This is a post I found on Reddit:
I feel like people either think it’s a scam/huge waste of money (according to Reddit, my husband, people I know), or the most important financial tool ever (friends who financial planners that I don’t work with, financial advisors that I’ve met with, my estate planning professor whose parting advice to everyone in our class was to get on that ASAP while we are young, other people I know), and I can’t figure out if we should get it or not.
My husband and I (mid-30s) have both been in school forever and are now in the first year of our careers. We went from years of making $30,000/year in grants/part-time jobs to $200,000/year, with fairly high/stable growth potential. Through some good investments, we have a net worth of around $600,000. Because we didn’t work for so long, we never really contributed anything to our RRSPs. We are currently replenishing our TSFAs after withdrawing most of it for a down payment on a house.
Given our savings rate, I expect we will be able to max out our RRSPs and TSFAs fairly quickly. We also have a maxed out RESP for our kiddo. We are currently reviewing our term life insurance to make sure it’s adequate for our new home purchase, and wondering if we should buy whole life or universal life insurance. I see people say that it’s for the “wealthy”…. what’s the threshold on being wealthy?
One of the reasons my husband says we don’t need it is because he knows he’s going to come into an inheritance of approximately $2 million, so we don’t need whole life/participating life insurance because that will cover our remaining mortgage and more. But I’m wondering… does that make us “wealthy” enough to need it? If we do need it, shouldn’t we get it as soon as possible?
We also met with a financial planner recently, who said it’s something we should definitely be considering, which made my husband all the more doubtful. Why is this so confusing?!?
I love this question! It highlights what’s wrong with our industry – too many advisors have bias to certain products/solutions. There is not a one size fits all solution. While a Cash Value Life Insurance policy (such as Universal Life or Whole Life) is a fantastic tool to help some accomplish certain financial goals, it’s definitely not for everyone.
First, term life insurance is for “IF” you die where permanent life insurance is for “WHEN” you die. So the first question you should be asking yourself is what are you trying to accomplish?
Second, your husband is right – many who should consider purchasing cash value life insurance don’t need it. They have enough assets to last them a lifetime, and they expect that they will be leaving their children an inheritance.
Just because one may not need the coverage, it doesn’t mean that they shouldn’t consider it. It’s like saying, you don’t need to put your money into a TFSA – because you have enough money already and don’t need the tax savings. However, why would anyone want to pay tax if they can avoid it? So while one may not need to invest into their TFSA, it simply makes financial sense to do so. It reduces tax, to give you more wealth. Insurance works in a similar way…however, it’s not about giving you more wealth – it’s about giving your children, estate or favourite charity more wealth.
So when does Cash Value Life Insurance make sense? Typically when you are investing in taxable investments (non-registered investments), meaning you should already be maxing out your TFSA and RRSP. Also, you know that you are already in a position where some of those taxable investments are earmarked for your children or favourite charity. You are simply moving some of your assets that you are paying tax on, and reallocating it to an insurance policy that grows on a tax-deferred basis. Upon death, your beneficiaries will receive the proceeds on a tax-free basis. Cash Value Life Insurance typically competes with the fixed-income portion of one’s taxable investments. Properly structured, Cash Value Life insurance can very likely outperform the fixed-income market with less risk.
By reducing taxes, you are giving less to the government, allowing you to leave more behind to those you love. Another benefit is that the payout can be a lot quicker to the beneficiary, because the insurance proceeds can bypass probate. As you can imagine, many who purchase these types of policies likely had much success in their life – and their estate may be complex. The more complex the estate, the longer it could take for their children to receive their inheritance.
Some may consider using surplus income, and investing that surplus towards such plan.
However, you need to be relatively certain that you will be able to maintain such income or payments into the plan. Think of those clients this year, who are impacted by COVID, and not making as much income as previous years. Many of these insurance strategies involve long-term planning. If you find yourself in the position where you can’t make the payment towards the policy, and need to lapse the policy – you just threw a bunch of money down the drain.
Yes, you do need to work with a professional who understands cash value life insurance and more importantly, helping you make an informed choice on if it makes sense or not. Too many push these types of solutions, as yes, they do pay out a nice commission given the size of some of these cases. There are many different ways these policies can be structured. Some are fully guaranteed, where the investment account and death benefit are guaranteed never to decrease. Others are very risky, where you may find yourself in a heap of trouble down the road (Universal Life, with an Increasing Cost of Insurance is one of those examples).
If one isn’t already maxing out their TFSA/RRSP and looking for additional tax-deferred growth, than it’s likely too soon to seriously consider cash-value life insurance. Majority of Term Life Insurance policies can be converted to a permanent plan down the road, without any medical underwriting. Just make sure the term policy is with a good company, that is most likely going to have a good product shelf for Cash Value Life Insurance.
If one has a family cottage or investment properties that they plan to leave to their children, than they could use a cash value policy to cover the capital gains tax bill upon their death as well.
Lastly, you are still young and dependent on your ability to earn an income. You may want to ensure that you protect your ability to earn that income. Disability Insurance may be something you want to consider. This can help you stay on financial track if life throws you a curve ball.
Hope that helps!
Wow this is so clear, even clearer than from my estate planning professor! Thank you!
Responses like this are why I love my job! I am happy always happy to help, so if you have any questions, do not hesitate to contact me (or find me on Reddit!).