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I recently became licensed to sell life insurance. I didn’t want to, but one of the higher ups in my company had been hounding me to get licensed for years. So to get him off my back I decided to take the exam. So I figured now that I’m licensed to sell life insurance, I should learn something about it. The first product I heard about from everyone was "segregated funds". After looking into these further, I can honestly say that the way these are being marketed to the public, (as a guaranteed mutual fund) is a bit of a scam. The second life insurance product that kept being mentioned was "universal life with leveraging". Let’s take a closer look at both: 1) Segregated funds – These are the life insurance industries answer to mutual funds. They are managed by professional money managers, the same as mutual funds. However the annual management fee for these seg. funds is generally 1% to 2% higher than a comparable mutual fund. As a result their returns tends to be less. So what do you get for that extra cost? The big thing is "creditor proofing". If the segregated fund is purchased by an individual outside their RRSP, and that individual, at a later date declares or is put into bankruptcy, the creditors/receivers CANNOT touch the segregated funds; (the jury’s still out on whether they’re protected inside the RRSP). Now for someone who owns their own business, or has gone bankrupt before, these seg. funds could be a very attractive option. The other characteristic of segregated funds that’s unique is the one that is being used to market them to the general public; that is the "guaranteed principal". If the buyer of a segregated fund holds onto that fund for at least 10 years, or dies during that time, then the original amount of the seg. fund purchased, is guaranteed. In other words, if I buy $10,000 worth of a seg. fund in August and by October it’s only worth $6000, and I die in October. My estate will receive the full $10,000. However, if it went up in value to $12,000 by October, then my estate would get the full $12,000. The same rules apply if I were to hold onto the seg. fund for ten years, then my principal would be guaranteed. Most of these funds also come with a provision that allows you to "lock-in" your guaranteed principal amount, usually once a year. For instance using the earlier example of the value of the seg. fund rising to $12,000 by October, I would have had the right to "lock-in" my guaranteed principal amount at $12,000 in October for that year and going forward. However, by doing this it means that my 10-year minimum waiting period to get that principal guarantee, begins all over again. I can sum up this "guaranteed principal" feature in two words: BIG DEAL! I can see how seniors might find this feature attractive, (since their life expectancy may be in doubt) but these funds generally can’t be sold to people over the age of 65, and must be rolled into an annuity by some maturity age, usually 70.
2) Universal Life insurance policy with leveraging – This is a strategy that was introduced by the Life industry a few years ago and it works like this. EXAMPLE: Mr. & Mrs. G Both 38 and both earn good salaries. They take out a whole life policy for 1 million dollars, "joint and last to die", (it pays out when the last spouse dies) and make the two kids the beneficiaries. The annual premium for this policy is $3800. However instead of just paying the $3800, Mr. & Mrs. G decide to pay $9800 per year. With the additional amount going into a separate pool of cash with the life insurance company, where it gets invested on behalf of the G’s, (usually in an index fund). Lets call this part their "overfunded account". The G’s continue to"overfund" this life policy for a previously determined number of years, usually 10, after which they no longer have to make any further premium payments. The G’s then retire at age 65 with a paid up million dollar whole life policy for their children; and let’s say for arguments sake that they’ve built up a million dollars in there "overfunded" account. They then take the million dollars in the overfund account, and assign it as collateral to one of the chartered banks. The bank then gives the G’s an open loan for them to use to live off during their retirement. Sort of like a line of credit that they never have to make interest payments on.
The bank keeps track of the amount of the loan plus interest that the G’s are racking up. As long as the loan balance doesn’t go beyond a certain limit of the value of the "overfunded account", (usually 90%). They can just keep on spending. Now the REAL beauty part is that since the money they’re spending is borrowed money, and not investment income, THERE ARE NO TAXES ON IT!!!!!!!!!! The G’s are thus living out their retirement COMPLETELY TAX-FREE!!!!!!!!!! When the G’s die, the bank will net out the balance of the loan plus interest, against the overfunded account, and remit the remainder to the estate. So the kids will get the million dollars from the life policy tax-free, PLUS whatever mom & dad couldn’t spend during retirement. I should mention however that the federal government (Canada Revenue Agency), is currently reviewing this strategy to determine its legitimacy as a life insurance policy; which in turn gives it the tax-free status.
I’ll let you draw your own conclusions with that one. |
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