What Is Permanent Life Insurance?
Why Would You Purchase It?

There are two types of life insurance – temporary and permanent life insurance.

Most people have some type of temporary insurance either as a term life insurance policy, mortgage insurance, or group insurance policy (likely through work or an association plan like an automobile club).

Some people also have permanent life insurance either in the form of Whole Life Insurance, Universal Life Insurance, or Term-to-100 Insurance. This article will discuss “what is permanent life insurance” and its purpose (with some examples and considerations when purchasing) plus 4 money saving tips.

Permanent Life Insurance for Estate or Retirement Planning

Permanent life insurance is used for estate planning and retirement planning. The primary difference here is that the need is not temporary and you want the insurance to pay when you die – hopefully at a very senior age.

About 40% of all life insurance policies sold are permanent life insurance policies. Many clients do not know they have a need until we spend time discussing what they want to have happen on their death and discover some major differences between what they thought would happen and what would really happen.

While saving taxes is an important issue, in many cases it is not the most important. Some other issues we address are how to structure things so that a second wife or husband can not strip out assets they wanted their current children to get, and ensuring that if a child married and it did not work out, that the inheritance was still with their child.

Why Choose Permanent Life Insurance?

The reasons for choosing permanent life insurance are as follows:

• To ensure your spouse will have sufficient money to retire even if you spend more than anticipated during your retirement - this was my reason for purchasing a permanent policy “I wanted to ensure that my wife or spouse has sufficient cash when I die to enjoy her retirement regardless of what we spend in retirement together”
• To guarantee that you will leave some money to children – it goes to them tax free and probate free if the beneficiaries are set up properly
• To leave money to a charity – there are some very interesting tax strategies around charitable giving. Please Contact IDC for a brochure on this issue
• A major use is to provide money to pay capital gains or estate taxes so that your beneficiaries can keep the assets or property on your death and not have to sell some to pay the taxes. This does not apply to your spouse in most cases as assets flow to them tax free
• Part of a tax planning strategy is to transfer money in an RRSP (Canadian) which will be taxed at over 40% on death to an insurance policy where the proceeds will pass tax free to the designated beneficiaries on death with no probate or executor fees - this is frequently done as part of the previous strategy for covering capital gains taxes – Ask us about our article on this with an example using a joint last to die policy.  We can generate similar tax sheltered growth but no tax on death.
• Maximize your pension. Many of those who have pensions will need to decide whether they want to set it up so their spouses will continue to get a pension (about 66 to 75% of your pension) when you die. Obviously, the pension will be a lot less if you choose this option as the Pension Plan will have to pay out money for a longer period of time. For many, there are advantages to taking the higher pension (where it stops when you die) and purchasing a life insurance policy with some of the difference which will provide a pool of capital when you die and for your spouse to live on. We can provide you with more information on this if you wish.

To Discuss Any of These Options Contact IDC

Permanent Life Insurance for Business Owners

• Business owners use Universal Life Insurance Policies for developing a corporate pension plan that is also tax advantaged. Business owners can also use a Universal Life Insurance Policy to get retained earnings out of a company on a tax favored basis.
• One insurance company has a built in Critical Illness provision which enables you to get the cash out tax free in the event of a critical illness.
• Another strategy which is very efficient for companies who need insurance but also need working capital enables the company to get up to 97% of their insurance premiums back in the form of loans and after 15 years the insurance is paid up and the loan is paid off.

These are just a few of the uses for Permanent Life Insurance Policies. They can also be set up so that premiums are only paid for a set number of years – usually 1 to 20 years after which the policy is fully paid up or there are sufficient funds in it to pay the premiums for life.

Learn More About Permanent Life Insurance for Business Owners

Term-To-100 Permanent Life Insurance

Term-to-100 life insurance is frequently used when all you want is a basic permanent life insurance policy that you pay for until you die and then the beneficiary collects the money. It is usually the cheapest solution for this need.  You agree to pay premiums for life and the insurance company pays out when you die.  This is also used as cheap funeral expense insurance in amounts of $25,000 to $50,000.

Whole Life Insurance has been around for years but has been replaced by Universal Life Insurance in many cases. Please refer to the article on the Difference Between Universal and Whole Life policies for more information.

