The Insured Annuity Strategy – Options in a Low Interest Rate Environment.
In a previous article, I introduced the concept of annuities. In this article, I’ll introduce a very intriguing concept, the “insured annuity”. It took me a few times seeing this concept presented to fully understand it, so if at first glance it seems complicated, that’s understandable.
Where is it used?
The insured annuity is alternative to a GIC. It’s best used when you do not need access to your capital but from an estate planning perspective, you want to pass along the value of that capital to your heirs upon your death. It works best for those in good health, who are generally over 65 years of age.
What follows is a typical example.
Assume a male (non-smoker) has $100,000 of non-registered funds and is considering purchasing a GIC that pays four-percent annual interest and that his marginal tax rate is 30%.
With a GIC after-tax, he would receive the following.
$100,000 times 4% times (1 – marginal tax rate) = 100,000 * .04 * (1-.30) = $2,800 or 2.8%
With an insured annuity, there are several steps as follows.
Step 1: Purchase a term-to-100 life insurance policy for $100,000. The premium (annual cost) for a 65-year old male, non-smoker in this example is estimated to be $3,072. Remember, you must be insurable or this concept does not work.
Step 2: Purchase a prescribed annuity for $100,000. A prescribed annuity has level taxation each year whereas the tax for standard annuity is variable. In this example, a prescribed annuity is estimated to pay $7,418 before tax. The prescribed annuity is estimated to have an annual taxable portion of $1,638 which at a 30% marginal tax rate is approximately $491. Therefore on net, the prescribed annuity pays $6,927 annually after-tax ($7,418 minus $491).
Step 3: Use the proceeds of the prescribed annuity to pay the life insurance premiums as follows.
Prescribed Annuity after-tax = $ 6,927
Less: Insurance Premium = $ 3,072
Difference =$ 3,855
While the GIC paid $2,800 after-tax, the “insured annuity” pays $1,055 more after-tax which is over 35% more income.
The insured annuity concept needs to be implemented in a very organized step-by-step manner.
This is not a do-it-yourself strategy. You need to work with a trusted financial planner who is life licensed and understands your personal situation to make sure this is a sensible solution. Because a life insurance policy is involved, it takes some time to setup and you must be insurable. Once it is set-up, you cannot change the terms. With a GIC, rates may rise.
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