Life Insurance: More Reasons to Own It
The advantages go beyond protection.
It’s wise to own life insurance. It protects your family’s lifestyle should tragedy strike, taking care of your mortgage, replacing lost income or putting your kids through college. But if you aren’t looking beyond its traditional role, you’re missing the big picture.
Think of the right life insurance policy as the Swiss army knife of your financial toolkit, with the ability to enhance your financial and estate planning in a number of ways, including a few you probably hadn’t thought of. Here are seven more reasons to have it in your corner.
1. Create a tax-sheltered investment
Building wealth and saving tax. When you think of life insurance, they won’t be the first words that come to mind. But with the proper policy, you can do both.
Under special provisions in the Income Tax Act, permanent life insurance – whole life and universal life – is generally considered exempt insurance. Premiums paid into exempt policies over and above what’s needed to keep insurance protection in force are eligible to accumulate in a cash, or savings, component of the policy, delivering two key benefits.
First, those dollars are free to grow tax-sheltered, similar to an RRSP, as long as they remain in the policy. That’s why permanent life insurance can be especially attractive as an investment option if you’re a high earner who routinely maximizes your RRSP and TFSA contributions, and is seeking additional ways to shield your income and capital from taxation.
Plus, in the end, the policy’s proceeds, including the savings you’ve built up, can be paid out tax-free to your beneficiaries, estate or to charity.
2. Hedge against market volatility
Most whole life policies are "participating"; when you have one you’re essentially sharing in the insurer’s earnings through a regular dividend that accumulates within the policy. These dividends help produce a steady and consistent rate of return that’s independent of the daily gyrations of financial markets. In this way, whole life behaves as a separate asset class, with a different risk profile than a conventional investment portfolio.
The chart below compares the experience of an established Canadian life insurer’s participating account to the performance of the broad Canadian equity market and GIC (term deposit) rates.
The account’s dividend scale interest rate, used to smooth swings in the participating account’s returns, averaged 8.8% on an annualized basis for the 25-year period ending in 2014. This performance is comparable to the average annual return for the S&P/TSX Composite Total Return Index, but with far less volatility.
3. Preserve and protect your wealth
Taxes are hard to avoid, even at death. Without proper planning, the estate you leave behind to your loved ones could come with a hefty tax bill.
Your death (or the death of your surviving spouse), automatically triggers any capital gains accumulated on unsheltered assets like your non-registered investment portfolio or rental real estate. If you own a vacation property south of the border you can face U.S. estate taxes. There’s also the sobering fact that close to half of the value of your RRSPs or RRIFs can be taxed away, since they’re now reclassified as income.
If your beneficiaries don’t have the means to cover your obligations, they might have to reluctantly sell property, including treasured assets like a family cottage, to raise cash. Even worse, they may be forced to do so at a discount.
That’s where life insurance steps in. A policy’s proceeds can supply much needed liquidity to your estate, and do it immediately and tax-free, to settle your taxes, debts and other expenses, preserving your legacy. Unlike property handed down through a will, which could be fought over during estate settlement or exposed to creditors, life insurance benefits can go directly to named beneficiaries, bypassing probate.
4. Share your estate equally
A vacation home. A business. A sentimental set of jewelry. If the plan is to hold on to indivisible assets like these, you could have a dilemma when figuring out your future estate.
Say, for example, one of your children wants to carry on the family business. Chances are it has significant value, perhaps accounting for a large chunk of your legacy. Life insurance can provide the means to compensate your other heirs monetarily and equalize each beneficiary’s inheritance, helping keep peace in the family.
5. Tap into a source of cash and income
One advantage the cash value you amass in a permanent life insurance policy has is it’s accessible, either for liquidity purposes, or as a means to supplement your income, particularly in retirement.
There are generally three ways to tap into your policy’s cash value.
Leverage your policy. Your first option is to “leverage” your life insurance policy, using it as collateral to obtain a loan from a financial institution. While you’ll still be responsible for the loan payments, the borrowed funds are tax-free. If you’re asked to assign your policy to the lender, part of your insurance costs may be tax-deductible.
Policy loan. Alternatively, you can borrow from the insurer through a policy loan. Think of it as an advance against the death benefit of your policy. The funds are tax-free, provided the advanced amount doesn’t exceed the policy’s adjusted cost base (in a simple situation, your total premiums paid less the net cost of insurance).
Withdrawal. Finally, you can withdraw from the cash value of your policy. There are two key points to remember about withdrawals. The amount can’t be repaid, which may wind up reducing your death benefit. And, the withdrawn funds are taxable if the cash surrender value of the policy (amount net of any outstanding policy loans, interest and surrender charges) is more than its adjusted cost base.
Having the ability to utilize your life policy’s cash value adds important flexibility in managing your finances. That said, the finer details around each option mean it’s best to seek guidance before you act.
6. Leave more to charity
Donating a life insurance policy to charity has the potential to be more rewarding for you and your favourite cause than simply giving cash.
For one, it may make it possible to leave a larger gift than you otherwise could, enhanced by tax-sheltered growth and a tax-free payout, all for a modest monthly premium.
How you choose to give your gift – naming the charity the owner and beneficiary of your policy, retaining ownership yourself, or taking out a new policy in the charity’s name – will determine if you’ll receive donation tax credits now or if they’ll go to your estate later. Your advisor can explain the pros and cons of each approach.
7. Secure guaranteed retirement income
For risk-averse individuals looking to invest their taxable savings, annuities are a way to secure guaranteed income tax-efficiently.
With an annuity there's no guesswork. It's an insurance contract that offers a steady, predictable stream of payments either for a specific time period, or for life. These payments continue regardless of what financial markets or interest rates do.
When you use your non-registered savings to purchase a prescribed annuity, the income you receive and the accompanying tax obligation are spread evenly over the life of the annuity contract, rather than being naturally higher in the first few years when the annuity’s principal is greatest. This levelling-out process is a form of tax-deferral, which can help boost your after-tax income compared to using alternative interest-bearing instruments.
A sticking point for some investors considering annuities is once funds are committed and the annuity is purchased, the money cannot be returned. If you die prematurely, that capital, which may have represented a good portion of your life savings, stays with the insurer instead of going to your estate. Life insurance can solve this problem.
When you match an appropriate life policy to an annuity, there’s an important difference. When you die, the life insurance benefit will go tax-free to your beneficiaries, replacing the funds used to buy the annuity, letting you preserve more of your estate for your heirs.
|How an insured Annuity Creates More After-Tax income|
Investment @ 2.50%
|Annuity / Life Insurance||$500,000||$500,000|
|Taxes Payable (30% tax rate)||($1,017)||($3,750)|
|Annual Life Insurance Premium||($13,473)||---|
|After-Tax Cash Flow||$13,776||$8,750|
|Annuity - Cash Flow Increase||$5,026|
|Insured annuity generates 57% more after-tax cash flow.|
Sample illustration for females age 65 using 1)single-life prescribed annuity (no guarantee period); 2) universal life policy at standard rates and level cost of insurance.
Understand all the advantages
When you’re weighing investment, estate planning and risk management strategies, it’s important not to look past the multiple benefits of a well-selected life insurance policy.
At BlueShore Financial, our in-house wealth protection experts will explain your options and recommend solutions to help you reach your financial goals, with the peace of mind that comes with being properly protected. Contact your advisor to learn more.