Life Insurance vs. RRSPs

by Kerri-Lynn McAllister September 14, 2016 / No Comments

At first glance, life insurance and RRSPs seem very different. One provides a tax-free death benefit while the other provides taxable retirement income.

Let’s compare and contrast. We’ll use cash value permanent life insurance as an example because term life insurance doesn’t offer tax-sheltered savings.

Similarities

Both give you tax-sheltered growth and withdrawals are taxable.

An RRSP’s value increases over the years as you make more contributions and your investments grow. Life insurance is worth more today since the death benefit is much larger than the premiums. As you live longer, the return on investment drops. That’s a trade-off you’re likely willing to make.

With an RRSP, you get a small tax deduction on your contributions. This allows your savings to grow in a tax-sheltered account. The price is the tax on your withdrawals, which are treated as income. If you’re in a lower tax bracket during retirement, this trade-off looks good.

The biggest tax on an RRSP is at death. If you have a spouse, you can defer the bill by having your assets transfer to your spouse at your death. The tax is then due when your spouse dies.

Differences

With an RRSP, you’re forced to make taxable withdrawals whether you want to or not. An RRSP takes decades to grow to a large amount. That also leads to a big tax bill at death.

With life insurance, you’re not required to make withdrawals and the death benefit is generally tax free. Also the death benefit is huge relative to the premiums.

Life insurance is generally protected from creditors. However, RRSPs are generally subject to claims by creditors in Ontario unless purchased from a life insurance company.

Life insurance can provide tax-free income by leveraging (for example, you can assign your contract to a bank, get tax-free income via loans, get the interest added to the loan, and have the tax-free death benefit repay the loan).

RRSPs have the same fixed contribution limits for everyone. With life insurance, the maximum deposits depend on your age, health, and the face amount (the amount of money paid out when the person dies).

Consider both

Why not get both? If you’ve reached your RRSP and TFSA contribution limits, cash value life insurance lets you save more.

Life insurance can supplement an RRSP during the accumulation phase. If you want to provide retirement income for your partner, you could use term life insurance.

If your partner will need to depend on your RRSP for retirement income, your death harms them. Life insurance provides a tax-free lump sum to replace the contributions you couldn’t make while term life insurance is a cost-effective solution.

During retirement, life insurance can prefund the taxes at death on RRSPs and other taxable investments. In this case, you’ll want permanent coverage.

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Flickr: Got Credit