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Life Insurance

Couple Looking out over Railing of Cruise ShipLife is uncertain. The future is largely unknowable. Insurance helps people remove the risk associated with going about their lives by compensating them when misfortune occurs. Insurance is all about managing risk—the financial risk that death, illness or disability would have on a policyholder as well as his or her dependants. Use it to help provide extra financial security to your spouse, to contribute towards your grandchildren’s education, or to help relieve the financial burden of final expenses.  

Life insurance in its basic form promises to pay a benefit upon the death of the person who is insured. Life insurance is purchased by people for many reasons, including a desire to cover the costs of a funeral, to create an estate so that a family can be supported, to pay off existing debts including a home mortgage, and to settle the expenses of an estate, including the payment of taxes.

There are a wide variety of insurance products that can be offered, in an almost endless variety of ways. 

An individual transfers risk by shifting the financial burden of the risk away from themselves to an insurance company, in exchange for a fee. Life insurance allows people to address the financial risks of dying too soon, living too long, or becoming disabled. These risks mean that individuals cannot provide the necessities of life for their surviving family members or repay mortgages, loans, taxes or other financial obligations.

Dying Too Soon

Most individuals earn the financial resources they need to live comfortably and acquire assets from a salary, commissions, or business income. These sources of income end when the individual dies. If the individual dies too soon, he or she may not have met all of his or her obligations, whether it is a loan or mortgage to be repaid, or building up sufficient financial resources to allow family members to continue to live as they are accustomed to do. Life insurance in its many different forms can help address the risk of dying too soon.

Living Too Long

Individuals who outlive their financial resources may face a life of poverty or may have to rely on the goodwill of others to survive. Life insurance products, such as deferred and immediate annuities, can address that risk by allowing individuals to put money aside so that one day, they will have an income that is guaranteed for life with an annuity.

Becoming Disabled

Life insurance products have been developed to address the needs of individuals who suffer a critical illness, or who for health reasons cannot care for themselves. Life insurance companies also offer disability income plans that provide a regular income to a policyholder who has suffered a disability.  

Other Uses 

MP900284951In addition to addressing the risks that everyone faces, life insurance can help people achieve certain financial goals.

For example, Eva wants to make a significant contribution to her favourite charity. She does not have the means to make a large gift, and her salary level does not allow her to accumulate the kind of gift she has in mind. She can apply for a life insurance policy and appoint the charity as the beneficiary. For a relatively small regular premium payment she can ensure that when she dies, the charity she chose will benefit from her gift.

Using Life Insurance Proceeds to Defray Capital Gains Taxes

When an individual dies, the executor of the estate must complete a final tax return. In the final tax return, all of an individual’s income from all sources, earned up to the date of death and not previously taxed, becomes subject to income tax. At the same time, any capital property that an individual owns is considered disposed of (that is, treated as if it had been sold) for income tax purposes. The difference between its fair market value and its original cost is the capital gain or loss. For any property that has a capital gain (that is, the fair market value exceeds the original cost), the excess amount must be reported as capital gain income; 50% of that amount is taxable.

Although life insurance represents a valuable asset to an estate, the amount of the life insurance benefit paid out either to the deceased’s estate or to a named beneficiary is not considered a taxable amount for income tax purposes.

Life insurance is therefore a valuable tool for defraying the potentially large tax liability for the capital gains realized upon a property owner’s death. Rather than the heirs of a deceased property owner having to sell a property in order to obtain the funds necessary to pay the taxes, they can use life insurance proceeds to pay the taxes.

Why Businesses Purchase Life Insurance 

Business Continuation Insurance

Small businesses, whether sole proprietorships, partnerships, or private corporations, depend on one or a few principal owners to ensure the continued operation of the business. If one of the principal owners dies, the business will not only lose the revenues that that person generated, but creditors may also require the repayment of any loans or liens that were guaranteed by the deceased owner. The family of the deceased may insist on the disposal of business assets to provide a legacy to the deceased’s heirs or payment from the surviving owners in exchange for their ownership interest in the business.

Business continuation insurance is intended to ensure the survival and continuation of a business by providing insurance proceeds to compensate in part for financial losses resulting from an owner’s death.

Segregated Funds

Do you like the feeling of knowing that your money is well invested and well protected? Segregated funds combine the growth potential of a mutual fund with the security of principal guarantees.

