Olga’s second option
This example assumes that Olga buys a universal life insurance policy with $600,000 face amount. She devotes not just the indexed annual $9000 to the UL, but she also repositions the $60,000 she has saved into the tax-shelter created by the universal life contract. She could select RRSP options also within the universal life policy's investment choices, but let's assume that she doesn't want that. In this case, half of the $9000 she can put aside goes to Revenue Canada, and only the other half is put to work for her within the UL. Using the illustration software of one of the best universal life policies available, the following can be projected if we conservatively assume a modest 8% annual return until she turns 65, and 6% afterwards. As for inflation, we stay with the 3% assumption used previously.
Assumed Rate of Return:
8% for 23 years, 6% thereafter
End| Age |Premium | Death | Account | Cash | Total | Bank |Accumulated
of | | paid | benefit | value | value | annual | loan | bank loan
year charges
________________________________________________________________________________
1 43 64,500.00 668,352 68,352 65,484 906 0 0
2 44 4,635.00 677,493 77,493 71,757 930 0 0
3 45 4,774.05 687,496 87,496 78,892 948 0 0
4 46 4,917.27 705,277 98,417 86,945 984 0 0
5# 47 5,064.79 750,879 111,920 100,448 1,103 0 0
From year 5, an investor bonus will be credited to her account. Investor bonuses in universal life polices are one of the important factors to universal life insurance illustrations. Almost all companies guarantee some bonus, but the actual value of these varies.
6# 48 5,216.73 799,167 126,930 115,458 1,244 0 0
7# 49 5,373.24 818,824 143,621 135,017 1,423 0 0
8# 50 5,534.43 837,209 162,007 156,271 1,598 0 0
9# 51 5,700.47 857,380 182,178 179,310 1,787 0 0
Up until year 9, if she wanted to cancel / surrender the policy, she would lose part of her investment. From year 10, however, this penalty disappears, and the cash surrender value will be equal to the account value.
10# 52 5,871.48 879,469 204,267 204,267 2,023 0 0
11# 53 6,047.62 903,683 228,481 228,481 2,246 0 0
12# 54 6,229.05 930,208 255,006 255,006 2,496 0 0
13# 55 6,415.92 959,348 284,146 284,146 2,678 0 0
14# 56 6,608.40 991,338 316,136 316,136 2,888 0 0
15# 57 6,806.65 1,026,486 351,284 351,284 3,077 0 0
16# 58 7,010.85 1,065,044 389,842 389,842 3,326 0 0
17# 59 7,221.18 1,107,396 432,194 432,194 3,536 0 0
18# 60 7,437.81 1,153,865 478,663 478,663 3,799 0 0
19# 61 7,660.95 1,204,862 529,660 529,660 4,062 0 0
20# 62 7,890.78 1,260,819 585,617 585,617 4,346 0 0
21# 63 8,127.50 1,327,646 647,028 647,028 4,630 0 0
22# 64 8,371.33 1,417,127 714,260 714,260 5,081 0 0
23# 65 8,622.47 1,511,314 787,591 787,591 5,819 0 0
When she is 65, she stops contributing to the policy. The next year she starts using the accumulated account value in a tax-effective way. She uses the policy as a collateral, and raises annual loans from a bank to live on. Since a loan is not considered to be earned income, she does not have to pay tax on it. Since the value of the policy is almost 0.8 million, she can easily get the loan at, or very close to, the prime rate. In this example, conservatively again, 7% interest on the bank loan is assumed.
