Q&A: Insurance dilemma

Question: A few days ago my financial advisor called me and told me that it was important that I buy insurance to safeguard the value of my RRSP in case of my death. The policy would pay the taxes owing to the government and my estate would receive the entire amount of the RRSP tax-free. I have approximately $800,000 in the RRSP and I am single and now 68 years old. The annual premium for the insurance is $10,000.00. – Shirley V.

Gordon Pape answers: There are two ways of looking at this. One is to take a rather cynical approach: it is in the advisor’s own financial interest to sell you a life insurance policy because he stands to earn a fat commission. The other is to look at this from a practical perspective.

If you were to die tomorrow, all the money in the RRSP would be deemed to have been cashed out and will be taxed at your marginal rate. That varies from province to province but to keep things simple let’s use a figure of 45%. That means that about $360,000 of your money is currently at risk. Of course, that will gradually diminish over time as you draw money from the plan but it will be many years before it reaches a negligible figure. So effectively, you are being advised to spend $10,000 a year to protect $360,000. It seems to make sense.

But where will that money come from? If you have to draw it out of the RRSP, the real cost to you will be a lot more than $10,000 because the withdrawal will be taxable income. You will be paying both the insurance premium plus taxes that might otherwise have been deferred.

As you can see, there is no easy answer. If you feel this type of protection is important, ask an independent financial planner (one with no vested interest) to prepare a cost/benefit analysis for you. This will look at the true after-tax cost of the insurance premium and estimate the amount of tax your estate will be liable for as each year passes.

You don’t say how much insurance the advisor is recommending but it should not be more than the projected tax liability.

Do you have a money question you’d like to ask Gordon? Send it along and then check out our Q&A section regularly to see if it was chosen for a response. Sorry, we cannot send personal answers.

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