Best Permanent Life Insurance - Money Saving Tips

1. Money Saving Tip #1: Permanent life insurance policies frequently have assumptions about the returns you will get within the policy for Universal Life Insurance or dividends for Whole Life Insurance. These are generally not guaranteed so be careful that they are reasonable and that you understand that if they are not achieved, the outcome could be very different from the illustration. Ask to see several illustrations with different assumptions so you understand what could happen.  You can get guaranteed returns of about 4% in some Universal Life Insurance policies which increase if the underlying bond rates go up.  This rate compares very favorably to GIC’s and is not taxed so it is the equivalent of 6% to 7% return on a taxable investment.
2. Money Saving Tip #2: Additional benefits of Universal life Insurance policies is that they also have various bonuses built in that can increase the returns by 1.5% or more under certain circumstances. These circumstances usually relate to how much you are putting into the policy (referred to as funding), and how long the policy has been in effect. There are very significant differences between companies so ask to see illustrations from several companies.
3. Money Saving Tip #3: Universal Life Insurance policies may have an opportunity to purchase riders like Critical Illness or Long Term Care Insurance and Term Life Insurance. There can be some real tax advantages to doing this if you are able to over fund the policy or if you have a large amount to put into the policy to start. The funds inside a Universal Life Insurance policy grow with no taxes on the profits. If you are paying for these other policies with funds outside a Universal Life Insurance policy you need to pay taxes on the income before you pay the premiums.
4. Money Saving Tip #4: A few companies now offer preferred rates for Universal Life Insurance policies and if you qualify, the savings can be very significant. Check out a typical qualifying questionnaire for Preferred Insurance. Also some companies consider pipe and cigar smokers to be non smokers.

While some uses of Permanent Life Insurance (such as providing extra cash for a loved one) is relatively straight forward, the use of an independent life insurance broker for most situations is recommended as many options are generally not known to the general public and even financial professionals like accountants and lawyers may not be familiar with some of them.

These types of life insurance policies have some real benefits and should be considered. You are about to sign up to pay a lot of money for a number of years so ensure you get good advice. If your Term Life Insurance policy is convertible, you can convert to a Universal Life Insurance policy without a medical.

Understanding Universal Life Insurance
Compared to Whole Life Insurance

I once wrote an article about the use of Universal Life Insurance policies for those who had used up their RRSP limits or whose taxable income was so low that they did not get a meaningful tax credit for RRSP contributions. The article elicited a number of questions about the difference between traditional “Whole Life” insurance policies and the new “Universal Life” insurance policies. I felt that the discussions I have had with several clients might be of interest.

5 Parts of Whole Life & Universal Life Insurance Policies

1. Mortality Cost - the part of the deposit that covers the pure cost of the life insurance death benefit. We recommend that this cost of insurance be level or the same over the insured's lifetime.  However, there can be advantages to having it as yearly renewable life insurance rates during the early years as the mortality cost is significantly lower and thus a larger portion of the deposit goes into the investment component.  At some age (usually in the early to mid 40’s) it is beneficial to convert to a level term and the added cost of the mortality at that higher age is more than made up by the increased investment in the preceding years.  These are generally guaranteed not to change in the policy. 
2. Administration charge - this is the charge for administering the policy and premium tax.
3. Premium Tax.   This is a tax charged on the contribution.  It is usually around 2% but could change. 
4. Savings or Investment. This is what is left from your deposit after the above two charges - the costs of insurance and the administration charges are deducted. You will have been provided with an illustration of how your savings will grow - it is frequently referred to as the Universal or Whole Life Insurance “Cash Value", "Fund Value" or "Cash Surrender Value" of your policy.
5. Return on the savings - this is the interest rate that is credited to the cash value in your account each year.

In addition, some life insurance policies guaranty that some or all of the above costs will not change and a minimum return on investments.

Whole Life Insurance policies were designed to provide Permanent Life Insurance (the kind that you plan to have when you die) plus have a savings component at a single monthly premium. There has been a lot of this product sold over the years and it continues to sell well particularly in certain ethnic groups.

Whole Life Insurance Explained

Whole Life Insurance has a level cost of insurance where the costs do not increase each year - what you pay in the first year is the same as in the last year but they do not disclose the cost of insurance. They also do not disclose the administration costs. After both the "cost of insurance" and "administration costs" are covered, the balance of the premium is the savings or investment portion. The returns on the savings or investment part is dependent upon excess interest and investment earnings, savings in mortality costs, the operating expenses and the “will” of "the insurance company board of directors" - they choose what they will pay.  Some policies have consistently offered dividend yields of over 7% and while their cost of insurance is more, they can be attractive in some circumstances.

To summarize, apart from a minimum guaranteed return, the policies do not disclose the cost of insurance, the administration costs, or how they calculate the returns on your savings portion. You can not choose where the money is invested and they do not disclose the return you are receiving. You will have an illustration showing a guaranteed Whole Life Insurance "cash value" and another cash value which reflects non-guaranteed projected returns.   They also have guaranteed 10, 15 and 20 pay policies.

Universal Life Insurance Explained

Universal life insurance policies were designed to provide an answer to the advice that you should "buy term insurance and invest the difference". In addition, it provides an answer to some of the complaints about Whole Life Insurance's failure to disclose how the premium is allocated between the cost of insurance, administration costs, and investment portion and to provide investment options that you can choose.

