In the past, those who had already maximized their RRSPs sometimes used universal life insurance (UL) policies to shelter investment earnings from tax. When Tax Free Savings Accounts (TFSAs) become available in 2009, some expect that clients will use their TFSA deposit room before overfunding UL.
Even so, experts interviewed by The Insurance Journal believe that TFSA's will have a limited impact on UL deposits.
In the last federal budget, the government announced the creation of TFSAs. Anyone over the age of 18 will be able to contribute up to $5000 into a TFSA annually.
Plan holders will be able to buy stocks, bonds, mutual funds, GICs, and shares of qualifying small business corporations - the same types of investments already available inside registered retirement savings plans.
While there is no deduction for amounts paid into a TFSA, any money earned on deposits will not be subject to taxation. Withdrawals are not included in income, nor will they affect the eligibility for government benefits or tax credits, such as employment insurance or old age security. The annual TFSA limit will be indexed to inflation and rounded to the nearest $500 every year, and any unused contribution room can be carried forward indefinitely.
Marty Mommersteeg, product Manager, universal life products, individual insurance, for Manulife Financial, points out that more than half of all universal life policies aren't being used as tax deferred savings vehicles in the first place, so it's not a question of competition. "In the lower end of that market individuals tend to purchase the product for the insurance need, not for tax deferral. Most of these policies are minimum funded and will continue to be purchased to meet the insurance need," he says.
Once TFSAs are introduced, he says they may divert some deposits away from UL, but wealthier clients will still need their universal life policies once they've reached the $5000 annual limit. "For most clients, Manulife currently recommends they fully utilize their RRSP deposit room before they overfund their UL policy. RRSPs simply offer a more cost effective tax deferral. The TFSA is also an attractive tax shelter, so the new recommendation will be for clients to fully utilize their RRSP and TFSA deposit room prior to overfunding their UL."
Kevin Strain, senior vice-president, individual insurance and investments at Sun Life Financial, is not worried about the impact TFSAs will have on UL deposits. "On the wholesale side, we've really targeted our relationships and our product at the 50-plus, affluent market.
On that side our average premium is in excess of $20,000," he says, and notes that there are a significant number of customers paying more than $100,000 into the UL policies each year.
Sun Life's career sales force, on the other hand, deals with a much broader market, where annual premiums are typically around $2000, and the policy has been sold to cover an insurance need.
He doesn't expect either end of the spectrum to be seriously affected by the introduction of TFSAs. "The TFSA will be a really important piece of after tax returns on the wealth side, but it doesn't take away from the fact that customers need insurance for estate planning and protection," he says.
And even after TFSAs are introduced, there are situations when clients may want still want to use universal life policies to shelter assets.
Take the case of minors, who will not have any TFSA room. Parents or grandparents who want to accumulate funds for a child under the age of 18 may prefer to take out UL policies, and keep their TFSAs for themselves. "A properly structured UL policy can be set up for each minor child today without a $5000 limit and parents can exercise ongoing control, even after transferring the policy," says Peter Wouters, director of tax, estate planning and risk product marketing at Empire Life. "No attribution applies if transfers occur after the child reaches the age of majority. Tax-deferral continues and tax-deferred becomes tax-free upon death of the life insured."
Mr. Wouters also notes that TFSAs may present problems for those who plan to move abroad. "Upon becoming a Canadian non-resident, TFSA holders can maintain their account but can no longer put in new contributions," he says. "This limitation does not exist with UL which can still accept and accumulate deposits on a tax-deferred basis."
But it needn't be an either/or decision. While the details are uncertain, there is a possibility that a UL policy could be registered as a TFSA.
"It is not clear whether Finance Canada and the Canada Revenue Agency intend UL policies and TFSAs to happen," says Lea Koiv, senior advisor, taxation and pensions, at Standard Life's retail markets division. "The Canadian Life and Health Insurance Association had sent out a communication to that effect. A ‘licensed annuities provider' is allowed to offer TFSAs. UL policies are something that a licensed annuities provider can thus offer. Thus, it appears to be something that the legislation contemplated. It would appear that there may be issues with such things as transferring the UL policy out of the TFSA, and trying to establish what the fair market value of the policy is at that time." Ms. Koiv points out that a UL policy, if offered as a TFSA, must be stand-alone. "There cannot be shared ownership, that is, having part be a TFSA and part be owned outside the TFSA," she says.
Curtis Findlay, an advisor in Canmore, Alberta, notes that most institutions are still developing the TFSA structure they will offer. Until advisors see the final product, they won't know whether it's even worth getting into the market. "These accounts permit withdrawals and subsequent replacement of the withdrawn funds. This increases both transaction related service costs and client queries resulting from increased account activity, while the institutions will require record keeping dimensions that are different from other accounts," he says. "Many advisors may choose to ignore these new accounts as not worthy of their time and being judged as not profitable. Banking institutions, particularly the virtual ones, will be aggressively trying to increase wallet share by offering higher interest rates and having consumers complete much of the processing themselves."
It may be awhile before advisors can make their decision. Mr. Wouters believes that companies who want to offer TFSAs face some significant and expensive administrative hurdles. "This may call for a cooperative effort designing and setting up systems to track and report deposits, growth and withdrawals. Until then, UL has no competition from TFSAs since the latter aren't available. Hopefully, the administrative challenges will be overcome. And when that happens, clients with more than $5000 shouldn't have to choose between these two vehicles," he says. "Take them both."