Back-to-Back Annuity

In this post I'm going to discuss a strategy that is not very-well known, or even discussed about in the industry, especially by banks. This, of course, is not a strategy that makes sense for, or to be used by, the majority of clients, however, it does have its niche - the older client population. The concept of Back to Back Annuity, or "Insured Annuity" as it is otherwise known, is not a new one. Advisors have been doing this type of strategy for their clients for years, so why is it that the vast majority of people (and even most advisors) have never heard about this? The reason: Because it's a strategy that involves Insurance products, therefore cannot be offered by banks, or the average advisor with only a Mutual Fund Licence.

Often the dilemma for people who are in the later years of their life is that they want to leave money for their loved ones, or a charity or something else, but don't have the means to leave a lump sum because they need to use their retirement funds to have an income to live their life. Another challenge is that they want to preserve their capital and don't want to risk losing any money, so they don't want to be invested in the markets.

When the low-return and inflexibility of GICs and Bonds is not something that attracts many retirees, what other options do they have? In this type of situation, the often overlooked strategy of the back-to-back annuity or "insured annuity" might fit in nicely.

So, how does it work?

Using this strategy is actually using 2 products together, to take care of 2 or more needs. The first part of the strategy is covering the need of being able to leave a lump sum for your beneficiaries after you pass away, and this involves getting a form of permanent life insurance (usually a Term to 100). Remember, insurance is a privilege, not a right, so you must qualify for it. This might be a challenge if you're in the later years of your life, and maybe had some health challenges over the years. Getting approved for the insurance is always the first step in the process, because if you don't get approved, then the rest of the strategy will not work.

Once approved, the second part of the strategy is fairly simple - using your lump sum of funds to purchase an annuity. In one of my previous posts (Annuities), I already discussed what an annuity is, and what type of annuities there are, so I won't get into too much detail about that here, but essentially the annuity would work as a vehicle to give you regular period cash flow so that you can live and enjoy your life.

So, essentially, you're using 2 of these products "back to back", which is why its called the "back-to-back annuity". Now, by using this strategy, both of your needs have been covered. 1) leaving a lump-sum of funds for your beneficiary, and 2) having a steady cash flow so that you can live and enjoy your life.

To better understand this concept, let's use an example of 2 people - one who just uses a simple GIC offered by the bank, and the other who uses the strategy discussed above. Just so we have a fair comparison, both clients will be the same age, in good health, in the same tax bracket and have the same amount of funds in their retirement savings.

Client #1:

John is a 75 year old non-smoker, and has his $250,000 of retirement savings invested in the bank, in a 5 year locked-in GIC giving him 4% interest. This translates into an annual income of $10,000 from that source. He also has a pension, is getting government assistance, and has some rental income putting the tax rate for his total income from all sources at approximately 31% (his MTR). This means, that he will have to pay approximately $3100 to the government in taxes from his GIC alone. This means he will be left with an after tax income of approximately $6900

His dilemma is that he's not sure if his after-tax income will be sufficient to keep up with inflation and live the type of lifestyle he wants, and might have to start taking extra money from his GIC, which would erode his capital. Also, he wants to leave as much of this money as possible to his kids and grand-kids without them having to pay taxes or other estate fees.

Client #2

John's friend, Jason, is also a 75 year old non-smoker, has $250,000 in his retirement savings, but is dealing with an advisor who has showed him a different option for his situation, which is not offered by the banks. He is also in a 31% MTR, and also wants to make sure that he has enough after-tax income to life a comfortable life. Jason is very adamant about leaving his family the $250,000 when he passes away, but wants to have more after-tax income from his money than just a normal GIC. He wants to make sure the funds go directly to his beneficiaries so that they don't have to pay any fees or taxes on the money.

His advisor recommends doing an "Insured Annuity" or "Back-to-Back Annuity" strategy, which intrigues him very much. His advisor shows him an illustration of how that strategy would work, and shows him how is after-tax income would be significantly greater, and he would still be able to leave the money for his loved ones. The advisor showed him a comparison between using this strategy versus just a GIC strategy that his friend John is using. The comparison is as follows:

	Jason (Client #2)	John (Client #1)
Capital/Single Premium Into Annuity	$250,000	$250,000
Annual Income	$24,378	$10,000
Taxable Amount	$1,024	$10,000
Tax Payable	$317	$3,100
Cash Flow Before Insurance Premium	$24,060	$6,900
Annual Life Insurance Premium	$13,738	$0
Annual Net Cashflow	$10,322	$6,900
Amount Left to Estate at	$250,000	$250,000
Subject to Probate Fees/Taxes?	NO	POSSIBLY

Please see attached for better view (click image):

Using this Strategy, Jason would have 49.60% higher after-tax income than John every year, but will still be able to leave money behind for his family when he passes away. This also means his equivalent rate of return would be approximately 6%. The strategy meets all his needs to live his lifestyle, and at the same time gives him the peace of mind that his family will be taken care of financially when he is no longer here.

This strategy works best for those who are 65+, but that doesn't mean someone who is younger will not benefit from it either. Older clients will receive a larger cashflow, as the insurance company is betting against their mortality, and therefore will offer them higher cashflow for their remaining years. Another thing to note is that it also works best for those who are in a higher tax bracket, as they are the ones who see the biggest difference in after-tax income compared to using the GIC strategy.

By no means should someone be putting all their money into this strategy, but using this strategy as a means to supplement other income is a great way to keep up their standard of living and let them enjoy a nice lifestyle. This is a great way for someone to create their own personal 'pension' if they do not have one, or are not receive enough from their own.

