Pros and Cons of Permanent Life Insurance
If you have a spouse and/or children, in other words, someone who is dependent on you, life insurance of some sort is an important consideration. Your dependants “depend” on your monetary contribution to the household. A monetary contribution includes income from employment or self-employment, but it also includes the care of the household and children. The traditional idea of one (usually male) spouse working outside the home while the other (usually female) spouse stays at home to take care of the home does not mean that the latter’s unremunerated services to the home are not of value or should not be insured. Consider the cost of replacing the services provided in the home with the amounts that are charged by a housekeeper and a nanny. You will want insurance for both spouses.
This risk of loss of income is often time limited. The mortgage is usually paid off by retirement. The cost of raising children and providing some funding for post-secondary education is usually also taken care of before retirement. At retirement, hopefully, sufficient savings have been set aside, in RRSPs, TFSAs, pension plans, etc., and you will have access to government-sponsored benefits like the Canada/Quebec Pension Plan and Old Age Security, such that income replacement is already in place. In that case, life insurance is no longer necessary. For that reason, term insurance, which is life insurance that is only meant to be in place for a certain period, makes sense.
But what about permanent insurance? That is, life insurance that is meant to be in place for the remainder of your life, even if you live to a ripe old age. What is its purpose?
What is Permanent Insurance?
As the name indicates, permanent life insurance is meant to be in place permanently, to the end of your life. It is often used for estate planning purposes, although it can have some value for income replacement or investment purposes.
Kinds of Permanent Insurance
Term-to-100 Life Insurance
Although based on the name, this sounds like a term insurance policy that expires at age 100, there are two things to recognize. First, few people live to age 100, and second, if you do live beyond age 100, current “T-100” policies stipulate that your premiums are fully paid up once you reach triple digits, but the policy is in effect for the remainder of your life.
This is the most basic form of permanent insurance. There is no investment component or “cash surrender value.”
Whole Life Insurance
Whole life insurance does have an investment component and cash surrender value does grow over time. While policies are usually paid for life, you can find some policies that are fully paid up by age 65, or for certain specific periods, like 10 or 20 years.
Participating Whole Life Insurance
The premiums (premia, if you prefer) are more expensive for this form of whole life insurance, but it allows policyholders to participate in the profits of the insurance company that are associated with that particular pool of whole life policy owners. To be clear, these policy “dividends” are different than the dividends that are distributed to the owners of the insurance company’s common shares. In the educational material provided to students seeking to gain a financial planning credential, author and instructor Jason Watt of Business Career College (a highly recommended program, by the way) enumerates seven different ways that policy dividends can be used: receive as cash, savings attached to the policy, invest in a segregated fund, purchase term additions to the permanent policy, purchase “special” term additions that are a hybrid between standard term additions and cash, purchase paid-up additions that involve buying small (“tiny”) additional participating whole life policies, or reduce the premiums owed by letting the insurance company keep the dividend.
Universal Life Insurance
Universal life is more complex than the other forms of permanent insurance discussed to this point because it allows the policyholder to manage investments within the life insurance product. The life insurance aspect is much the same as any other form of permanent insurance. However, you have more flexibility than you do with whole life insurance. Premiums can be adjusted, you can allocate investments within the policy, and the death benefit is also flexible.
Pros of Permanent Insurance
I think I might liken permanent insurance relative to term insurance as the difference between owning a home and renting one. You can walk away from term insurance when you no longer need it, just like you can choose to leave the home you are renting without any strings attached at the end of your contract. On the other hand, owning a home gives you the potential for permanency and can potentially be left as a tax-free inheritance to your heirs at the end of your life. Likewise, permanent insurance is meant to be owned for life and paid out at the end of your life, and coincidentally, also tax-free. Rent often feels like you are getting nothing for your monthly payments, and it feels that way when you pay your premium for term insurance.
Permanent insurance is intended to be just that – permanent. It is intended not just to cover the risk of the loss of life for a specific period, but for the remainder of the insured person’s life.
Investment Component Available
Both whole life and universal life have investment components to them. The investments grow tax-free and can be paid out to the beneficiaries tax-free.
For whole life insurance, you pay the same premium throughout your life.
Options for Limited Period of Premium Payments
You can arrange for insurance policies where you pay for 10 or 20 years and then you are “paid up.”
Option to Participate in the Insurance Company’s Profits
As discussed above, a participating whole life policy allows you to participate in the profits of the company by receiving policy dividends.
Ideal for Estate Planning
If your estate at death will consist of a mortgage-free home and investments in a TFSA, which could exceed $1 million in 35 years, then you have little need for insurance to offset taxes or help you in dividing the estate. However, if you have three children and decide to will the home to one child while the amount in the TFSA is to be divided between the two other children, it may not make for an equitable split. A permanent life insurance policy can be used to top up the estate tax-free to achieve an even balance.
Another use is to cover the taxes due to substantial capital gains on a cabin or cottage. Again, a life insurance payout can take care of those taxes and allow the assets to remain in the family.
The Cons of Permanent Insurance
Permanent insurance is usually much more expensive than term insurance. It should be noted, though, that as you get older, term insurance becomes more expensive, while permanent insurance provides for the aforementioned level premiums.
Frequency of Policy Cancellations is High
Because the premiums for permanent insurance are high, as household expenses climb, affordability becomes an issue. If you cancel your policy, you will still have had those years of coverage against death, but you will have lost out on the investment component in your whole or universal life policy.
The Investment Component is of Secondary Importance
Insurance is about offsetting risks by paying someone else – an insurance company – to take on the risk for you. The investment component is secondary and should not be persuasive. It may make sense to use insurance for investment purposes, but consider maximizing the purpose-built investment account types first, such as the RRSP and the TFSA, before focussing on the investment component of permanent insurance.
Permanent Insurance is Inappropriate for a Short-Term Need
If you are buying insurance to cover the risk of your mortgage, which you hope to pay off in 20 years, permanent insurance is overkill. The risk will end, but your premiums will continue.
This is the 161st blog post for Russ Writes, first published on 2022-08-22.
Click here to contact me for an appointment.
You may be interested in a half-hour no-cost, no-obligation financial planning conversation with me. Click here to sign up for a free session of FinPlan30.
Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.