With September being Life Insurance Awareness Month, we thought it would be the perfect time to dispel some myths about life insurance. This is the second in a series of articles about life insurance. Life insurance is vital for families, especially those with children. It allows you to take care of the people that matter the most to you should the unthinkable happen. It ensures your hard work and legacy lives on even when you’re no longer around. For the wealthy it is used as an advanced planning tool to mitigate the impact of taxes on winding down an estate or transferring wealth to the next generation.
Yet millions of Canadians are underinsured – they either don’t have enough life insurance coverage or don’t have any at all. Some people believe term life insurance is better, while some say permanent is better. Let’s start by looking at the pros and cons of the different types of permanent life insurance. There are two main types – universal life and whole life – and a little less known term 100.
What is Permanent Life Insurance?
As its name suggests, permanent life insurance offers coverage until you die, reach age 100, or your premiums are unpaid (and your reserves are not sufficient to cover your premiums).
Type 1: Universal Life
Pros
- Tax Sheltering
When structured properly, a universal life policy can be a very good estate planning tool. A properly structured universal life policy, when very well-funded can generate sizable investments, which can be accessed tax-free either by the insured or their beneficiaries.
- Maximizing Estate
Due to the tax sheltered nature of the investments within a universal life policy, it can be used to maximize an estate. The investments within a universal life policy are passed directly unto the beneficiaries and bypasses probate.
- Permanent
In theory a universal life policy is a permanent policy, meaning coverage is till age 100. Unlike a term policy that expires after a certain time, you don’t need to worry about your coverage expiring (as long as you pay your premiums).
- You can borrow against your Cash Value in the later years of your policy
This can be used as an income stream in retirement and because a loan is not considered “income” you do not pay tax. Most institutions allow you to borrow against the cash values at around Prime + 1.5% which is a much better rate than your average tax rate; even in retirement.
Cons
- Costly
It can be quite expensive. For a universal life insurance policy to be structured properly and actually do what it’s supposed to do, which is pay out those investments (and also pay out a death benefit), it has to be extremely well-funded. Therefore, it is not for everyone.
- Lapse Risk
This con is closely related to the previous one. Many insurance agents today do not fully understand how this policy works and often sell it to almost anyone who would listen on the premise that it will pay out investments in retirement. To make the offer attractive to unsuspecting consumers, they adjust the premiums to make it quite low (e.g. increase interest rate assumptions or pay close to minimum payment). The pitch is this: get this policy, pay the premiums for X number of years and then down the road you can use the investments as part of your retirement and it will never lapse. The problem with this is that in later years, a policy that’s not well-funded or structured properly to begin with has a very high chance of lapsing. In cases like this, additional premiums have to be paid to keep it inforce with very little investment accumulated.
- No Guarantees
The investments within a universal life policy are tied to the performance of the market, through the funds that are chosen by the client and their advisor. That is, if the markets do well, there is a good chance the investments also do very well. When the markets don’t do well, the investments also suffer. In addition to this, the fees within a universal life policy, which are hidden to the average consumer, in some case, can be quite high. These fees over time add up and can eat into your investments. A combination of poor returns and high fees can totally erode whatever investments were being accumulated within the policy.
Type 2: Whole Life
Pros
- The pros are mostly the same as universal life, albeit with slight differences.
- Unlike Universal life, there is no lapse risk in whole life, unless of course, the premiums aren’t being made.
- It has a guaranteed component for the investments
- Some Whole Life policies (Participating Whole Life) also pay out attractive dividends which further increases the cash value within the policy.
- Qualified Professionals within the Insurance Company are choosing the investments, which have a proven and consistent track record.
- You can borrow against your Cash Value in the later years of your policy
Cons
- Similar to Universal Life, the premiums are also more expensive than Term insurance, however can generally still be less than Universal Life for the same amount of coverage
- It’s not as flexible as a universal life policy is in terms of premium payments
Type 3: Term 100
As the name implies, it offers coverage until age 100. Unlike universal and whole life, there isn’t any investment component or cash value built up in the policy; it’s just pure insurance. Term 100 is similar to term life insurance, except it provides coverage for a longer period of time (until age 100). As such, the premiums are quite expensive. We’re only going to provide a brief summary since very few companies still offer it, as it is being phased out.
Permanent Insurance is generally more appropriate for families with longer term needs like estate planning or those who might have much higher permanent responsibilities. It can often be combined with term insurance to give families the best of both worlds. It is also used by corporations to minimize tax liabilities and maximize wealth transfers (this will be discussed in more detail in a subsequent article).
If you’re thinking about life insurance, feel free to contact our office and let us help you fully weigh your options. Deciding between term and permanent isn’t an easy decision. It actually depends on the total financial picture of each family and business. It’s a good idea to sit with a professional to figure out which is best for your family or business.
