While you’re living, permanent life insurance policies can:
- Combine permanent life insurance protection with a tax-advantaged savings component
- Draw upon the tax-advantaged savings as needed for personal or business opportunities
- Supplement your retirement income or provide for long-term care or home care for yourself or a family member
- Be paid off in 20 years or by age 65, relieving you of the burden of paying an insurance policy in your retirement years
Permanent life insurance is more suitable for those who want to ensure their estate transfers intact to their beneficiaries or favourite charity. It is also flexible in that the cash value within the policy can be accessed via a withdrawal or policy loan to supplement their retirement income or fund a grandchild’s education. It acts as a tax-advantaged account for extra tax-sheltering beyond the traditional RRSP and TFSA.
There are 3 types of permanent insurance: Whole life (Participating and non-participating), term to 100, and universal life.
With a whole life policy, initial premium is higher than what is needed to fund the pure risk of death. But since premium is level for life and the risk of death increases with age, the extra premium paid in the early years effectively funds the risk of death in the later years of life. If a policy is cancelled, the insurance company no longer needs to keep the reserve to fund the policy in the later years, so it will refund to you the overpayment of premiums, called the cash surrender value. Instead of taking back the refund, you can choose other non-forfeiture options, such as using the cash to continue to pay premiums, acquire reduce paid-up insurance (using the cash to buy a reduced amount of permanent coverage) or acquire extended term insurance (keeps the coverage the same, but reducing the length of the policy)
Participating whole life (Par) insurance adds the element of dividends to them and allows you to participate in the success of the insurance company. Your premium not only pays for the cost of insurance, but is also invested in an account managed by the insurance company and shared with all other par policyholders in Canada. In a sense, the cost of insurance and the investment accounts are bundled together. If the performance of the investment for a particular year is well, the insurance company will pay out a tax-sheltered dividend to you, which can be used to increase coverage. Although increasing coverage is the most popular option in Canada, you can also use dividends to reduce premiums, put it on deposit to earn interest, buy extra term insurance or cash it out.
Now whenever an investment is involved, the biggest concern for people is losing money. But actually, a few insurance companies have paid a dividend every year since they started offering this product – in some cases over 100 years ago. They take pride in the fact that a dividend was paid even through the depression, world wars, tech bubble burst, financial crisis, and other recessions.
Cash built up in the policy will experience compound growth. It can either be withdrawn directly when needed, taken to a financial institution as collateral for a loan, or you can loan the money from the policy without affecting the growth.
Non-participating whole life (Non-par) insurance eliminates the dividend, so the cash buildup is less than for a par policy. Those looking for permanent life insurance without an investment component would find either non-par whole life or term-to-100 appealing.
Term-to-100 is similar to whole life, except without any refund of the cash surrender value if you cancel your policy. Therefore, term-to-100 is less costly than whole life insurance.
Universal life (UL) insurance is another type of permanent insurance with a tax-sheltered investment component. If whole life is referred to as bundled insurance, UL is the unbundled counterpart. You may have heard of the phrase – buy term and invest the rest. Well, universal life takes care of both at the same time within the same policy. With universal life insurance, you pay an amount of money that is deposited into one or more investment accounts. Each month, the insurance company takes out money to cover the cost of the insurance and administrative costs. The money left in the investment account earns a tax-sheltered return based on the performance of the investment account(s) you’ve chosen inside the policy.
Unlike participating whole life in which the investment mix is chosen by the insurance company, you have the freedom of choice among the different investments offered by the insurance company. For instance, you can choose the safety of a daily interest account or be more aggressive and go with an account based on the performance of an equity index. What investment mix you choose will be based your financial goals and risk tolerance.
It’s important to note that investments within a UL policy are not guaranteed and depending on your option, will experience the same turbulence as the stock market. It is generally better to max out your RRSP and TFSA before considering investing in a UL policy.
Other features of unbundling include the right to increase (with evidence of insurability) or decrease coverage, replace one life insured under the contract for another and add more lives to the contract.
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