Retired

Segregated funds have gained wider recognition in recent years and are a growing segment of the investment fund industry in Canada. Segregated funds have unique features that enable them to meet special client needs such as maturity guarantee, death benefits and creditor protection. Unlike other types of investment funds, segregated funds are insurance contracts and, therefore, mostly exempt from the requirements of provincial securities laws. A “segregated fund” is a pool of assets owned by the life insurance company. They are separate and apart from other similar pools and its general assets.

Like mutual funds, segregated funds offer the advantages of professional investment management and portfolio diversification. Another similarity is that these benefits come at a price. Management fees and expenses are deducted from fund assets and have a direct and measurable impact on fund performance.

Segregated funds alter one of the conventional principles of portfolio selection. Namely the notion that the older the client, the less exposure he or she should have to riskier long-term assets. With the availability of maturity guarantees of up to 100%, along with death benefits, the risks associated with capital markets become less of an investment constraint. Segregated funds enable clients to invest in higher-growth asset classes, while offering assurance that the principal amount of their contributions is protected, either fully or partially

Maturity and Death Guarantees

One of the fundamental contractual rights associated with segregated funds is the guarantee that the beneficiary will receive at least a partial return of the funds invested in accordance with the provisions of the contract. Provincial legislation requires that the guarantee be at least 75% after a 10-year holding period. Some sponsors of segregated funds top up the maturity guarantees to 100%. These guarantees – whether full or partial – appeal to people who want specific assurances about the return of the principal amount invested and a limit on their potential capital loss.

Example; Maturity Guarantee

John deposited $150,000 in a segregated fund policy and named his son, Robert, as
beneficiary. The policy offers a 100% guarantee on death or maturity with a minimum 10-year holding period. Five years later, John dies in a car accident while driving to work. If we assume that the investments within the segregated fund policy are worth $200,000 at John’s death, Robert would receive $200,000. If, however, the investments have dropped in value and are worth $110,000 at John’s death, then Robert would receive $150,000, the amount John originally deposited.

The maturity date of a segregated fund contract is an important date. It is normally set 10 years from the contract date and, by law, it cannot be less than 10 years. The maturity date is a critical component of the contract because the maturity guarantee comes into effect on that date, and no sooner. So, if an investor decides to redeem a segregated fund contract, say 8 years from the contract date, the investor would be paid the market value of the segregated fund holdings, whatever the market value may be on the date of redemption. The maturity guarantee would not get triggered until the maturity date.

Do you really need a guarantee?

In historical terms, the risk of losing money in the North American stock markets over a minimum 10-year holding period has been virtually non-existent. The rarity of negative 10-year returns has led many advisors and experts to conclude that the costs of full (i.e., 100%) maturity guarantees exert an unwarranted drag on a client’s investment returns.

But the potential value of maturity guarantees should not to be dismissed outright. As the performance of the Japanese market suggests, even the largest and most developed markets are vulnerable to capital loss over a 10-year (or longer) period. The Nikkei (Japan’s most widely watched index of stock market activity) peaked in December 1989 at 38,915 and was only in the 9100 range in August 2011, nearly 22 years later.

Bypass Probate Fees

When you designate a beneficiary other than your estate, the value of your segregated fund policy flows directly to him or her, generally bypassing the estate and potential probate fees. Upon death, proceeds of your contract are paid directly to your beneficiary, avoiding the time and expense of probate. Probate is a legal proceeding whereby the Will of a deceased person is validated by the courts. The fees vary from province to province and in most cases these fees are based on a percentage of the value of the estate.

Also, probate is a public process and information associated with it is accessible to the public. By helping your heirs bypass probate, segregated funds can ensure that your personal decisions and information remain the way they were meant to be…personal.

This feature is quite beneficial. As you can see by the following example, the amount of money saved can be quite significant.

Potential Creditor Protection

This feature is of primary concern for business owners or professionals as their assets may be exposed to creditors. You may be able to achieve potential creditor protection by naming a “preferred” or “irrevocable” beneficiary. The key relationship is between the life insured (the annuitant) and the beneficiary. There are exceptions to this and it is recommended that you consult independent legal counsel.

Put the benefits of segregated fund policies to work for you. Segregated funds, are a powerful investment solution that can help you meet your retirement goals. While similar to mutual funds, they offer many unique advantages— including maturity and death benefit guarantees, the ability to bypass estate probate, potential creditor protection and the ability to reset any market gains. Contact Guaranteed Income Advisors to discuss how segregated funds can become part of your retirement solution.

The Downside

Segregated funds offer a host of features and benefits, but those amenities aren’t free. The cost of investing in segregated funds is often higher than the cost of investing in similar mutual funds.

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