If you want your investment to be guaranteed, you have to be prepared to receive relatively low return. For example, the going GIC rate today is only around 3%. After you pay tax on this return, your net growth will be below inflation, which means that you are losing money on the NPV basis. But your principle is protected and your interest, albeit small, is guaranteed.

But in certain situations it is possible to achieve much higher returns using guaranteed investment vehicles. For example, a strategy called Insured Annuity works really well for people over sixty. But don’t stop reading if you are younger, you can always “borrow a life” from your parents or grandparents for this purpose. An Insured Annuity is simply a combination of a life annuity and a permanent life insurance policy. A life annuity is a guaranteed investment account that provides you certain income for life in exchange for a lump sum deposit. Because this investment is guaranteed, the rate of return used to calculate your income is low. But the trick is that your income consists of two elements: return of your capital and interest. Obviously, the return of capital portion is not included in your taxable income, and you only pay tax on the growth portion resulting in a very low overall tax. But the problem is that when you die your capital will be gone. In order to bring it back into the picture, a life insurance policy is used. Premiums on this policy are paid out of the annuity income, which reduces the disposable income. But the remaining portion is much larger than what you would get from a GIC. Let’s look at some numbers.

A $1,000,000 life annuity on a 70 year old male will produce a monthly income of $8,099, but only $2,103 will be taxable. This leaves our annuitant with a net income of $7,257 assuming a 40% tax rate. In order to replace the original million dollars on death, we introduce a life insurance policy which will cost this gentleman $3,478 leaving him with $3,780 of net disposable income. Let’s compare it to a GIC at 3%. The gross monthly income will be only $2,500 or $1,500, which is less than half of what this investor would receive from an Insured Annuity. This means that the effective pre-tax return of this Insured Annuity is 7.56%. No other guaranteed investment comes even close.

There are three reasons why this strategy works so remarkably well. First, we benefit from the inherently high IRR on death built into life insurance. Second, the preferential tax treatment of annuity income increases the after tax income. And last but not least, insurance companies (which sell both life policies and annuities) use different mortality tables for the two products. Newer table assuming longer life expectancies are used for insurance, while older tables assuming shorter life expectancies are used for annuities. But regardless of why it works, this strategy is something many people can take advantage of.

Nikolay Sisan is a Certified Financial Planner and freelance writer in Vancouver.