(photo from flickr)
We all wonder and fear what would happen if we were diagnosed with one of many critical illnesses or suffered a heart attack or stroke.
You work hard to achieve personal and financial goals during your lifetime. Your plan is working and you have accumulated savings and investments, using tax-efficient investment strategies such as your registered retirement savings plan (RRSP). If you have to sell investments prematurely or stop investing in order to manage recovery costs, your future plans may never recover. So what should you do?
The survival rate of these critical illnesses has risen over the years and we are now most likely going to survive “the big one.” In Canada, these are the statistics: 63% likelihood of surviving at least five years after a cancer diagnosis, 90% will survive a heart attack, and there is an 80% survival rate after a stroke and hospitalization.
Here’s the problem
The issue is that there are significant costs associated with the treatment and recovery from such an illness. There can be large medical bills that are not covered by our various healthcare plans. In Canada, many will want to pursue treatments offered by private clinics at home or abroad, which can be extremely costly.
In addition to these costs, we often neglect to consider the other realities that people face, such as not being able to work. The most obvious is the loss of income suffered when one cannot work or run the family business or professional practice for an extended period of time. This might also affect the income of the spouse and other family members, those who are needed to provide home care.
What are the options?
To deal with the unexpected costs and loss of family income there are really two choices:
- One may choose to self-insure, meaning that one accepts the risks and has put money aside to cover the eventuality, or
- One may purchase critical illness insurance, which provides a lump sum after one is diagnosed with one of the critical illnesses covered in the policy.
The options in more detail
Removing the costs and lost income from one’s financial plan is a considerable setback to the financial plan. The projected retirement income is suddenly reduced and, for most people, it will never be made up. The impact is even greater if one is forced to withdraw from RRSP accounts, as these amounts are fully taxable as income.
As an example, if one needed to cover $100,000 of costs and had to withdraw it from a RRSP account, at a marginal tax rate of 50%, the person would have to withdraw $200,000 of savings intended for retirement.
The eventual impact on one’s projected retirement must be considered carefully, taking into account the income tax issues based on the source of funds, plus the loss of compounding that will no longer be enjoyed on the growth of those funds from the time of the critical illness until the time one planned to retire.
Suffice it to say, the decision to self-insure needs to be taken very seriously. Unfortunately, there are statistics that reaffirm the risks of falling ill with a critical illness are significant.
Critical illness insurance is sometimes referred to as “new insurance,” as it is a newer solution than traditional life insurance. In the past, before the many medical advancements we have enjoyed, life insurance was the solution because it was more rare to survive the illnesses.
Critical illness policies are designed to pay out a lump sum, say $100,000, typically 30 days after the diagnosis. The illnesses are defined and one can purchase a basic plan that covers heart, stroke and cancer, or the more comprehensive plans that have up to 25 covered conditions and include long-term-care insurance as well.
As of the end of 2019, one major life insurance company reported the following statistics:
- It has paid out $520 million on 5,360 claims. In 2019, 67% were for cancer, 13% for heart attack, four percent for strokes and the remainder for coronary bypass, multiple sclerosis and other illnesses. The average age of claimants was 53 for women and 55 for men.
The lump sums paid out are used to cover medical costs, replace lost income, retire debt such as loans and mortgages, cover salaries within a business and often pay for time off and bucket list-type vacations.
There are programs available where, if one has been fortunate enough to not have made a claim, in other words, not have fallen ill with a critical illness, the policy can be canceled and all the premiums refunded. The only cost, in that case, is the time value of money on the premiums, as 100% is refunded.
It is even possible to model such a plan where one uses funds earmarked for a RRSP contribution to cover the premiums. This is more effective than one might first think, as the refund of premiums is tax-free.
The first step is to identify and understand the risks to one’s retirement plan. The second step is to consult a qualified professional to consider what protection works best for you.
Philip Levinson, CPA, CA, is an associate at ZLC Financial, a boutique financial services firm that has served the Vancouver community for more than 70 years. Each individual’s needs are unique and warrant a customized solution. Should you have any questions about the information in this article, he can be reached at 604-688-7208 or [email protected].
Sources: Manulife Insurance – Critical Illness: Asset Protection: Keep Your Retirement Savings for the Future, and Critical Illness: Retirement Protection Handbook.
Disclaimer: This information is designed to educate and inform you of strategies and products currently available. The views (including any recommendations) expressed in this commentary are those of the author alone and are not necessarily those of ZLC Financial. This information is not to be construed as investment advice. It is for educational or information purposes only. It is not intended to provide legal, taxation or account advice; as each situation is different, please seek advice based on your specific circumstance. This commentary is not in any respect to be construed as an offer to sell or the solicitation of an offer to buy any securities.