Borrowing to purchase or leverage life insurance

BY ANDREW STEWART

Borrowing money to invest can be an effective way to boost your potential returns, but it also involves more risk than if you paid outright with cash. Investing with borrowed money is also known as “leveraging”. The thinking behind the strategy is, if your investment increases at a rate that is higher than your borrowing costs, you are making more money sooner than if you had waited to save and then invest.

However, the flip side to that coin is, whether your investment makes money or not, you still must pay back the loan plus interest. If you rely solely on your investment returns to cover your borrowing costs and your investment falls in value, you could end up defaulting on the loan. Now the internet is a great source for anyone who wants to read and research about why this strategy can work for them. But you should always consult an advisor. It is the responsibility of the advisor to determine your risk tolerance and make recommendations that are appropriate to your risk tolerance.

Before we discuss the why’s and how to leverage a life insurance, let’s go over some of the more known and common ways people borrow to invest.

Topping up your RRSP

Many people borrow so they can make a larger contribution to their RRSP and get a bigger tax refund. A common strategy is to use the tax refund to pay off or pay down the loan to reduce the amount of interest payable. If you don’t pay the loan off as scheduled, you could end up paying more in interest than what you get back in a tax refund.

Using your home equity to buy investments

People who have built up equity or paid off their mortgage may be tempted to “unlock” some of this value by borrowing against their home and investing the money in mutual or seg funds or stocks. They may refinance their existing mortgage, take out a new mortgage or get a line of credit secured by their home. The hope is that the investment will not only cover the loan and related borrowing costs, but also generate extra income. The downside is that you could be putting your equity, and possibly your home, at risk.

Borrowing to purchase or leverage life insurance

Okay let’s talk about why you would want to borrow to purchase or leverage against a life insurance policy. Unlike in the previous scenarios of borrowing to make money, leveraging against a permanent life insurance is a way to access money tax-free without depleting the cash value growth and balance that within the policy. Permanent life insurance is another way to accumulate retirement savings beyond what is allowed with registered plans. An Insured Retirement Program (IRP) Line of Credit secured by the life insurance policy provides you with access to cash and allows the policy proceeds (minus the loan and interest repayment) to pass on a tax-free to their beneficiaries.

A nice bonus is that interest on the line of credit can be capitalized (added back into the loan) so you don’t need to make monthly payments if you so choose.

What’s needed to set up an IRP line of credit

1. Personal line of credit application
2. Security documentation
   1. Assignment of life insurance policy
   2. A recent policy summary no more than 30 days old
   3. An in-force life insurance policy illustration

• Pay an application Fee (0.25% of requested amount or minimum $250, whichever is greater)

1. Personal void cheque

Key questions to ask before you invest

• Are you comfortable going into debt for an investment that may fluctuate in value?
• Can you afford to lose the collateral you put up for the loan? Any asset used as collateral, including your home, can be taken by the creditor to satisfy the loan
• What are the terms for repaying the loan and interest?
• What are the tax consequences? You may be able to deduct the interest you pay on money you borrow to invest

Make sure you take your time when making investment decisions. Never sign documents you have not read carefully. Don’t invest in anything you don’t fully understand. If you have any questions or

concerns about borrowing to invest, get a second opinion from a financial adviser, lawyer or accountant.