Whole Life Insurance - A Good Investment?

Recently I had a friend ask me about the benefits of whole life insurance policies.  After further discussion it became apparent that his curiosity arose after he had heard about growing investments tax deferred, one of the key benefits of a whole life insurance.  When used correctly, whole life can be an excellent product within your family's financial plan.  With that said, it's important to be careful and make sure you understand the product before purchasing.

In the insurance world there are two types of life insurance; term or permanent. If you/re married and have a family, you are probably familiar with term insurance.  

Term insurance is used in situations where the liability or need for insurance is only for a certain time period (like a mortgage or other loans).  It most commonly comes in periods of 10 years, 20 years or to age 65.  It is significantly cheaper than whole life and usually meets the needs for most families situations.

Permanent life insurance comes in two forms; whole life and universal life. The fundamental difference with permanent insurance is that it's permanent for life; it also comes with an extra savings component, known as the 'cash value.'  With permanent life insurance, certain portions of the premium you pay fund this cash savings component; therefore these policies end up being much more expensive.

Differences Between Whole Life and Universal Life

With whole life insurance the company pays interest on the money in the savings account at a predetermined guaranteed rate. The industry has seen a rise in these types of policies after the 2008 financial crash due to their growth guarantees.  On top of this, these policies pay the largest commissions to insurance advisors making them appealing to sell. If these large premiums are not maintained the policy will lapse, which is a downside we will discuss further.

Universal life is similar in that there is a cash value from parts of your premiums, but instead of the company paying a set amount of interest, the cash value has flexibility in what it is invested in.  This means the growth and final benefit will vary depending on how the investments do.  Although you give up the guarantee, you have flexibility to decrease or increase your death benefit as well as premium payments.  You're giving up the guarantee provided by whole life for more flexibility or higher potential returns.

Key Benefits of Whole Life Insurance

The cash value in permanent policies grows on a tax deferred basis and can be used later which is a big part of why these policies are so enticing. You can access this cash value through a variety of strategies or leave it for your beneficiaries upon death. Returns on the cash value component, although moderate, are typically guaranteed by the insurance company. You can also opt to participate in the surplus of your insurance company and receive the dividends annually. It lasts a lifetime. For situations where insurance is an indefinite need, as long as premiums are maintained the insurance will be there forever. In most cases premiums remain level meaning the insurance company cannot raise prices as you get older or if you were to become ill.

The drawbacks: Premiums are a lot higher than a term life insurance policy with the same amount of coverage.  This is because you're also paying money into the cash value portion of your policy. Costs of these policies can commonly be about 6 to 10 times higher than a typical term insurance policy.  The savings portion also is restricted in what you can invest in, so you often are left with what most investment professionals would consider mediocre investment performance.

With whole life you have a set level of payments that must be made in order to keep the policy in effect.  In early years, most if not all of your premium will go towards the life insurance component.  It can take many years before the cash value of your policy begins to build to a point where it can be utilized.  If you have to forfeit the policy too early, chances are your cash value is extremely small.

Data suggests that 45% of policies that are surrendered in the first ten years end up as a poor financial decision for the owner.  On top of this, whole life policies can become very complex making them confusing for clients to understand.

When can it make sense as an investment?

If a client is a high net worth client who has exhausted all their options for tax deferred investing (RRSP & TFSA), and they have enough cash or cash flow to fund such a policy, at that point it can be considered primarily for its tax deferred investment capabilities. Beyond this, whole life insurance should be very carefully purchased and there should be a genuine need for the insurance if it is going to purchased. Common situations in which permanent insurance may be required include:

Significant capital gains liabilities at death – Common for families who have amassed significant amounts of assets that will be taxed upon death.

Estate equalization – maybe you're leaving business assets to your daughter who works in the business and would like to leave non-business assets to your son who lives across the country.

Business succession planning – life insurance proceeds can be used to fund the purchase of the shares of the deceased ensuring a smooth succession.

You have a charitable intent that you would like to leave a significant sum to.

Closing

Whole life insurance is a great product when purchased appropriately. I've seen a fair bit of over selling occurring in the market, where advisors typically hone in on high income earners dislike for paying taxes, and sell them on the tax deferred investment advantage.  Whole life insurance is expensive and inflexible.  If you have a change in your financial circumstances and can't continue to fund the policy, it can end up being a VERY poor investment.

Hopefully the information above gives you a better understanding of the pros and cons with this insurance.  These policies are complicated and require a coordinated effort between your accountant, lawyer, and financial planner.  Because of the complexity with these policies it's recommended that you work with a professional that you know puts your interest before all else.  If you or someone you know is considering whole life insurance and is looking for advice on if it fits for you, don't hesitate to reach out to myself or another Endeavour Wealth Investment Advisor, and we'd be happy to review with you.

- Brandt Butt, Investment Advisor

Brandt Butt is an Investment Advisor at award winning firm Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Brandt Butt who is a Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.