Financial Planning, Investment Counselling, Tax and Accounting

Contents

Life insurance as an investment — fact or myth?
Oil and gas provide a “boost” to investors
30% RRSP foreign content eliminated
Ontario to phase out labour sponsored investment funds tax credit

Life insurance as an investment — fact or myth?

by David Burnie, CFP

Most individuals satisfy their life insurance need by either self-insuring or through term insurance coverage. A common misconception is that life insurance is purely a risk management tool designed to provide a lump sum payment at time of death, and hence mitigate the cost associated with premature death. However, life insurance in specific circumstances can also be used effectively as a tool for wealth accumulation. The reality is that certain life insurance policies have some unique and oftentimes advantageous tax planning elements. This article will highlight some of the features of a universal life insurance policy including some of the tax planning benefits associated with this type of policy.

Universal life insurance policies

An individual may purchase a life insurance policy for a number of different reasons including: income replacement; support of dependants; payment of final expenses; estate costs; debts and tax liabilities; creating, increasing, or replacing an estate; funding bequests to charity; or funding buy-sell obligations with a business partner.

Unlike basic term insurance, a universal insurance policy has two components; the insurance component and an investment account. The investment component of a universal life insurance policy generally qualifies as “tax exempt” for income tax purposes. This allows for tax-deferred growth of the investment value of the policy and tax-free receipt of the proceeds at time of death. Alternatively, the deposits can be designed so that they remain tax-sheltered within the contract and can actually pay for the cost of insurance and expenses in future years, or they may be withdrawn prior to death.

As mentioned previously, the growth on the investment within the policy is not subject to annual accrual taxation and is only subject to tax when funds are withdrawn (similar to an RRSP). Significant investment values can accumulate on a tax-deferred basis if the maximum amount permitted by the Income Tax Act is deposited into the policy.

Methods of accessing the cash value

There are several alternatives available to the policyholder in order to access a policy’s investment value. The policyholder may withdraw some or all of the investment value. However, any amount withdrawn is considered as taxable income.

The policyholder may also request a “policy loan” from the insurer if the policy contract includes this option. A policy loan is an advance payment of the policyholder’s entitlement to benefits under the policy. A policy loan is considered a disposition for income tax purposes and will also result in taxable income.

A more attractive method of accessing cash value involves pledging a universal life insurance policy as security for a bank loan, otherwise known as a collateral assignment. A collateral assignment of a policy is specifically excluded from the definition of “disposition” under the Income Tax Act. This allows the policyholder to withdraw some or all of the investment value tax-free. The loan will be repaid upon the policyholder’s death from the insurance component of the policy.

Significant financial benefits can be achieved using life insurance strategies, and in particular through the use of a universal life insurance policy. However, as with all financial planning strategies, it is important to fully understand the financial and tax issues associated with this strategy and ensure that the strategy is well aligned with personal financial planning objectives.

Oil and gas provide a “boost” to investors

by Thomas Ryan, CFP

It is widely known that Canada is rich in natural resources. A significant portion of Canada’s economic activity is resource based, including forestry products, oil and natural gas, and mineral extraction. Most investors have some exposure to resource companies in their investment portfolios, either directly through resource specific mutual funds, or indirectly via broad-based Canadian equity funds that have a resource component.

Resource based companies in general have done quite well over the last 24 months, and this success has been reflected in positive investment results for most Canadian investors. Most recently, Hurricanes Katrina and Rita have caused a significant run up in world oil and gas prices, resulting in even higher valuations for many Canadian resource companies. As a result, Canadian investors have experienced a further short term “boost” to their investment results.

However, investors need to be aware that resource stock prices tend to be quite volatile, and that recent returns will not likely be replicated in the future. The current spike in oil and gas prices is likely temporary, and as these prices decline, so too will company valuations. Although this significant market segment growth does not directly parallel the run up in technology stocks that we experienced in the late 1990’s (and subsequent market crash in the summer of 2000), investors still need to be cautious about becoming over-exposed to a specific market sector. Investors should continue to adhere to their asset allocation model, and follow through with periodic portfolio re-balancing.

This is your best assurance of not only benefiting form the short term portfolio “boost”, but also insuring that you achieve long-term portfolio gains.

30% RRSP foreign content eliminated

by Marc Lamontagne, CFP, R.F.P., FMA

The 2005 federal budget contained some good news for investors looking for greater flexibility in managing the investment composition within their registered plans. This forward-thinking budget eliminated the 30% foreign content limit for investments held within all registered savings plans including RRSPs, locked-in RRSPs, DPSPs, and pension plans.

The foreign content restriction was introduced in 1971, and was essentially designed to encourage domestic investment in the Canadian capital markets. While there is some nobility in that notion, the reality is that the restriction acted as an indirect subsidy to domestic industries as they had access to a larger share of Canadian investors' capital than they might otherwise have had.

As Canada accounts for only 3% of the world's stock market capitalization, removing the foreign content limit will give investors even greater choice and flexibility when it comes to designing a portfolio asset allocation model to meet their investment objectives. It is worth noting that in recent years, most mutual fund companies have developed clone versions of their non-Canadian mutual funds and as a result are already circumventing the foreign content limit. A clone fund replicates the performance of an existing mutual fund or index through the use of derivatives.

The elimination of the foreign content limit will simplify RRSP reporting and eliminate the need for RRSP clone funds. Some mutual fund companies have already merged their RRSP clone funds into their underlying regular fund versions. We expect all mutual fund companies to follow suit in the coming months.

All of this translates into greater flexibility at a lower cost for most individual investor.

Ontario to phase out labour sponsored investment funds tax credit

The Ontario government announced last month that it plans to eliminate its 15 per cent tax credit for investors in Labour Sponsored Investment Funds (LSIFs).

“The LSIF tax credit was introduced when there was a need to kick-start the venture capital sector in Ontario," Finance Minister Greg Sorbara said. In 1988, the federal government introduced the Labour Sponsored Venture Capital Corporation tax incentive program to help stimulate venture capital investment.

In 1991, at a time of recession and high unemployment, Ontario joined the federal program with its own Labour Sponsored Investment Fund (LSIF) program. Since then, the province has invested more than $600 million in this program through tax credits to Ontarian’s. Individual investors who buy shares in an LSIF receive a provincial tax credit of up to 20 per cent on a maximum $5,000 investment on top of the federal tax credit of 15 per cent. The investment must be held for eight years to avoid repayment of the tax credit.

LSIFs are venture capital corporations, designed to provide alternative sources of capital to small and medium-sized Ontario businesses. Today there are 46 registered labour sponsored investment funds and almost $3 billion in capital under management in Ontario.

"Ontario's venture capital market is much healthier now, and we believe that this incentive is no longer the best fit in today's economic and fiscal climate.", added Minister Sorbara.

A healthy venture capital market is important to promoting innovation and research, a priority of the McGuinty government. Ontario's venture capital market includes more than 200 private sector venture capital funds, and close to 200 U.S. funds have invested in Ontario companies over the past six years.

A spokesperson for Vengrowth, one of the largest LSIF firms in Canada with offices in Ottawa and an active investor in the high tech community, stated that the venture capital industry plans to lobby the Ontario government to revisit the elimination of this tax credit, or to at least phase out the credit over several years.