A major health event is more common than you may think. 2 out of 5 Canadians will develop cancer during their lifetimes, with 69% of new cancer cases occurring between age 50-79 (1). 9 in 10 Canadians have a risk factor for heart disease or stroke (2). Fortunately, our chances of surviving a major health event is greater than ever. What we may not be prepared for is the elevated financial stress following the event and the cost of a critical illness on our retirement plans.
How will having a major health event affect our retirement plans? Consider the following example. A 45 year old man, John, is married to a 42 year old woman, Jane, and together they have $100,000 saved up for retirement. They are currently contributing $15,000 annually into their RRSP in a moderate growth portfolio, with a 6% expected return. They both make $70,000 annually, have long-term disability coverage through their employers, and are in the 30% marginal tax bracket.
In scenario A, they both remain healthy and retire happy with $905,604 at age 65. If they wait until mandatory conversion to a RRIF before withdrawal at age 71, they will have a nest egg of almost $1.4 million.
In scenario B, John is diagnosed with cancer at age 55 and survives. Although treatment and drugs administered in the hospital are covered by the provincial health plan, coverage ceases after he is discharged from the hospital. The average drug cost for a single course of treatment of cancer with drugs is $65,000 (3). Assuming Jane takes six months off work to provide in-home care for John resulting in an income loss of $35,000, the total cost due to the illness is $100,000.
Since John may return to work soon after the treatment ends, the benefit he receives from his group disability plan will be negligible. John and Jane will have to withdraw $140,000 from their RRSPs to net $100,000 after-tax, since they are in the 30% tax bracket. The withdrawal drops their retirement funds to $626,411 at age 65 and slightly under $1 million at age 71, a far cry from their total had a critical illness not afflicted John.
Withdrawing money from the RRSP, especially such a large amount, results in a significant immediate tax liability and diminishes the tax deferral benefit of the RRSP. Their retirement fund will be stretched thin, and it will take five years for their investment portfolio to catch up to scenario A. This results in John and Jane having to work longer and retire later, or reducing their quality of life in retirement to get back on track, none of which are preferable. Let’s take a look at how they can avoid this with critical illness insurance, and how much of a difference it will make.
In scenario C, John purchases $100,000 of critical illness insurance at age 45 for $2,451/year, which drops his RRSP contributions by the same amount. The plan he chooses provides term coverage to age 75, with the option to have all premiums refunded at age 65 if he does not suffer a critical illness. If he is diagnosed with cancer at age 55, he receives $100,000 in insurance proceeds tax-free, covering the cost of the drug treatment and Jane’s loss of income. They will not have to dip into their RRSP, and their retirement plan will remain unaffected.
If John does not suffer any of the covered critical illnesses by age 65, all the premium he paid into the policy will be returned to him tax-free. Since he paid $2,451/year for 20 years, he will receive $49,020 back from the insurance company. He can contribute this amount into their RRSPs to boost their retirement funds. Notice the bump in their RRSP portfolio that takes their balance to $864,593 at age 65 and $1.34 million at age 71.
The return of premium or insurance benefit, whichever John receives, can be used for any purpose he sees fit. If it turns out he overestimated the drug costs for the treatment of cancer, he can use the remaining funds to pay down his mortgage or contribute into his RRSP. He can also use it to pay for in-home nursing care so Jane can remain at work. The return of premium can be used to pay off any remaining balance on the mortgage, so they can retire debt free. They have complete freedom as to how they would like to allocate their money.
John can also continue the critical illness insurance policy past age 65 by declining the return of premium option, if he feels like he requires the coverage until age 75. The probability of suffering a critical illness increases as we age, so he may prefer to keep the policy just in case.
Although the example only showed coverage for John, Jane is equally as important to the family and is also a suitable candidate for critical illness insurance.
Without critical illness insurance, John and Jane’s retirement plans may be in jeopardy if a serious illness strikes either of them. With the protection in place, they create a safety net that will help protect their retirement savings so their long term financial plans aren’t interrupted by a serious illness.
1. Canadian Cancer Society, Cancer Statistics 2012.
2. 2009 Public Health Agency of Canada report, Tracking heart disease and stroke in Canada.
3. 2009 Canadian Cancer Society report, Cancer drug access for Canadians. Cost and coverage varies by province.
4. Quote from Sun Life. Rates are current as of November, 2014.
Image courtesy of holl7510 / flickr