Life insurance: Is term life always enough?

Most families are better off buying cheap, straightforward term insurance, but there are situations where universal or whole life policies make sense.

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From the December/January 2012 issue of the magazine.

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If someone you care about depends on your salary, then life insurance is not an option: it’s essential. If you die prematurely without the proper coverage, your spouse and kids may be left without any means to pay the mortgage or buy groceries.

But what kind should you get? The most popular is term life: you pay a fixed premium that covers you for a specific period, usually 10 or 20 years. The other major category is called permanent life insurance, because the coverage continues for life. Within the permanent insurance category there are two types: whole life and universal life (see “Whole vs. universal life” below). Permanent policies typically have an investment component as well as the insurance, and a “cash surrender value” if you cancel them.

The usual advice from the financial media is that you should only buy term, because it’s simple, transparent, and cheap. Permanent insurance is none of those things. The premiums for universal and whole life policies are often five times higher than those of a 20-year term policy. To give a rough example, a 35-year-old male non-smoker might pay $35 a month for a term policy with a death benefit of $500,000. A universal life policy with the same death benefit might cost $190 a month, while a comparable whole life policy could easily top $250.

Because such policies are expensive, they’ve developed a bad reputation. Anyone in the insurance business will tell you that whole life and universal life policies are widely loathed by the general public. “Be prepared to get beaten up for suggesting anything other than term,” says Glenn Cooke, an independent broker who operates Insurecan.com and uses term policies for more than 90% of his clients. “Permanent insurance may be more appropriate in certain cases, but whenever I mention it, people get upset. Anyone who has done a little bit of reading gets aggressive.”

There are legitimate reasons for being skeptical: whole life and universal life policies have a long history of being oversold by pushy salespeople motivated by higher commissions. That’s left some families paying for the wrong benefits. Geoff Graham, president of Graham Financial Strategies Group in Niagara-on-the-Lake, Ont., stresses that a family’s first concern when buying insurance is to make sure the death benefit is large enough. Any investment or cash value component is secondary. “I’ve seen people who got the deluxe plan with all of these features, but if they die, their spouse and children are going to be in trouble.”

When Myron and Anne Janzen went looking for insurance, their goal was to protect their three children, not to build an investment. “I was looking to get coverage for 10 times my annual income,” says Myron. The Janzens, who live in Winkler, Man., also wanted coverage for Anne, who works from home. So they chose a joint term policy that will pay $500,000 if either was to die. The cost is just $49 per month. “When I looked at the premiums for term versus whole life, I knew I would be much better off taking the difference and investing it myself.”

Does that mean you should avoid whole and universal life under any circumstances? Turns out the answer is no. A simple term policy is adequate for the vast majority of Canadians, especially young parents who need a hefty death benefit they can afford (see “How to buy term” on the facing page). But there are several situations where permanent insurance really is the better choice.


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You want to leave a legacy

Say you have a disabled child and you want to leave her $500,000, no matter how old she is when you die. In this case, it makes more sense to buy a permanent insurance policy than to try to save that yourself. The least expensive way is with an “unfunded” universal life policy, which means you pay only for the insurance and never add money to the investment component. A similar product called “term to 100” also provides coverage for life, but with no investments and no cash surrender value.

Asher Tward, vice-president of estate planning at TriDelta Financial in Toronto, explains that the median life expectancy for a healthy 35-year-old male is about 44 years. If you pay a premium of $190 per month for 44 years and your heir receives a half-million-dollar payout, that works out to an annual after-tax return of about 6%—more than most people would be able to get by investing on their own. “You also went to sleep every night of your life knowing that you had $500,000 of protection,” Tward says.

You could become uninsurable

If whole life and universal life policies are controversial for young parents, try recommending them for kids. Despite what your agent or broker says, in cold financial terms children are a liability, not an asset that needs to be protected: no one depends on young children for their income. But there is one situation where a permanent policy for a child makes sense.

Just ask Christina Huppé, a 33-year-old mother in Kanata, Ont. She and her husband Marty purchased whole life coverage for nine-year-old Hanna and three-year-old Sébastien. “I know this is a touchy subject for some parents: they think it’s morbid to insure their children,” says Christina. “But in our case, I have a genetic blood disorder, and my children have a 50% chance of inheriting it.” If her children do inherit the disorder, they’ll find it difficult or impossible to get affordable coverage as adults. “So we decided to give the children an insurance policy now to protect them and their families for the future. We’re looking ahead a couple of generations.”

You have more than you’ll need

“Whenever I recommend that people use whole life, it’s never because they need more insurance,” says Warren MacKenzie of Weigh House Investor Services in Toronto. “It’s because they’ve got more money than they will need, and they’re paying tax on it.”

The crucial point here is that using a permanent insurance policy as a tax shelter makes sense only when your RRSPs and TFSAs are maxed out, you have a significant amount invested in bonds or other fully taxable investments, and you are virtually certain you won’t need the money in your lifetime.

Anil Yaser has found himself in just that predicament. A physician in Toronto, Yaser (not his real name) has amassed enough money to retire today at age 50. Even though he’s single and has no children, he’s considering buying permanent life insurance to shelter some of his wealth from taxes.

Yaser has a lot of money in bonds, and he’s losing almost half the interest payments to taxes. If he uses that money to fund a whole life insurance policy with an investment component, he can shelter it while he’s alive. Then it will transfer to his nieces and nephews tax-free when he dies.

