software that will calculate how much I can draw each year. The final number depends on life expectancy, rates of return and interest rates. A modest calculation show that starting at retirement, age 66, I can draw a TAX FREE income of $12,451 from the LoC every year till age 90. If all goes according to plan the loan balance will equal $554,233 at age 90, this is 90% of the value of the life insurance policy. At this point the bank can call the loan, this is a good time to die.
Once you kick the bucket, your life insurance policy pays out $709,538 in benefit, the bank gobbles up their half million and your heirs are left with a little over $150,000.
The linchpin of the whole exercise comes back to taxes, income and dividends are taxable, a loan isn’t. The $311,275 you drew drawn from the Line of Credit over the years is 100% tax free, furthermore the interest on the loan is potentially tax deductible (obligatory, refer to your accountant or tax specialist).
Sure you had to pay the insurance premiums and the interest but that is still $158,000 less than the taxes.
The Line of Credit is paid off with the life insurance, which comes in tax free. The income drawn from the Line of Credit was spent tax free, the retained earnings in the company were sheltered from tax in the life insurance policy.
So what is the downside, well risk. If the investments in the life insurance policy underperformed they might not be able to pay off the Line of Credit. If the loan was callable the bank might force you to liquidate other assets or even cash in the insurance policy against your will. You need to be insurable to get the life insurance policy in the first place. Lastly its confusing, its complex and the average person doesn’t want to think about it, a good accountant is often in charge of the whole plan.
While a very effective and intriguing plan, it is complex and requires a long time horizion, usually 25 years to complete. While proven to work, diversity is king, I would never recommend this as a sole retirement strategy, but it can be a powerful part of your retirement strategy.
TL;DR
1) Borrow a bunch of money
2) pay it off with insurance when you die.
3) ???
4) Profit
EO&E
No comments:
Post a Comment