Protecting your loved ones in the event of your untimely death is serious business. That’s why insurance companies offer you so many options. But understanding those options can be a bit of a challenge. We sat down to explain one of the least understood types of life insurance out there – permanent insurance.
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Permanent life insurance represents a category of life insurance products that provide lifetime insurance coverage, otherwise known as coverage until the policyholder passes away. As the name suggests, permanent life insurance is best suited to protect ‘permanent’ or ‘lifelong’ needs such as estate tax liabilities, care for a disabled child or dependent, liquidity for closely-held businesses and even funeral expenses.
Most kinds of permanent life insurance policies tend to include a savings or investment component, in addition to the pure lifetime insurance coverage. Part of the premiums are used to pay for investments, which accumulate within the policy on a tax-deferred basis and generate a cash value that can be accessed as needed by the policyholder. The policyholder may use the cash value as savings available for retirement through partial or full withdrawals or by taking loans against the cash value by offering it as a collateral to a lender. Due to the lifelong coverage and the embedded investment component, the premiums for permanent life insurance are much higher than other products.
If you are looking to protect your loved ones when they are financially most vulnerable, you may want to instead look at term life insurance
Term life insurance is better suited as a strict protection product rather than an investment and planning tool.
The difference is pretty easy to understand. Permanent life insurance covers you for an unspecified amount of time, from whenever you start the policy until the day you die. The policy will pay the death benefit to your beneficiaries at any time you pass away as long as you have been paying the policy premiums and have not cancelled the policy.
On the other hand, with term life insurance, you are covered and benefits are paid if you pass away within a specific period of time. The usual terms tend to come in increments of ten years, although some companies allow you to pick the specific years of coverage you want. You see – with term insurance, you pay less as you get to choose the period of your life when you feel you need the most protection; it’s a bit more nimble than permanent insurance.
Also, term insurance does not have a savings or investment component in it, a feature that is associated with many kinds of permanent insurance policies, in particular with whole life policies.
Whole life, implying that you are covered for your entire life, is sometimes loosely used to refer to all categories of permanent insurance. However, there are different types of permanent life insurance Canadians can choose from. Besides whole life insurance, many Canadian companies also offer universal life insurance and term-to-100 insurance – we define them all in great detail here.
The most important differences between the different types of permanent life insurance products have to do with whether you want:
- To have an investment component and
- To actively manage the investment account or let the insurance company managers run with it
It can feel reassuring that permanent insurance is not limited to a specific period of time – or “term.” You keep paying and it keeps covering you in return until you die. Unlike this exercise in trust:
It also has an automatic savings component. If you weren’t savvy with investing your money (who are we to judge!), permanent policies can guarantee you some growth on your excess savings.
Permanent insurance products usually build up a cash value which grows tax-deferred. If you surrender the policy at any time, the cash value (or most of it) can be returned to you.
You can use the cash value to cover for any premium shortfalls if you are not able to temporarily make premium payments.
With bigger gains, come higher costs. The major drawback of permanent insurance is that the premiums tend to be much higher than those of term insurance. It stands to reason: you’re exposing the insurer to more risk by asking them to insure you for an indefinite period of time including through your riskier years, from a health perspective. Once you start paying the high premiums of a permanent insurance policy, it doesn’t feel great to let it lapse.
The returns on whole life policies tend to be modest. It may take several years for a whole life policy to accumulate significant cash value than if you invested on your own.
Most policies have a surrender charge, which is essentially a fee you will have to pay if you decide to cancel the policy and withdraw the cash value. If you surrender, there will also be income tax consequences on some portion of the returned cash value. Did you hear that? It’s the sound of your accountant shopping for a new wallet as he dreams about your next invoice.
The investment component of permanent (read whole life) policies has merits in facilitating a disciplined investment schedule, ability to access surplus cash when needed, like retirement, and tax-efficient estate transfers. While all of these sound alluring, make no mistake: the primary purpose of permanent life insurance is still protection so that your dependents have financial security when you pass away.
If you’re primarily looking to grow your money or shore up your retirement plans, look at TFSAs, RRSPs, RESPs, or even paying down your mortgage early rather than the modest gains you’d make with a permanent insurance policy.
Permanent insurance should not be treated as a primary investment vehicle. The return embedded in such policies, while guaranteed is usually modest. The built-in management fees are higher than what fund managers may charge. There is a cost (‘surrender charge’) to accessing such cash during your lifetime. Premiums for permanent life insurance may be better deployed in alternative investment vehicles such as RRSPs, RESPs or even to pay down your mortgage. So if you have maxed out on some of those registered products, then whole life policies can be a good place to deploy some of your surplus cash.
Do you still have some questions about the different types of life insurance plans out there? That’s understandable and exactly why we wrote the Honest Guide to Life Insurance. Check it out, or jump straight into our life insurance calculator to instantly see how easy it is to protect your loved ones for less.