Life insurance companies and advisors who sell their products got an extra treat when federal Finance Minister Jim Flaherty unveiled his pension-splitting proposal this past Halloween. If the measure is enacted as proposed, they will gain a new edge in the seniors’ GIC market.

In 2005, seniors aged 65 and older held more than $108 billion in GICs and other deposits outside RRSPs and RRIFs, according to Statistics Canada. That was twice their direct holdings in bonds and stocks — including income trusts — and almost three times their unregistered investment fund assets.

Starting in the 2007 taxation year, Flaherty would let married and common-law senior couples split certain types of retirement income on their tax returns, which could generate substantial savings.

Draft legislation has not been released, but Finance officials say any income that qualifies for the $2,000 federal pension income tax credit would qualify for splitting.

This includes insurers’ guaranteed investment accounts, which are functionally equivalent to GICs. So, a depositor aged 65 or older could split interest from an insurer, but not interest from a bank, trust company or credit union.

GIAs qualify for the pension credit because they are technically deferred annuities, says Ron Sanderson, director of policyholder taxation and pensions at the Canadian Life and Health Insurance Association. Each contract includes a guarantee of regular income starting at a “maturity” date set by the depositor. This creates a pension-like element. GICs have no such guarantee.

Despite the “annuity” label and maturity date, GIA money can be withdrawn at the end of the term for which the rate was fixed, just like a GIC, or sooner; GIAs typically are cashable, with a “market value adjustment” that depends on interest rate movement since purchase.

The gain here is the availability of income-splitting, not the pension tax credit itself. A 65-year-old GIC saver with no workplace pension could use RRIF withdrawals to get the federal credit, which covers up to $2,000 of eligible income from all sources. Provincial limits vary.

Although most GICs issued by banks and trust companies are backed by the Canada Deposit Insurance Corp. , GIAs are protected by Assuris, the life insurance industry’s compensation program.

A Jan. 17 survey of posted deposit rates by Fiscal Agents Financial Services Group in Oakville, Ont., indicated GIAs generally pay more than big-bank GICs and generally less than GICs from other deposit-takers. But Martin Kosterman, senior financial advisor at Fiscal Agents, says there are enhanced GIAs that can close the high-yield gap.

In addition to the pension tax credit, the ability to split taxable income and cashability, GIAs qualify for the same protection from creditors as other life insurance contracts, Sanderson notes, whereas GICs are not creditor-proof.

“Yes, there is a marketing opportunity here for the industry,” Sanderson says. ”The challenge is that with comparatively low posted rates on both bank deposits and GIAs, getting the public to consider fixed-yield assets can be difficult.”

Flaherty’s proposal would also allow splitting of taxable income from “prescribed” annuities that are sold as alternatives to GICs. These annuities level the blend of taxable interest and tax-free return of capital over their expected lifespans. Thus, monthly payments in the early years contain more tax-free capital and less taxable income than they would otherwise.

This provides more spending power than a fully taxed GIC. Kosterman says a 70-year-old couple with assets of $100,000 could buy lifetime monthly payments that total $6,897 a year, with $1,742 of that being taxable. Taxes at a 35% rate would leave $6,287 for spending.

The highest posted rate on a CDIC-backed GIC was 4.075% on the day the annuity quote was obtained. Even if the couple’s $100,000 boosted them to 4.75%, the GIC would net just $3,088 after taxes.

But the GIC returns their $100,000, while the annuity runs for life but leaves nothing for their estate. The couple could provide for that by matching the annuity with a $100,000 life insurance policy. Assuming good health, Kosterman says, a $100,000 payout on the second death would cost $1,155 a year, noting that this quote from a major insurer was not the most competitive. Insurance premiums would cut the prescribed annuity’s spendable payout to $5,132 — still 66% more than the GIC’s payout.

Flaherty’s pension-splitting proposal would widen this after-tax gap if one spouse is in a lower tax bracket than the other. And the gap would widen still more if the split income enabled the second spouse to claim federal and provincial pension income credits. IE

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Bruce Cohen is co-author of The Pension Puzzle, a retirement planning guide for members of pension plans and group RRSPs. A new edition has just been published by John Wiley & Sons Canada Ltd.