June 15, 2008

How Pink Floyd's Insights On Mortality Help You

you're older,
shorter of breath
and one day
closer to death
--- Pink Floyd, Time

Back To Basics
When you buy insurance on your car or home, you pay premiums which get adjusted annually (usually upwards) based on claims experience. That model doesn't work with life insurance. As closet actuaries Pink Floyd correctly observe, we get closer to death each day. Even if we take care of ourselves, our mortality rates continually increase and increase. If you pay-as-you-go, coverage becomes less and less affordable as payment of the death benefit becomes more likely. Term insurance becomes unavailable.

Tax Incentives
The government uses tax incentives to encourage behavior which reduces burdens on society. For example
  • saving for retirement (pension plans, RRSP, Tax-Free Savings Account)
  • saving for a child's education (RESP)
  • saving in general (TFSA)
Life insurance clearly qualifies: the death benefit helps families and other survivors. While premiums are not tax-deductible, the death benefit is tax-free.

Big Opportunity
Increasing mortality rates make affordability a big problem. The solution is pre-funding. The government encourages you to invest extra money in your life insurance contract by allowing tax-sheltered growth.

The amount you can invest depends on the cryptic Maximum Tax Actuarial Reserve (MTAR), which varies with the amount of coverage, your age and your health. Since our probability of dying is 100%, you can essentially invest any amount of money --- even millions of dollars.

But why would you?

Because the tax savings on the investment growth are often more than enough to pay for the insurance charges. The government effectively pays for your insurance if
  • you're healthy
  • you make large deposits in the early years
  • you allow time for tax-sheltered compound growth
Needs Change
Tax-sheltered growth is great but what happens if you take money out? As with an RRSP, you pay tax on the investment growth. But you have several advantages over an RRSP
  • you can make much larger deposits
  • you aren't forced to make any withdrawals
  • you can get tax-free access to the savings
Suppose you want to supplement your retirement income. Banks like lending when you don't need the money. You can use the savings in your insurance policy as collateral for loans. Since loans are tax-free, you get tax-free income. You don't need to pay the loan interest either. Banks usually let the loan interest accumulate and wait for the tax-free death benefit to repay the loan. What's left goes to your heirs.

Thanks to tax savings, you can benefit from mortality during your lifetime.


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