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Mar 5, 2018

Should You Buy Permanent Insurance?

by David Townsend

David TownsendOne savvy insurance professional put it like this: “consumers do not buy permanent life insurance; they are sold it.” That has been my experience also. First, permanent life insurance is expensive. Although commissions are certainly not transparent, my research indicated that about 100% of the first-year premium (and sometimes more) will go to the selling agent. In my view, the large commissions have resulted in permanent insurance being oversold. As a result, many consumers and independent financial advisors are skeptical about the product.

The skepticism is understandable when you hear stories from policy holders in the U.S. who are suing major insurance companies for 200% premium increases on universal life policies that go back decades. The lesson to be learned is that consumers better understand what they are getting into when they buy permanent insurance. I have found that many do not.

Permanent insurance includes many complex products and some equally complicated strategies. Terms like permanent insurance, whole life, universal life and term to 100 are often used without any background information; as if everyone is familiar with the benefits and limitations of different types of policies.

In my research for this article, I found much conflicting information and many radically different opinions on the value of permanent insurance. Granted, much of it was American based and the Canadian rules are different, but the concepts are similar. I also came across several celebrity financial planners who were over the top (in my view anyway) that whole life insurance is a “rip-off”. On the other side, insurance providers are equally adamant about the effectiveness of permanent insurance to do everything but cure cancer. The debates were, well, not very polite at times.

On the positive side, I found some of the best unbiased information came from a fellow Moneysaver contributor. As I write this, Colin Ritchie has contributed some new articles on this topic. He also wrote a series of articles on permanent and term insurance several years ago. For anyone wanting details on the different types of insurance, I recommend going to his website or previous Moneysaver issues.

In my experience, clients do not always hear the “permanent” part when they commit to this type of insurance. This type of policy is designed to be in place for life! Needs and/or income levels sometimes change and winding up or adjusting the policy is expensive. Many do not adequately consider this.

Mr. Ritchie often refers to the “need for permanent insurance”. To follow up on that, when is there a need for permanent insurance?

For those who have significant capital and will not spend it all, it is a useful way to accumulate funds tax efficiently and leave a legacy. At some point, everyone becomes uninsurable. If you qualify for the insurance, are comfortable you can afford the premiums, and want to pass something on to the next generation, permanent insurance works. However, you still should be careful of the level of coverage. Some overestimate their ability to pay the premiums, resulting in additional expenses and stress.

Cash, GICs, principal residences and Tax-Free Savings Accounts (TFSAs) are other assets that can be passed on to the next generation tax-effectively. Granted, they do not have tax advantages of permanent insurance, but simplicity has advantages too. Permanent insurance seems to get very complicated very fast. Often the client does not fully understand all the implications and I suspect that some agents do not either. And a complete analysis is only done if there are misunderstandings

I have also seen permanent insurance sold as a retirement vehicle. The most common example is when a company buys a permanent insurance policy and the insured shareholders borrow against it. The funds accumulate tax-free within the company policy as opposed to the company paying high-rate tax on investment income. The shareholders then draw loans that are essentially tax-free and repaid out of the insurance proceeds when they pass.

However, the company can also reduce its high-rate tax by paying out dividends. The permanent insurance plan works in the right circumstances, but it is important that the client understands the ramifications and alternatives. There may be simpler ways to achieve the same result.

To quote Colin Ritchie: “What’s the difference between term and perm coverage? Insurance advisors often describe it as the difference between renting and owning.”

That’s a good analogy to a point. With term insurance, the premiums are basically paid and gone, like rent expense. On the other hand, with a permanent life insurance policy, you can build up equity and borrow against it. However, permanent insurance is not a property that can be easily liquidated.

“Owning” permanent insurance for a lifetime is a big commitment. Any reader of this article would not consider a major property purchase without investigating and comparing alternatives. They would not talk to one realtor and buy the first property they saw.

Buying a permanent life insurance policy requires the same level of due diligence. Be open-minded but skeptical. Evaluate pros and cons, discuss alternatives, get second opinions, consider “worst case scenarios”, and only then make an informed decision.

David A. Townsend, C.A., C.F.P. has been providing accounting and tax services in Calgary since 1990. Clients include a wide variety of individuals, trusts, estates and private companies.

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