Critics of whole life point out that you have no control over how the money in your policy is invested. But MacKenzie argues this feature is often a benefit in disguise, since most people do a poor job of managing their own investments.

Your estate will face very high taxes

If you die at a ripe old age, you’re not likely to have dependents who are still relying on your income. But that doesn’t mean your family won’t face big expenses when you pass on and your estate is divided up. If you own property, for example, you can’t pass it to your children tax-free: your estate will be on the hook for capital gains taxes, whether or not your heirs sell the real estate.

If your partner is already gone, the final tax bill on your investments can also be enormous. When the second spouse dies, RRSP and RRIF investments are fully taxable in the year of death. Depending on your province, that means 39% to 46% of your nest egg will go to the government instead of your children, grandchildren or charity. “Some people say they don’t care about these taxes because they’ll be dead,” Tward says. “Others realize they can put aside some money every year and make their estate whole.”

As part of a comprehensive estate plan, you might consider a permanent life policy with a death benefit designed to offset all or part of your final expenses. The premiums can be very high if you don’t get the coverage until late in life, but the payout is guaranteed. If you know you won’t need the cash while you’re alive, it may be the best way to keep your wealth in the family.

10 comments on “Life insurance: Is term life always enough?

  1. The problem with only looking at term because of cost many advisors miss out on a number of things.

    Term is renting over time (assuming one lives beyond 65 which the majority do) one loses in two ways one to inflation and opportunity cost.

    I wrote a story about annuities using insurance one can get at retirement over 7% or better guarranteed for life and pay very little taxes.

    The key is to look at the end game …which is retirement. Why not spend and enjoy more money pay less taxes and take on less risk?

    Leave the market (or reduce) at retirement and be happier with less taxes. You can't do that with term.

    I have shown on my web site that having up 25% less money (with permanent life insurance) is far less risky than more money and no insurance.

    Reply

  2. I love reading articles like this. It's interesting that people who prefer universal life over term look at the taxes. What they may be missing, is that there are many tax free vehicles available now. First of all, most universal policies sold today have increasing insurance costs.. Term is level through out the term. If you invest the difference in a TFSA (not a GIC at the banks but in an actual investment such as a mutual fund), the income earned on the investment is tax free. Also, with term, you can get "guaranteed renewabilty options. Buying term and investing the difference is more sound.

    Reply

    • “What they may be missing, is that there are many tax free vehicles available now.”
      I think one of the potential situations for considering using UL is when you are already maxing out on your tax free/deferred accounts. UL is a good fit for only certain situations in my opinion.

      Reply

      • I just found out that cancelling my yearly-term renewable UL policy would cost us close to $100K in taxes on the investment gains. Subtracting the taxes in the gains and the policy costs from the gains leaves us nothing more than the initial capital and perhaps $10K less. Keeping this policy with increasing policy annual costs will not be sustainable in 10-15 years even with the very expensive Maximizer option. The crooked Ottawa Broker that sold us this policy 10 years ago, when we had no need for insurance, told us that the policy had level premiums, we were tax-sheltering our investment invested in mutual funds (a lie, it was indexes to mutual funds), and that we could cancel the policy anytime after 10 years with no tax consequences – what a lie. Never did this charlatan divulge the $50 in commission that he made lying to us and not telling us nothing about the consequences. He even forged documents. How bad, immoral and unethical can one be! The OSC and Ontario Financial Ombudsman are totally useless in protecting and helping us, being of no value-added. What a shame that the finance and insurance industry continue to encourage such crooked people as this Ottawa Broker.

        Reply

        • It is unfortunate that this happened to you. The info that you stated above such as the policy has been enforced for 10 years along with the $100K taxes on the gain in 10 yrs seem a bit odd. It is true that there are strategy that use the investment portion of the policy tax free. It is depend on the type of the policy and the company that you have the policy with. I think it best of you seek out a second opinion on this. And this time make sure you ask questions and get all the answers clearly.

          G’ luck Mike

          Reply

          • spoken like a true universal and whole life agent. their is never a good time to get whole life or universal policies. I can pick apart any one of these policies. you pay for 2 things and only get one. the rates of return are terrible. if you purchase term and invest the difference properly you will make out way further ahead, whatever tax implications arise. A complete financial plan with awareness on the taxes payable is all that is needed. don`t let anyone ever convince you that whole life insurance is necessary. a commission grab and makes the particular insurance company millions in profit per policy…

          • Hi there,

            Please help me with your suggestion. I have universal life policies for my family( myself wife and 3 kids. We are paying about $670 per month altogether and it will be two years in this September. Somebody advised me that it is the worst decision I have ever made in my life. I didn’t do enough research before buying this product and the agent didn’t care about explaining possible situations in the future, but only discussed scenario with policy making 7% returns per year as it did in that year.

            Now that I’m doing research on it and feels like a fool myself.

            I have few option infront of me now.
            1.go on policy holidays

  3. And let it pay itself for few months and loose money

    2. Convert the present ART to 100 option to level cost and keep the policy
    3. Keep paying the same hoping that policy will make 7% return . Fingers crossed

    Anybody with any suggestion would be great dog appreciated. I would like to correct my mistake some how . But I do not know how .

    Thanks for your help

    Mathew

    Reply

    • Do you live in Ontario?

      Reply

  4. Yeah, I am agree with you Dan, in the end it always depends on the needs of each one of a policyholder. In some case whole life insurance is better, for another, term is suitable one, and there might be someone who does not need insurance at all. This where we need a financial advisor to help us know what is the available option and choose the best one of them.

    Reply

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