Golombek offers tips for a

They are averse to risks involved in beating 6.00%. They will lose group life and health benefits tied to the pension. They may lose ad hoc inflation adjustments that aren’t reflected in the commuted value. The client is in a plan with a big surplus, since they are now entitled to a portion of this […]

By Steven Lamb | September 17, 2004 | Last updated on September 17, 2004
5 min read
  • They are averse to risks involved in beating 6.00%.
  • They will lose group life and health benefits tied to the pension.
  • They may lose ad hoc inflation adjustments that aren’t reflected in the commuted value.
  • The client is in a plan with a big surplus, since they are now entitled to a portion of this in the event the plan is wound up.

Aside from corporate pension plans, Golombek suggested some tax-efficient alternatives to the fixed income investing that is so familiar to many seniors seeking to fund their retirement.

Insured annuities

On the topic of tax-efficient generation of retirement income, Golombek explained the benefits of insured annuities over vehicles traditionally viewed as the safe option — bonds and GICs.

As any tax-savvy advisor knows, income from bonds and GICs is taxable at the highest marginal tax-rate. Factoring in inflation, Golombek pointed to Schulich finance professor Moshe Milevsky’s conclusion that GICs tend to offer negative real returns.

An insured annuity takes advantage of the lower tax rates imposed on annuity income, since a large portion of the income is treated as return of capital. The annuity is guaranteed for life, eliminating the interest rate risk associated with renewing bonds and GICs. Because the annuity is wound up on the death of the annuitant, the initial investment can be lost.

That’s where the insurance comes in. The annuitant purchases a life insurance policy with a death benefit equal to their initial annuity investment. When they die, the estate receives this initial investment amount tax-free as an insurance payment, avoiding the “disinheritance” aspect of the annuity.

Take the example of a 70-year-old retiree with investible assets of $300,000, in the 30% marginal tax bracket. This retiree could invest in a GIC yielding 5%, to derive income of $1,250 per month, which is entirely taxable at their marginal tax rate. After deducting $375 in tax, the investor’s monthly income is $875.

Golombek suggests a better investment might be the insured annuity, which could pay out $2,350 per month in pre-tax income, but because of the investment’s preferential tax-treatment — where only $433 is taxable — the retiree faces a tax bill of only $130. Even after deducting a hefty insurance premium payment of $1,076, the annuitant still receives after tax monthly income of $1,144.

That’s an increase in annual after-tax income of $3,228 (31%), the equivalent of investing in a 6.5% GIC.

The insured annuity’s benefits over interest bearing investments become even more pronounced further up the tax scale. Using the same assumptions as the above investor, but with a marginal tax rate of 46%, the annuity option becomes the equivalent of an 8% interest yield, due to the higher taxation of the GIC/bond option.

“The biggest negative is that the insured annuity is pretty much irreversible,” says Golombek. “If you decide a few months after buying the annuity that you didn’t like it anymore, you can’t get your money back, which is very different from a GIC, which you certainly can break if you need your money back.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(09/17/04)

Steven Lamb

  • They are averse to risks involved in beating 6.00%.
  • They will lose group life and health benefits tied to the pension.
  • They may lose ad hoc inflation adjustments that aren’t reflected in the commuted value.
  • The client is in a plan with a big surplus, since they are now entitled to a portion of this in the event the plan is wound up.

Aside from corporate pension plans, Golombek suggested some tax-efficient alternatives to the fixed income investing that is so familiar to many seniors seeking to fund their retirement.

Insured annuities

On the topic of tax-efficient generation of retirement income, Golombek explained the benefits of insured annuities over vehicles traditionally viewed as the safe option — bonds and GICs.

As any tax-savvy advisor knows, income from bonds and GICs is taxable at the highest marginal tax-rate. Factoring in inflation, Golombek pointed to Schulich finance professor Moshe Milevsky’s conclusion that GICs tend to offer negative real returns.

An insured annuity takes advantage of the lower tax rates imposed on annuity income, since a large portion of the income is treated as return of capital. The annuity is guaranteed for life, eliminating the interest rate risk associated with renewing bonds and GICs. Because the annuity is wound up on the death of the annuitant, the initial investment can be lost.

That’s where the insurance comes in. The annuitant purchases a life insurance policy with a death benefit equal to their initial annuity investment. When they die, the estate receives this initial investment amount tax-free as an insurance payment, avoiding the “disinheritance” aspect of the annuity.

Take the example of a 70-year-old retiree with investible assets of $300,000, in the 30% marginal tax bracket. This retiree could invest in a GIC yielding 5%, to derive income of $1,250 per month, which is entirely taxable at their marginal tax rate. After deducting $375 in tax, the investor’s monthly income is $875.

Golombek suggests a better investment might be the insured annuity, which could pay out $2,350 per month in pre-tax income, but because of the investment’s preferential tax-treatment — where only $433 is taxable — the retiree faces a tax bill of only $130. Even after deducting a hefty insurance premium payment of $1,076, the annuitant still receives after tax monthly income of $1,144.

That’s an increase in annual after-tax income of $3,228 (31%), the equivalent of investing in a 6.5% GIC.

The insured annuity’s benefits over interest bearing investments become even more pronounced further up the tax scale. Using the same assumptions as the above investor, but with a marginal tax rate of 46%, the annuity option becomes the equivalent of an 8% interest yield, due to the higher taxation of the GIC/bond option.

“The biggest negative is that the insured annuity is pretty much irreversible,” says Golombek. “If you decide a few months after buying the annuity that you didn’t like it anymore, you can’t get your money back, which is very different from a GIC, which you certainly can break if you need your money back.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(09/17/04)