When Permanent Life Insurance Beats Term

Term insurance is cheap and available everywhere.

It could also be the worst purchase you make!

On the list of easy sales, term life insurance ranks near the top. It’s cheap, effective, and popular—especially with consumers who’ve embraced the “buy term and invest the difference” mantra touted by many specialty term insurers – and financial advisors…

And for young families on a budget, term is often the only product they can afford that will provide them with the amount of coverage they need – for the short term.

But term life isn’t a panacea, especially for high-net-worth consumers with complex financial-planning objectives.

For these clients, permanent life insurance—either whole life or its two most popular derivatives, universal life or variable life—offers important tax savings and estate planning advantages that often can’t be duplicated by other financial products.

Even with initial premiums running as much as 10 times higher than term premiums, permanent life for these clients will often end up being the more cost-effective and more appropriate purchase.

Perhaps the best way to decide when permanent life is the better choice is simply to know when term insurance does make sense. For most consumers, term will be the appropriate purchase only if:

1. The period for which insurance is needed is finite (since term insurance is, by definition, finite), and there are no savings or estate planning objectives associated with the purchase.

OR

2. The consumer simply cannot afford the amount of life insurance coverage needed except by purchasing a term policy.

The general rule, is that permanent insurance should be purchased—assuming the policyholder can afford the premium–if that person wants to have the insurance in force when he or she dies.

That seemingly simple statement reveals a surprising basic truth about term insurance – it all expires at age 80 meaning well before the policyholder does (except for Term to 100).

While that’s a risk that a 28-year-old father of two might be willing to assume-he needs lots of coverage and he needs it right now, just in case he does die young—it’s not palatable to insurance buyers with long-term needs.

Let’s look at some examples.

Estate Planning

If it’s true that death and taxes are the only certainties in life, it’s also true that they are tightly, maddeningly linked—and destined to remain that way for the foreseeable future.

Taxes continue to take a big chunk out of estates—ranging from 13% to as much as 40%. Paying these levies can be a tremendous burden on heirs, who in some cases must sell off personal property or the family business to settle up with Revenue Canada.

Life insurance provides a way out!

Because the death proceeds of an insurance policy are free of income taxes, a policy can provide family members with the wherewithal to pay estate taxes and still retain family assets.

Similarly, an insurance policy can be used to fund a business-succession plan by ensuring that whoever takes over a company upon the death of the current owner can afford to do so. (In such cases, the proceeds of the policy would be used to pay for the business rather than to settle estate taxes.)

In the same vein, an insurance policy can serve as a tax-advantaged tool for bequeathing money to heirs. It can, for example, finance a grandchild’s college education or provide for someone, such as a handicapped child, who otherwise couldn’t provide for his or herself.

But all of this works only if the insurance policy is in effect at the time of the insured’s death.

This is an instance where permanent insurance is not just preferred but almost required, since term insurance is rarely in force at the time of death.

Tax-deferred Investing

The federal tax code stipulates that the cash value of a life insurance policy accrues on a tax-deferred basis. Accordingly, no taxes are due on the profits in a permanent life policy until, and if, the policyholder begins to access its cash value.

For high-net-worth clients who have exhausted other tax-advantaged investment vehicles such as RRSPs, a life insurance policy provides yet another way to build wealth while minimizing income taxes.

Generally speaking, we don’t think of life insurance as an investment vehicle.

However, if one analyzes this issue from an internal-rate-of-return perspective, many clients cans that if they keep their insurance for a long period of time, perhaps 20 years or more, they may be better off buying a permanent insurance policy and then surrendering it to receive the cash value, rather than purchasing term insurance and investing the difference in a taxable account.

Special Note: If set up properly, the cash surrender value of a policy may be used as collateral for a bank loan or series of loans, the income of which to the investor is tax free. (The interest on the loan need not be paid by the investor, simply left to be collateralized along with the loan. On death the loan is discharged and the residual is paid to the named beneficiaries – tax free).

Planning for the Unexpected

To be sure, conveying the value of permanent life insurance can sometimes be challenging. The younger the client, the farther out the benefit.

Many clients have a difficult time appreciating how much their net worth is likely to grow in 30 or 40 years, or what their estate planning picture might look like.

Sometimes, life insurance needs that were expected to disappear at 60 or 70 years of age remain.

However, by then, buying a new policy or any sort, term or permanent, may be prohibitively expensive.

With a properly selected permanent policy, you have the ability to say, I don’t know what my feelings are going to be or what my needs will be when I’m an octogenarian, but I don’t have to worry about that.

And if I decide that I don’t need my life insurance policy any more, I can cancel it, and there will be a nice cash value waiting for me as a bonus.

About The Author

Mark Huber is a full time practicing certified financial planner (CFP).

This article may be freely distributed if this resource box stays attached.