This strategy does not work in all situations, so its always best to sit down with your advisor and crunch all the numbers. Remember, this strategy is using 2 products to achieve the same goal. Usually what will happen is that you will get the annuity from one life insurance company, and the life insurance from a different life insurance company. It's very rare that the same insurance company will have the best rate for both products, so it is key to have an advisor who is fully independent, and can shop the market for you.

I hope you have learned a few things from this post, and if you have any questions about this strategy, or even want to see if this strategy would be good for you, please do not hesitate to contact me!

Using Insurance as a Charitable Donation

Many of us want to help the less fortunate or want to give back to an organization that has helped us in our lives. I've discussed, in my earlier posts, about using insurance as a means of personal/family protection as well as briefly touching upon the ability to grow money tax-sheltered. In this post I will discuss one of the other uses of insurance, which is using it as a charitable donation.

There are many people in society who either don't have dependents or any person(s) that they want to leave money for after they pass away, but have a favourite charitable organization or religious group etc... that they would love to leave money for. Many are regular donors to these organizations or charities and want to continue their giving even after they pass on. Some people will include the organizations name(s) in their will to have their assets given to one or more of their chosen organizations, but some might not be able to give as much money as they want due to lack of savings or pre-mature death. In cases like this, using an insurance policy as a means of leaving money for a charity/organization can be a great way to do that!

A person can make a substantial contribution to any charity by naming the organization as a beneficiary. Most likely, the amount they leave behind will be larger then any amount they would be able to afford on their own, so it is an easy and affordable way to make a generous contribution at the time of death.

Tax Advantages

There are usually tax advantages when you donate/contribute to a registered charity, and this situation is no different. All proceeds will go directly to the beneficiary, since we know that life insurance policies will pay out tax-free.

Having the tax-free proceeds being paid to the charity is great, but that is something that happens after death, so, what other advantages are there during life? Well, the premiums that are paid can actually be deducted from the annual income as an itemized deduction. So in this way, there are tax advantages both before and after death!

In order for this to be official, the policy's rights actually have to be signed over to the organization, and all the documents be delivered to them. All this means is that, the organization must be consulted before any change to the policy itself.

Other Details

By signing over the policy to the organization (basically making them the owner), the proceeds are not included in estate of the person who has passed away. If the policy is not passed over to the organization, but just has the organization as the beneficiary, the proceeds will be included in the estate's worth, even though the funds will be going directly to the organization. This could result in much higher taxes for the estate and might leave less money for other beneficiaries from the estate (i.e. family).

Other Options

Getting a new insurance policy might be something that is not affordable by everybody, so what other ways can be used to leave money through a policy? One way is, if someone has an existing policy, to have the dividends paid out by the policy (if there are any) to be allocated to the organization itself, rather then re-invested back into the policy (or given as cash). This can be done by contacting the insurance broker or the company who provided the policy, and they can check to see if it is possible with the policy that is already in place.

Another option is to add the organization as a beneficiary to an existing policy, which will still allow to make a large contribution, but won't cause any extra taxes since the existing policy would have been added to the estate anyways -- the only thing that would be done is splitting up where the funds are allocated at the time of death. The amount of donation given can actually be deducted from the gross estate of the person who has passed away (there will be a charitable donation tax credit for the amount of contribution), which is something that would benefit the heirs of the estate. However, using this option, where the life insured is still the owner of the policy, the premiums cannot be deducted by the life insured from their annual taxes.

Using an RRSP/RRIF

Another way to leave money for a charity is to designate them as the beneficiary of an RRSP or RRIF, and then buy an insurance policy equivalent to the value of the RRSP/RRIF. At the time of death, the charity will issue a tax receipt which will offset the tax burdens, and then the estate will receive the life insurance proceeds tax-free.

Wealth Replacement Insurance

This is a very interesting way to use existing assets and insurance to donate money, lower your tax bill, and accumulate more wealth overall. This is something I actually got from http://lsminsurance.ca/tips/general/charity-life-insurance . I will just copy and paste it:

This is a creative option which allows you to donate a large asset or lump sum of money to charity. In return, you receive a charitable credit for the donation which results in tax savings for the year the donation is made. You can then invest these tax savings in an insurance policy that potentially results in enough proceeds to replace the value of the gifted property.

Let's look at an example of the last method.

Mrs. Jones own a piece of land that originally cost her $100,000. It is now worth $300,000. She donates the land to charity and receives a donation receipt for $300,000, which will equate to tax savings of approximately $138,000 (assuming a 46% marginal tax rate).

Mrs. Jones incurs a taxable capital gain on the disposition of the land of $100,000 (50% of $300,000-$100,000) resulting in tax payable of $46,000. However, the net tax savings of $92,000 could be used to fund a life insurance policy on Mrs. Jones producing a potential tax free death benefit for her heirs in excess of her original donation.

Annuities

A charitable gift annuity allows someone to give a lump sum contribution to a charity, but still receive guaranteed periodic income in return (usually monthly). Generally, the older the person is at the time of donation, the higher the returns will be.

Using this strategy, keep in mind that the donations are irrevocable, which means, once they are given, they cannot be taken back and the control of those funds is no longer there.

A tax receipt will be issued for the amount the gift exceeds the total annuity payments made to the donor (calculated by Canada Revenue Agency's life expectancy tables). Also note, that most (or all) of the income that is received is tax-free.

Using the life insurance strategy can be used with either term or permanent life insurance policies, so it can be used for short term and long term plans. If this is something that interests you, please consult an advisor to get more information on all the details.

I hope you have learned something from this post, and if you have any questions, please do not hesitate to contact me.