In a Universal Life Insurance Policy, the mortality charges are disclosed and you can choose whether to have a level mortality rate, an annual increasing mortality rate, or a combination where you convert from annual to level at a future date.  The administration charges are also identified and frequently guaranteed not to change for the life of the policy. They are generally in the $100 to $125 per annum range. Consequently, the cost of insurance and administrative costs can be shown on the illustration.

It is the investment options inside a Universal Life Policy that have grown dramatically over the past four years. While some of the older policies did not disclose how the returns were calculated, the newer ones are offering a list of investment options that have similarities to mutual funds. In fact, some are designed to provide returns that mirror well known mutual funds and they are managed by mutual funds managers. Examples include Standard and Poor Index Accounts, Canadian Index Accounts, Canadian and American Equity Index Accounts, Bond Index Accounts, and 1, 5, and 10 Year GIC Type Accounts.

Life Insurance Verses Mutual Funds

The returns inside a life insurance policy are generally slightly lower than mutual funds will generate but they have four significant advantages compared to mutual funds.

1. Life insurance funds grow tax-free - you do not pay any income tax on the growth. This is similar to an RRSP, however unlike RRSP's there are ways to have the use of the money on a very tax favored basis. This was the subject of my previous article on Leveraged Deferred Compensation Plans. Please Contact IDC and I would be pleased to forward a copy of this article to those who feel that it might be of interest.
2. You can invest 100% of the savings/investment component of a life insurance policy in an index where the returns are based on the performance of an index outside Canada. Options include S&P Indexes, American and Global Equity Indexes, and Bond Indexes. Some indexes are tied directly to the performance of well known mutual funds with one policy offering access to indices that emulate over 400 mutual funds. The Management Expense Ratio (MER) on the investment fund options within a Universal Life Insurance policy have been a concern for some advisors although one can argue there is a benefit of having them within a policy and thus an additional cost is justified. However, some companies now offer fund options with no addition to the underlying MER of the fund.
3. The funds are "creditor proofed" if the policy is set up properly. Creditors can not get at the funds inside this life insurance policy, which is important for many business owners and others who are concerned about lawsuits.
4. If the life insurance policy is set up properly, the entire investment account plus the face value of the insurance policy goes to the beneficiary tax-free on death of the insured. There are not even any Probate Fees.  The same applies to a Whole Life Insurance policy but the cash value may or may not be in addition to the face value depending on the type of Whole Life Insurance policy

One life insurance policy permits the entire cash value to go the insured in the event of a covered critical illness and it is a full feature 23 illness definition of critical illness. There is no additional cost for this feature.

Tax Treatment: RRSP Verses Universal Life Insurance

Let me provide an example of the different tax treatment on money in an RRSP and a Universal Life Insurance policy on death.

Let us assume that Peter had $100,000 in the investment part of a Universal Life Insurance Policy and $100,000 in a standard mutual fund when he died. The entire investment account of $100,000 would pass to Peter's beneficiaries (provided they were identified in the policy) together with the face value of the policy with no taxes or probate fees. Further, the cheque could be issued within a few days of proof of death. The same applies to the Whole Life Insurance policy with the caution of point 4 above.

The mutual fund $100,000 would be subject to both income taxes (likely at a tax rate of about 43%) and probate fees and the funds may not be released until after the estate has gone through probate and has been settled.

Use Universal Life Insurance for Estate Planning

It is my experience that Universal Life Insurance policies are being used for estate planning as much as they are for meeting traditional insurance needs. There are numerous tax saving and estate planning strategies that utilize this type of life insurance.

It may be advantageous to stop contributing to an RRSP when you believe that you already have sufficient RRSP funds for retirement and set up a Universal Life Insurance policy. It should be noted that consideration of whether this strategy would be of benefit and then when to start it, should be part of your retirement and estate planning process.

The face value of the life insurance policy can cover anticipated estate taxes and a savings component grows tax-free and will pass on to your beneficiaries without the probate fees and a potential 43% tax hit that the RRSP funds experience. You can still get at the money in the savings portion if it becomes necessary but in a significantly tax favored basis compared to withdrawing money from an RRSP. The downside is that you do not have the tax credit on your RRSP contribution but it still may make sense from an estate planning perspective.

Example of the best non smoker rates for a old male non smoker of average health

Example of the best smoker rates for a 35 year old male smoker of average health

Contact IDC for More Information

To learn more about permanent life insurance including Whole Life Insurance policies and Universal Life Insurance policies, please Contact IDC Toll Free at 1-866-238-9271 or visit our Insurance Direct Canada corporate site. You can also shop and compare using our online Instant Life Insurance Quote form.