Leveraged Supplementary Retirement Account - Standard Life

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Leveraged Supplementary Retirement Account Sources of retirement income Three ways to access investment accounts in retirement 4. Using a Leveraged Supplementary Retirement Account (LSRA) to fund retirement This strategy involves purchasing a universal life (UL) insurance policy generally a minimum of 10 years prior to retirement. Policies that qualify as “exempt” under the ITA (most UL policies issued in Canada qualify), allow funds to accumulate within an investment account inside the policy on a tax-sheltered basis by virtue of sections 148 and 12.2 of the ITA. The other component of the policy is the life insurance component. It is separate from the investment, but both form part of the same life insurance policy. What makes universal life insurance attractive is premium flexibility. A client can deposit more or less into the plan, as long as there is enough to cover the premiums for the life insurance component. Excess contributions (up to a maximum limit calculated with reference to ITA rules) form part of the investment account in the policy that can grow on a tax-sheltered basis. Upon the death of the insured, the total death benefit is paid out tax-free to the beneficiary(ies). Tax may be payable if the policy is disposed of and the investment funds withdrawn, in whole or in part, before the death of the life insured. Three ways to access the investment accounts in retirement: 1. Withdrawals from the policy 2. Policy loans from the insurance company 3. Collateralization with a financial institution Withdrawal from the policy Withdrawals can be made directly from the life insurance policy’s cash surrender value. When a partial withdrawal is made, the adjusted cost basis (ACB) may have an impact on the net amount withdrawn as the difference between the amount withdrawn and the ACB is taxable. The amount of the ACB is proportional to the total amount withdrawn. Policy loans Funds can also be accessed as a policy loan. In essence, these are not typical loans, but rather advance payments of the policyholder’s entitlement under the policy. The advances do not have to be repaid to the insurer. A policy loan constitutes a disposition for tax purposes and will attract taxation when the total loan amount exceeds the adjusted cost basis of the policy. The insurance company will charge interest on any outstanding balance of policy loan. Any outstanding loan balance will be deducted from the policy proceeds at death with the net amount then being paid to the beneficiary(ies). For additional information on this topic, please refer to the Taxing Issues document entitled “Policy Loans” (PC 6140). Collateralization with a financial institution Another way to access the account value of the life insurance policy is by pledging the policy as collateral for a loan or series of loans from a financial institution. At retirement, the policy may be used as collateral security, and the financial institution will grant yearly loans or a lump sum, which can provide an additional source of yearly income to meet needs in retirement. Based on current tax rules (as at November, 2007) the loan proceeds are not taxable. Standard Life 5
Leveraged Supplementary Retirement Account The LSRA concept – Collateralization The LSRA concept – Collateralization The LSRA concept uses the collateralization method to access the account value in the policy and operates as follows: • The individual purchases universal life policy on his/her own life (or jointly with spouse). • The individual makes deposits (subject to certain limits under the ITA) into the investment accounts, in excess of the minimum premium required for the life insurance. • Income accumulating in the account(s) is tax-sheltered unless it is withdrawn from the policy or exceeds maximum allowable limit under the ITA. • When the individual retires and desires additional funds, the life insurance policy can be used as collateral to obtain a loan, or a series of loans, from a financial institution. • The financial institution will lend up to a specified percentage of the cash surrender value of the policy. This percentage varies depending on the type of investment account. • Loan amounts can be received as periodic payments or as a lump sum. Based on current legislation, loan proceeds are tax-free. • The loan is repaid when death proceeds are payable from the policy, unless loan repayment is demanded earlier. The residual balance of the death benefit, if any, goes to the deceased’s other beneficiaries. 6 Standard Life There are two ways in which the loan arrangement can generate cash for the retiree: 1. Borrow a lump sum and purchase an annuity The maximum amount allowable based on the policy cash value is borrowed as a lump sum and used to purchase an annuity. This is not the most effective method. While the loan itself is tax-free, a part of the annuity income is subject to income tax every year. In addition to the income tax due, the loan interest owing must be addressed. There are two options: the interest can be paid each year if the borrower so chooses or, the interest on the loan could be capitalized each year. If the interest is capitalized, the financial institution will advance an amount equal to the interest due and use this amount to pay the interest. The net effect is that the loan increases each year by the interest amount. The initial loan amount will be set lower, so that the projected loan plus capitalized interest over the life expectancy of the borrower will not exceed the financial institution’s maximum lending ratio based on the projected cash value of the policy over the same period.
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Leveraged Supplementary Retirement Account - Standard Life

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