January 20th, 2011 | Author: Mitch Reynolds

Protect Your RRSP from A Critical Illness

Surviving a critical illness can have major financial consequences

Critical illness insurance to protect RRSP If you are in a regular saver through your RRSPs, do you also have a plan to insure your RRSP from being depleted in case of a major life altering critical illness of injury? Many people in Canada already have disability insurance through their group plan (if you don’t have disability insurance, then this article relates to you with even more importance) to protect them in case they are unable to go to work and earn money. Disability insurance usually provides about 65% of prior income tax free. This might or might not be enough to meet your monthly living expenses, but usually does not provide financial flexibility to cover other health care costs that might rack up.

Critical illness insurance provides you with a lump sum, tax free cash payment 30 days after diagnosis of cancer, heart attack, stroke, bypass surgery, and 20 other major illnesses and injuries. You can use this money for anything you want, like paying off debts, seeking alternative medical treatment outside of Canada, taking extra time off work to recover, or spending quality time with family. There are no rules on how you would use the money. The most important thing is that when you are struck down with a life altering critical illness that you have cash flow, and lots of it, to give you options for recovery that you might not have had before.

So, how does this relate to your RRSP savings? When people do have a health crisis in Alberta, there are usually two asset classes that are liquidated to create money for health care expenses – their RRSP plan and refinancing their home. The financial damage either of these two actions can have on your long-term financial plans is enormous. As an example, if a 40 year old man had to access $100,000 of after-tax income from his RRSP in Canada, he would have to make a withdrawal of $163,934 if he was paying 39% tax on the funds. The more important question is what is the opportunity cost of liquidating the money at age 40 vs. beginning to make withdrawals at age 65 as originally intended.

Here is a more detailed scenario: John, a 40 year old Canada man, gets cancer and seeks treatment in the US at the Mayo Clinic. He needs $100,000 cash, and therefore has to take out $163,934 from his RRSP. Prior to making the withdrawal, John had $250,000 in his RRSP account, which is now depleted to $86,066. He was making regular contributions of $15,000 per year to his RRSPs, but during his recovery he is unable to make these deposits for 3 years. At age 43 he resumes his savings, having survived his critical illness, and continues to save until age 65. Let’s assume he earns 6% compound interest annual until age 65. How much is left in his RRSP account? How much would have been in his account had he never made the withdrawal?

By making the $163,934 withdrawal John will have an RRSP of $1,059,321 at age 65.
If John never made the withdrawal and continued saving he would have an RRSP of $1,945,313 at age 65.
The need for $100,000 after tax dollars at age 40 cost John $885,992 from his RRSP plan!

Alternative to the financial risk of a critical illness

By owning a Critical Illness Insurance plan, a person can offset this huge potential loss for a fraction of the cost. Let’s assume John bought a $100,000 Critical Illness policy at age 38 (2 years before his cancer), and he purchased a Term 20 critical illness plan (level premiums for 20 years). If John is a healthy non-smoker, the premium would be $58.05 per month. If his RRSP at age 38 was $200,000, earning 6%, that would be $12,000 interested earned for that year. The premium is only $696.60 per year, which equals 5.8% of the annual growth. So, using less than 6% of his annual growth, he is able to insure his RRSP against a significant health risk that could cost him upwards of $1,000,000.

At the end of 20 years, John can drop the critical illness plan, as he has now built up over $1.2 million in his RRSP plan by age 58 and can more easily afford to self-insure his health risks.

Wouldn’t it be good to know that for a fraction of your total investment value you can insure your retirement savings from a health risk that could deplete your nest egg quickly and maybe irreversibly? By spending a very small amount of money, you can rest assured no matter what happens to your health, you will have the tax free cash to handle a life altering diagnosis in any way you see fit, and your savings and the value of your home will be secure.

If you are saving for retirement and would like to know how to protect your investment from a critical illness, please feel free to contact Life Guard Insurance for a quote and more information.

The article was written by Mitch Reynolds+. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about critical illness insurance would also be very much appreciated.