What is an Insured Retirement Plan (IRP)?

Sometimes referred to as the Insured Retirement Program, the Insured Retirement Plan (IRP) is a concept, not a product. It allows a person to leverage their life insurance coverage to have peace of mind in retirement. The product used to implement this concept is whole life insurance or universal life insurance policy. So, first let’s talk about them. Retirement planning for insurance can involve an insured retirement plan. Basically, an insured retirement plan is a financial plan that offers clients permanent life insurance coverage as well as the ability to supplement their retirement income. This method is excellent for clients who have reached the contribution maximum on their RRSP or pension plan.

Life insurance, as you may know, is a legally binding contract between the insurer and the insured. In return for monthly premiums, the latter agrees to pay a certain amount to the policy’s beneficiaries when the insured dies. Simply put, a life insurance plan is a product that helps your family deal with the financial impact of your death.

There are two types of life insurance — term and permanent. Term life insurance coverage lasts for a specific period, which can be as short as one year or for 30 or 35 years. A permanent life insurance policy, by contrast, provides life insurance coverage that you cannot outlive. Permanent life insurance is further divided into different types, the two most common being whole life insurance and a universal life insurance policy.

An insured retirement plan focuses on leveraging your permanent life insurance policy cash value to fund income after retirement. First, you take out a whole life or universal life insurance policy. When the life insurance policy accumulates sufficient cash value, you use it as collateral to obtain a loan to provide you with a tax-free retirement income. Upon your death, the proceeds will be paid tax-free. The insurer will first use the death benefit to pay off the loan. The remaining amount will then be paid out to your loved ones.

You can access your life insurance policy’s cash value in many ways, including by taking out a loan against it. When you take out a loan, you can access cash from your policy on a tax-free basis. Since you are not withdrawing funds from the cash value, it continues to grow on a tax-deferred basis. Also, the interest accumulated is added back into the loan, so you do not have to worry about it while you are still alive. The insurer deducts the loan amount and interest from the death benefit when you pass away and issues the remainder to your beneficiaries.  

How does an insured retirement plan work?

The insured retirement plan (IRP) takes advantage of two tax beneficial features of life insurance:

• Proceeds of a policy get paid out tax free.

• Permanent Life plans accumulate an account value with interest on a tax-deferred basis.

A life insurance retirement plan allows you to leverage these tax benefits to save for your retirement. However, it is most effective as a retirement tool when you have already maxed out traditional savings and investment vehicles like TFSA, RRSP, etc. Typically, these strategies are more advantageous than an insurance retirement plan, so consider using an insurance retirement plan only when you have fully implemented others. Changes in tax laws may also impact the effectiveness of the IRP.

Implementing an insured retirement plan can be a difficult process. We recommend speaking with an advisor to guide you.

An insured retirement plan has three distinct phases. These are:

• Saving/Accumulation phase: You take out a whole life or universal life plan with an inbuilt investment component. As you pay the premiums, your policy’s cash value grows. It grows on a tax-deferred basis, just like funds in a TFSA or RRSP account.

• Withdrawal phase: The cash value of a permanent life insurance policy grows slowly during the first few years before picking up the pace. So, upon retirement, you will likely have accumulated sufficient supplementary retirement income, especially if you did not miss any premium payments and have not yet tapped into the cash value. However, if you were to make a withdrawal from your cash value to fund retirement, the money will count as a taxable income. So, the idea is to access this pot of money without making a withdrawal. This can be done by taking an annual bank loan with your life insurance policy as collateral. The annual loan helps fund your retirement, and the yearly payments and interest are recapitalized into the loan. This means you do not have to repay the loan during your lifetime.

• Repayment phase: When you pass away, the death benefit is used for repaying the loan, and your beneficiaries receive the remaining benefit amount. Since the proceeds of a life insurance policy are not taxable, the loan is paid down with tax-sheltered money.

Why would you get an insured retirement plan?

It is a good strategy to max out your TFSA and RRSP first before implementing an IRP. While the latter offers a way to fund all or part of your retirement, it is principally a life insurance coverage plan with a cash value component. For this reason, implementing an insured retirement plan if you do not have an insurance need does not make sense. Nor is it advantageous to give it precedence over RRSP and TFSA, but there are exceptions.

The RRSP contribution limit for 2024 is 20% of your income, up to a maximum of $30,780. In contrast, the annual dollar limit for TFSA is$6,000. An insured retirement plan is a good retirement strategy for someone who needs life insurance and can invest more than $35,210 a year for retirement. Generally speaking, the ideal candidate would be a higher-net-worth individual who consistently maxes out traditional investment vehicles.

With that said, not everyone is able to put money in RRSP. In such cases, using both TFSA and an insured retirement plan to ensure income after retirement in the future can be an effective strategy.  

Before implementing an insured retirement plan (IRP), carefully consider the following two factors:

•  Type of life insurance policy and company:

‍Whole life or universal life insurance policies are suitable for implementing this strategy. Both build a supplementary retirement income, but a universal life insurance policy offers more flexibility. It is also typically more complicated and requires closer maintenance. You can pick the type of life insurance plan that suits your goals better. Depending on the insurer and the policy you pick, you might be able to use 95% or 75% or a different percentage of the life insurance policy as collateral.  

• Cost of insurance:

As mentioned above, a part of your premium covers the cost of insurance and administrative fees and the remainder is funnelled into an investment account. The cost of insurance either remains the same throughout or increases annually. You can pick the option that best works for you. Generally speaking, the latter is a better investment strategy because a bigger part of your initial premiums is used for building cash value.

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What are the pros of insured retirement plans?

An insured retirement plan offers many advantages, such as:

• Your life insurance policy provides supplemental retirement income in addition to protecting your loved ones from the financial impact of your death.

• Your policy’s cash value grows on a tax-deferred basis.

• The interest on the loan can be (and usually is) capitalized, meaning it is payable upon your passing away. So, in effect, you do not have to worry about paying it during your lifetime.  

• Your policy acts as an asset. You can tap into your cash value without giving up ownership when you use the life insurance policy as collateral for a bank loan.

• The death benefit is not subject to tax.

What are the cons of insured retirement plans?

Like other financial products, an insured retirement plan has a few disadvantages.

•  An insured retirement plan is better suited for supplementing retirement income, not as a primary source of retirement income. That is because the money is not liquid. If you need to surrender the policy to access the cash value, you will have to pay surrender charges and fees, which are quite high during the first few years.

• Implement an insured retirement plan make sense only if you have an insurance need. If you already have a life insurance policy, an IRP is not likely to be the right retirement tool for you.

• You can use an insured retirement plan to fund retirement only if you qualify for life insurance. Most whole life and universal life insurance policies (if not all) require taking a medical exam and answering a few invasive health questions. If you have a serious underlying health condition, you might not qualify for a traditional life insurance policy.

• There is a risk that changes in lending practices and/or tax laws could prevent access to the strategy in retirement.

Conclusion

The Insured Retirement Plan is a financial strategy that leverages the tax beneficial features of permanent life insurance to supplement retirement income. Using this strategy can help you achieve two aims at once — financially protect your loved ones and generate retirement income.

A Dundas Life expert can help you decide if an insured retirement plan is the right option for you. If so, we will help you find the best life insurance policy at the lowest price.