24# 66 0.00 1,592,439 857,815 857,815 6,799 69,075 69,075
25# 67 0.00 1,677,605 933,889 933,889 7,795 71,147 145,058
26# 68 0.00 1,766,774 1,016,125 1,016,125 9,043 73,282 228,493
27# 69 0.00 1,860,177 1,105,001 1,105,001 10,410 75,480 319,968
28# 70 0.00 1,958,046 1,201,066 1,201,066 11,877 77,745 420,110
29# 71 0.00 2,060,781 1,304,969 1,304,969 13,396 80,077 529,595
30# 72 0.00 2,168,635 1,417,376 1,417,376 15,015 82,479 649,145
31# 73 0.00 2,282,716 1,539,578 1,539,578 16,203 84,954 779,539
32# 74 0.00 2,402,868 1,672,060 1,672,060 17,842 87,502 921,609
33# 75 0.00 2,529,764 1,816,067 1,816,067 19,259 90,127 1,076,249
34# 76 0.00 2,663,760 1,972,674 1,972,674 20,730 92,831 1,244,417
35# 77 0.00 2,805,682 2,143,485 2,143,485 21,854 95,616 1,427,143
36# 78 0.00 2,956,039 2,330,068 2,330,068 22,813 98,484 1,625,527
37# 79 0.00 3,115,346 2,534,241 2,534,241 23,519 101,439 1,840,753
38# 80 0.00 3,283,923 2,758,036 2,758,036 23,934 104,482 2,074,088
39# 81 0.00 3,462,274 3,004,008 3,004,008 23,754 107,617 2,326,890
40# 82 0.00 3,651,042 3,275,314 3,275,314 22,645 110,845 2,600,618
41# 83 0.00 3,850,999 3,576,037 3,576,037 20,021 114,170 2,896,831
42# 84 0.00 4,062,223 3,910,662 3,910,662 15,884 117,596 3,217,205
43# 85 0.00 4,384,849 4,284,849 4,284,849 9,532 121,123 3,563,533
Age 85 is an important year again. Olga has about 1 in 2 probability to attain this age. From this on, there will be no insurance charges, as can be seen from the indication of only a nominal administration charge of $126 annually. The so-called face amount of the policy will have been gradually reduced to zero by then, but the tax-shelter remains, and the pending death benefit (that is the account value) is enough to pay back the accumulating bank loan. Even after that, the heirs can get a nice sum of money tax-free.
44# 86 0.00 4,705,700 4,705,700 4,705,700 126 124,757 3,937,737
45# 87 0.00 5,167,900 5,167,900 5,167,900 126 128,500 4,341,879
46# 88 0.00 5,675,510 5,675,510 5,675,510 126 132,355 4,778,165
47# 89 0.00 6,232,993 6,232,993 6,232,993 126 136,325 5,248,962
48# 90 0.00 6,845,248 6,845,248 6,845,248 126 140,415 5,756,805
49# 91 0.00 7,517,657 7,517,657 7,517,657 126 144,628 6,304,409
50# 92 0.00 8,256,130 8,256,130 8,256,130 126 148,967 6,894,684
51# 93 0.00 9,067,157 9,067,157 9,067,157 126 153,436 7,530,748
52# 94 0.00 9,957,868 9,957,868 9,957,868 126 158,039 8,215,939
53# 95 0.00 10,936,090 10,936,090 10,936,090 126 162,780 8,953,834
Olga has 10% chance to live until age 95. If she dies then, and uses only the above cited bank loans, her beneficiaries will get almost 2 million dollars tax-free. The purchasing power of that will be much less than it would be today, of course, but still, ...
54# 96 0.00 12,010,422 12,010,422 12,010,422 126 167,663 9,748,266
55# 97 0.00 13,190,306 13,190,306 13,190,306 126 172,693 10,603,337
56# 98 0.00 14,486,113 14,486,113 14,486,113 126 177,874 11,523,445
57# 99 0.00 15,909,233 15,909,233 15,909,233 126 183,210 12,513,296
58# 100 0.00 17,472,173 17,472,173 17,472,173 126 188,706 13,577,933
As always, read the small print as well: This is an illustration only and NOT A CONTRACT. Rates of return and values contained within are projections only and are NOT GUARANTEES or forecasts of future performance. However, Cost of Insurance used above are fully guaranteed.
Remember, with Option 1, Olga would have used up all her saving by this time. With this option, the cash value of the policy is considerably larger than the accumulated bank loan, therefore, she can continue receiving the same level of annual income (but tax-free in this case!) for as long as she lives. When she dies, the amount of the bank loan will be deducted from the death benefit, and the remaining sum from the death benefit will be paid out tax-free.
Of course, if the annual rate of return is going to be less than the assumed 8% and 6%, then her account value will be less, allowing less bank loan to live on; but even a dismal 6% annual return in the first 23 years would generate more than half a million dollars as account value within the tax-shelter that could be used as a collateral to draw a modest bank loan as long as she lives. Using the same 6% assumption would give really bad results with the Option 1 strategy: She would have used all her money by a much younger age she will quite likely achieve.
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