Licensed benefits

Financial planning seems to be the new buzzword, with many more firms adopting a holistic approach to managing client relationships.

And recent research indicates this is a step in the right direction. According to the Financial Planners Standards Council (FPSC), about three-quarters of all Canadians say a written financial plan is crucial to their financial success. Surprisingly, however, only about one-quarter have such a plan.

While it’s true that proper planning can’t stall illness or death, it can prevent those things from turning your clients’ financial lives upside down.

Generally speaking, time and money are the two main inputs to any investment program: with enough of each, the plan should work. But what if your clients run out of time or money? This is where an alternative is needed. And, in most cases, the backup involves insurance because it provides the best tools to ensure death or disability don’t derail a financial plan if investors are unable to complete it on their own.

Dual Licence

That’s why comprehensive planning often involves insurance planning as well as investment planning. It’s also why many investment firms today either require or strongly recommend that their advisors become dual-licensed. The good news: most advisors are on board. The bad news: very few are actually putting their insurance licences to use.

When investment advisors hold an insurance licence, the benefits are plenty, and not just for advisors. Of course advisors benefit because they can collect fees and commissions from both the insurance and the investment sides of the business. Moreover, offering a more complete solution helps them strengthen their client relationships, thus boosting retention. Clients, in turn, benefit because they ideally end up with a more comprehensive plan, without the hassle of having to deal with numerous professionals. Finally, the firm benefits because hybrid operations tend to be more profitable.

So why are so many advisors ignoring their life insurance licences? Excuses abound: Here are some of the common ones: “I’ve been doing it this way for 25 years,” “I don’t want to change my business now,” “I’m making enough without it,” “People have enough insurance already,” or “I’m not an insurance specialist.”

This approach will leave the door ajar for other advisors to fly in and scoop your clients. So let’s look at a few scenarios where an insurance-based solution can prove more powerful than a traditional investment- based solution. While strategies for managing registered assets are typically more restrictive, many creative things can be done for clients who have nonregistered assets. Oftentimes, these solutions involve using multiple products in tandem. Insured annuities and term-certain annuities are perfect examples.

Structuring Income and Inheritance

Joe MacDonald, 65, is a non-smoker. He likes GICs for the certainty they allow of not losing his principal; he feels they are safe, so he’s stuck with GICs for many years. Joe’s goal is to live comfortably in retirement, supplementing his pension with some extra income generated from his investments, but without dipping into the capital. When he dies, he wants to leave the capital to his adult children. He receives a healthy employer pension, CPP and OAS benefits, so his investment income is supplemental, and not the sole component of his retirement income. Joe has $200,000.

There are two basic things to accomplish for Joe: first, construct an income stream generated from his investments and second, leave the remaining $200,000 to his heirs.

A traditional GIC solution enables him to do just that. Joe’s income stream is guaranteed—he can never make less than the stated rate, and can never lose his original invested capital. Sounds great, but the GIC-based recommendation is a poor solution.

Let’s consider an alternative—an insured annuity. This instrument is actually two products: an annuity and a life insurance policy—note that both these products require the advisor to be insurance- licensed. Instead of purchasing a GIC, the original capital is used to purchase a life annuity. To implement the strategy, Joe would first apply for the life insurance to make sure he qualifies. Once it’s approved, he can purchase the annuity. A portion of his annuity payment is used to pay the life insurance premium and the adult children are named beneficiaries on the life insurance policy, ensuring they receive the inheritance (see “Insured Annuity Versus GIC,”).

Insured Annuity Versus GIC
Male, aged 65, non-smoker. $200,000 initial investment	Insured Annuity	GIC @ 4.9%
Annual income	$15,416	$9,800
Annual tax payable	($1,472)	($4,410)
Annual life insurance premium	($6,445)	0
Net annual after-tax cash flow	$7,499	$5,390
NOTE: These examples are for illustration purposes only and not a guarantee of the future. Actual results will differ depending on factors such as age, gender, tax bracket, current interest rates, insurability and form of annuity chosen. The annuity rate used is that in effect April 30, 2005 and is based on an annuity for life without a guarantee period, with the first payment being received one month after the purchase date. A 45% tax rate is assumed. The life insurance quoted is Standard Life’s Universal Life Perspecta, with premiums based on non-smoker rates.

Note that Joe receives $2,109 more after tax each year from the annuity solution, as opposed to the GIC solution— an increase of over 39%. In order to end up with $7,499 after tax (as in the case of the annuity) the GIC would have to yield approximately $13,634—over 6.8%.

Why it Makes Sense

With a GIC, income is extremely taxinefficient, as every dollar is treated as regular income. An annuity, by contrast, pays a blend of interest and capital. Only the interest portion is taxable, making the tax treatment much more favourable. Another important aspect of this solution is what happens when Joe dies. In the case of the insured annuity solution, the life insurance proceeds pass directly to the adult children as the named beneficiaries. Joe can avoid costly probate fees while ensuring 100% capital preservation. Joe can also free himself from any concerns over future interest rates as the insured annuity strategy will eliminate any reinvestment risk that comes along with the GIC solution.

Severance Package for Risk-Averse Investor

Rebecca Jones is a casual smoker, aged 55. Although she’s still quite young, Rebecca has recently retired after 20 years. She was a founding member of a very successful company, and as a result has a significant retirement bonus of $300,000. Ideally, Rebecca would like to keep working, but due to mental health concerns, she’s elected to resign from the company and begin retirement. Rebecca describes herself as extremely risk-averse when it comes to investing, and she’s always favoured GICs.

