The power of guaranteed investment funds in tax-efficient retirement planning
Guaranteed investment funds can offer capital protection, tax benefits and a guaranteed income stream
Date: July 7, 2017
When it comes time to retire, most seniors would prefer to spend their time travelling, exploring new hobbies or spending time with family and friends - perhaps all of the above. At that point, it's all about enjoying the fruits of a lifetime of hard work.
However, neglecting to consider tax implications when planning for retirement can be a huge oversight, says Jennifer Poon, director of tax and estate planning - wealth, at Sun Life Financial. In fact, she advises the exact opposite approach, prompting clients to think about tax-efficient planning well before retirement.
With ample time to work with, advisors can help prospective retirees design an investment strategy that takes their future retirement and lifestyle plans into account - while educating them and opening their eyes to the diversity of investment tools at their disposal.
As an example, Ms. Poon says that many investors may not be aware of the benefits of guaranteed investment funds (GIFs), also known as segregated fund contracts, exclusively offered by insurance companies.
"I don't think GIFs are fully understood and I do think a lot of people are missing out on opportunities," says Ms. Poon, adding that many Canadians don't understand the difference between these and other investment tools such as mutual funds.
A GIF is essentially an insurance product with underlying investment funds, explains Tim Faunt, an independent, fee-only financial planner based in Calgary. "There's the underlying fund with the variability and the basic characteristics of an investment product, but at the same time there's an insurance contract that provides guarantees."
As such, GIFs protect either 75 per cent or 100 per cent of an investor's initial capital investment when the product reaches maturity or the annuitant dies. In essence, this means that unless a GIF is cashed in before it matures, the initial investment remains secure. Some contracts provide the opportunity to reset the guarantee as the market value increases.
One option available in some GIF products is guaranteed income, but this is sometimes overlooked by investors. It's an advantage that can provide a lifetime of financial stability.
While an investment option such as a mutual fund or a stock will deliver variable returns (if any), there are no guarantees, and investors will inevitably have to pay capital gains taxes and probate fees on death. If a GIF promises a $1,000 monthly payout, for example, investors would receive that monthly cheque until their death, guaranteed.
GIFs, like any insurance product, can have a designated beneficiary. This means that upon death, the value of the contract bypasses probate and the amount of the benefit is transferred to the named beneficiary with no legal or administration fees, potentially delivering thousands of dollars in savings.
In addition, Ms. Poon explains, for non-registered contracts, a portion of the guaranteed annual income from a GIF is a return of capital for tax purposes, while the rest is considered a capital gain, thereby reducing the investor's taxable income and lowering his or her tax burden. This is particularly advantageous for seniors who have multiple sources of income, including Old Age Security (OAS), and who hope to avoid benefit clawbacks. Contract owners are also subject to an allocation of income from the underlying funds in the contract.
GIFs may also offer an element of creditor protection that can be beneficial for self-employed individuals. As an insurance product, a GIF can be protected from creditors in situations such as bankruptcies.
But like any investment vehicle, GIFs are not without their drawbacks. Financial security comes at a price.
Mr. Faunt notes that segregated funds typically cost more than mutual funds due to the insurance benefits.
Fees on segregated funds include investment management fees and the insurance fees to cover the cost of the guarantees. When compared with a mutual fund, the additional cost of the guarantee can provide investors with guarantees, potential creditor protection and other estate planning benefits.
"You're paying for peace of mind and ease of administration," says Ms. Poon.
GIFs can be a valuable component of any investor's retirement-planning toolkit, she says. When deciding what proportion of an individual's retirement portfolio these vehicles should comprise, Ms. Poon offers a simple rule of thumb.
"In financial planning, I tell people that when you do a budget, figure out your basic living needs," she says. "As a minimum, I would recommend having your basic living needs, often about 20 per cent of your portfolio, guaranteed through a product such as a GIF with guaranteed lifetime income."
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