Dear Expert:
Universal life insurance or RRSPs? Which is the better route? Should I put all my retirement money in a universal life (UL) policy instead of an RRSP? With UL insurance, you will not be taxed after you die and is tax-sheltered just like RRSP. You can obtain a loan from the bank on your investment portion of the universal life insurance and use it as your income tax free after you retired.
Expert Opinion:
You are comparing "apples and oranges" by looking at UL and RRSP as tax-deferral vehicles with similar characteristics. I am not a fan of UL, as it is generally very expensive both as a way of buying life insurance, and also because it is also a costly investment vehicle and its much-touted tax benefits are often highly over-rated.
First you need to realize that, with the RRSP, you have full tax deductibility of the eligible contributions. Therefore, it's difficult to compare accumulation within a UL policy with growth within an RRSP. For example, if you make a $13,500 RRSP contribution and you are in the top marginal income tax bracket, this would be comparable with an after-tax UL contribution of $7,236 (or $13,500 minus the tax saving). Then you must ask yourself if the UL insurance coverage really is required for all of the time you will own the policy. Would you be better off with straight term insurance now and much less insurance — or no insurance — later on?
An RRSP can hold many types of investments, plus you can transfer the plan's assets to another institution or another advisor if you so choose. You can be selective about the costs of investing and use low-cost, multi-manager structure for the RRSP portfolio. Granted, all the withdrawals from the RRSP will eventually be taxable, normally during retirement. However, future tax on income is a small price to pay for what likely will be significantly higher investment growth, and a lot more flexibility, that what is offered by a UL policy.
A UL policy typically utilizes high-cost, in-house funds for its investment component. You likely will be limited in the choice of funds or investment products available and, once you have committed to a policy, it must stay with the same insurance company. Finally, the so-called "tax-free withdrawal" promoted by UL salespeople is by no means guaranteed by the insurance company. Nor is it supported by any ruling from the Canada Customs and Revenue Agency that ensures the rules will not change to adversely impact the taxability of UL proceeds.
Imagine the retirement pickle you might face if you save half as much as you could for the next 20 years on the assumption that all withdrawals will be tax-free, and then find out that the withdrawals or borrowings are indeed taxable? UL is fine for specific applications that require very long term access to high amounts of life insurance. But I do not see it as a genuine alternative to an RRSP.
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No statement in this article should be construed as a recommendation to buy or sell securities or to provide investment advice or individual financial planning. Morningstar Canada does not provide specific portfolio advice and recommends the use of a qualified financial planner when appropriate.