Despite a healthy severance, Rebecca’s early retirement unfortunately also means a reduced pension. In order to maintain her lifestyle, Rebecca will need to supplement her employer pension with an income from her investments. She’s concerned about the next 10 years in particular, after which time she feels her CPP and OAS payments will eliminate the need for the extra investment income.

A typical approach would be a laddered GIC portfolio, to suit her riskaverse nature and provide the desired income to supplement her pension. This would certainly be the path of least resistance, but the laddered GIC portfolio is a poor solution for this client.

Let’s consider an alternative—a termcertain annuity, along with a regular investment account. Again, the annuity is a tool in the life insurance advisor’s arsenal, so the dual licensure is being leveraged. The term-certain annuity is structured to provide the same level of income as a GIC. But since the cost of the annuity is less than is required with GICs, the remainder can be invested in a basket of funds. The investments are structured for moderate growth, providing an appropriate blend of equity and fixed income exposure (see “Term Paper,”).

Term Paper
Female, aged 53, smoker. $300,000 initial investment	GIC @ 4.9%	Term-certain annunity (10 yr)	Growth Fund
Annual income	$15,416	$9,800
Initial investment	$300,000	$76,096	$223,904
Annual income	$14,700	$8,959
Annual tax payable	($6,321)	($580)
Net annual after-tax cash flow	$8,379	$8,379
Growth fund after 10 years at 4.5%			$347,716
Growth fund after 10 years at 2.97%			$300,000
The examples are for illustration purposes only and are not a guarantee of the future. Actual results will differ depending on factors such as age, gender, tax bracket, current interest rates and form of annuity chosen. The annuity rate used is based on a 10-year term-certain annuity. A 43% tax rate is assumed. The performance of the growth fund is not guaranteed or linked to any specific product.

In both cases, Rebecca receives the same after-tax amount of $8,379 annually. This is achieved by investing $300,000 in a 4.9% GIC or from purchasing a $76,096 10-year term-certain annuity. But, in the case of purchasing the annuity, Rebecca is left with an additional $223,904 to invest.

Why it Makes Sense

First, with a term-certain annuity, age and smoking status are irrelevant. And short-term volatility is also a non-issue, because Rebecca is not yet drawing from her investments. The term-certain annuity would provide the desired cash flow for 10 years in this case. So Rebecca would not be forced to sell any investments at an inopportune time. After 10 years, she should benefit from a better overall return from the diversified basket of funds than she would from the GICs.

If the average return over the 10-year period is 4.5%, the $223,904 would grow to $347,716. In order for the account to simply break even, that is, to return to the original $300,000, the required annual rate of return is a paltry 2.97%.

There’s no guarantee about stock market performance over any 10-year period. But we can let history be our guide by taking a look at the last 35 years. Consider the S&P/TSX Composite Index from December 1974 to February 2008: • 277 rolling 10-year periods; • Periods when the market was up: 277 (100% of the time); • Periods when the market was down: 0 (0% of the time).

Keep in mind that we’re not predicting or calibrating the future—we’re simply stating historical fact. Is it possible to get a negative return after 10 years? Absolutely. But we can, with reasonable probability, expect a positive return.

Keeping the Cottage

So we’ve demonstrated that dual-licensed advisors can use their insurance licences to implement more creative solutions than those using only their securities licences. But aside from offering more powerful investment alternatives, there are many real-life situations where an insurance licence enables advisors to deal with issues outside the scope of investment portfolios. A prime example is dealing with the family cottage, an exercise in estate planning.

The Walshes are experiencing a problem that’s facing many older cottage owners: the march of time. They paid just $18,000 for it in 1958 but they’re now in their eighties, and fair market value (FMV) of the cottage is $500,000 and could be higher by the time they die.

In addition to market value, the cottage has tremendous sentimental value. The Walshes want their adult children to inherit the cottage when they pass. But it’s not as easy as just giving it to them. The CRA will treat the appreciation on the cottage as a capital gain, and that gain will be taxed accordingly. The capital gains exemption for a principal residence isn’t available because they’re using it on their home. If the kids don’t have sufficient cash to pay the tax bill, CRA may require that the cottage, and possibly other assets, be sold to raise the necessary funds. The money is due when the Walshes’ final tax return is filed.

There are a few solutions available. One common approach is for the Walshes to transfer the cottage to the children now. The major pitfall to this strategy is the selling price: the Walshes can’t sell to their children for some arbitrary, low-ball figure. The CRA will claim it was sold at FMV, and they will be taxed accordingly on the appreciated capital gains. Even worse, if they do sell it to their children for less than the FMV, this lower number will be the adjusted cost base (ACB) for the children, resulting in double taxation when the property is eventually sold again.

Another approach is to incorporate an insurance solution to take care of the taxes. The type of insurance that works well here is a joint last-to-die policy, on both Mr. and Mrs. Walsh. With this insurance policy, the benefit will be paid on the second death, precisely the time that taxes will be due.

Why it Makes Sense

When the surviving spouse dies, the insurance benefit is paid to the benefi- ciaries, in this case, the adult children. This provides the cash needed to paythe tax bill owing. Since the children will be the ones to inherit the cottage, they could also be the ones to pay the premiums on the insurance policy. Life insurance is often the cheapest way to manage taxes due on death. And it’s important to note that there’s no comparable investment-based solution in this case. This particular situation requires a life insurance policy, and therefore a life-licensed advisor.

Clearly, advisors who ignore their insurance licence are ignoring something bigger—the opportunity to present powerful and comprehensive solutions to their clients. Dual-licensed advisors are in a better position than ever when it comes to developing comprehensive strategies and solutions for clients. So what are you waiting for? Leverage your licensure.