Leveraged Supplementary Retirement Account - Standard Life

More documents

Recommendations

Info

Compounding effect of loan Leveraged Supplementary Retirement Account Factors and risks to consider In a case where the interest is capitalized, the loan will increase each year by the amount of the interest. If the loan is in effect for a long period of time, the compounding effect of these additions may cause the loan amount to exceed the financial institution’s lending ratio based on the policy cash value and the financial institution may call the loan. Therefore, use of this loan arrangement should be restricted to applications where there is a natural limit to the likely duration of the loan. Use of the arrangement at retirement is ideal because life expectancy will tend to limit the loan duration. Since the ultimate intent is to repay the loan from the policy death benefit, the arrangement would not be appropriate if a person aged 40 or 50 were to start a series of loans today. Financial institution calls the loan If the loan were to exceed the maximum allowable percentage of the cash value, the financial institution could call the loan. If the financial institution recalls the loan, the life policy would be surrendered resulting in the loss of the tax-free death benefit and the triggering of tax on the accumulated gain. This possibility should be averted at all costs. It is especially important to note that any income tax liability arising out of a forced policy surrender is a liability for the policy owner, not the financial institution. The risk of the loan exceeding the cash value arises from three sources: 1. An increase in the spread between the interest rate charged on the loan and the interest being earned within the policy. 2. The time over which the loan is growing is longer than anticipated. 3. The cost of insurance has a negative impact on the growth of the account. Investment risk There are risks associated with any type of investment. When debt is also incurred, additional factors must be considered. The maximum loan amount will depend on the investments held in the policy account. Financial institutions, currently, will generally loan up to 85% to 90% of the value of fixed income investments but only up to 50% to 60% of equity-linked investments. At the time of borrowing, the investment mix may need to be amended to maximize the amount that may be collateralized. Since the loan is generally a variable rate loan, the interest rate can increase without a corresponding increase in the return on the investments. Higher interest charges, if not paid yearly, can cause the outstanding loan balance to increase more rapidly and thus reducing future loan capacity. If the return on investments also drops, the fund and the maximum loan amount are also reduced. The outstanding loan and the policy account need to be monitored frequently to avoid a situation where the loan exceeds the financial institution’s ratio and forces a reduction in the loan through capital repayments or a collapse of the life policy to repay the debt. Changes in financial institution policy or tax rules Currently financial institutions make no commitment that they will continue to offer these types of loans in the future. Lending rules can change and may make this type of loan unavailable. As well, upon renewal, the financial institution may wish to change the terms of the loan. In addition, should the treatment of these loans by the tax authorities change, this arrangement could be rendered much less attractive. Standard Life 9
Leveraged Supplementary Retirement Account Using a corporation to own and leverage the life insurance policy Using a corporation to own and leverage the life insurance policy There are situations where a corporation is the owner of the life insurance policy on the life of one of its shareholders. The corporation may want to leverage the policy and use the loan proceeds to redeem the shareholder’s shares as part of a retirement strategy. There could, however, be negative tax consequences if the loan proceeds are forwarded to a shareholder or employee directly, for the purpose of supplementing retirement cash flow. In general, loans to shareholders will be included in the shareholder’s income without a corresponding deduction to the corporation pursuant to subsection 15(2) of the ITA. The only way to avoid this result is for the shareholder to repay the loan within 1 year of the end of the taxation year in which the loan was made. (Note: there cannot be a series of loans and repayments). The same rule applies to employees unless the employee (and related family members) own less than 10% of any class of shares of the business. If the employee fits within the exception, the loan will not be included in income but an imputed interest benefit will be included. If the business redeems shares or distributes the loan proceeds by way of dividend to the shareholder, they will be considered taxable dividends in the hands of the shareholder. (assuming that the corporation does not have a balance in its Capital Dividend Accont (CDA) and thus cannot declare a Capital Dividend) 10 Standard Life Retirement Compensation Arrangement (RCA) Rules Where a corporation acquires a life insurance policy with a view to providing retirement benefits, the policy may be deemed to be an RCA pursuant to subsection 207.6(2) of the ITA, and specific tax rules will apply. This would have negative tax implications. The following rules would apply: 1. The employer/corporation would be required to withhold and remit a tax equal to the amount of the insurance premium to a refundable tax account with Canada Revenue Agency (CRA). 2. The employer would receive a tax deduction for twice the amount of the insurance premium. 3. Refunds from the refundable tax account would be included in the income of the recipient. 4. The full amount of the death benefit that is received by the employer would be taxable to the employer as a distribution from the RCA. Deductibility for tax purposes Deductibility for tax purposes of interest incurred on a loan The general rule is that interest is only deductible for tax purposes when it is paid or payable pursuant to a legal obligation to pay, and when the proceeds of the loan are used for the purpose of earning income from a business or property (paragraph 20(1)(c) of the ITA). With the LSRA strategy, where an individual leverages the policy and the loan proceeds are used for personal living expenses, the interest would not be deductible since the borrowed funds are not used to gain or produce income.
Page 1 and 2: Protection Solutions Your guide to
Page 4 and 5: Leveraged Supplementary Retirement
Page 8 and 9: 2. Receive a series of loans Levera
Page 14: Retirement Investments Insurance Ta

Leveraged Supplementary Retirement Account - Standard Life

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?