When someone is thinking about buying individual life insurance, three main options are generally offered:
- term life insurance;
- whole life insurance;
- universal life insurance.
While term insurance is exclusively focused on the need for protection, the other two types, known as “permanent” life insurance, also accumulate cash value. This feature partly explains the higher cost of premiums for these options.
As we can see from the graph below, the majority of Canadians who purchase individual life insurance do so mainly for protection purposes. However, what about those who see their life insurance as an investment vehicle as well?
Protect first, then invest
There’s an old saying in the insurance world: “Buy term and invest the difference.” It’s a reminder that life insurance is primarily intended to protect the standard of living of those – spouse, children – who depend on the insured person. This is why a financial security advisor will often recommend that a client consider term life insurance to begin with, followed by disability coverage (or “income protection insurance”). Once this need has been taken care of, the person might consider using part of his or her disposable income for investing, often outside the insurance policy through mutual funds or segregated funds.
But there could also be good reasons to do this investing inside the actual life insurance policy.
An investment for others
One reason is the tax exemption granted to life insurance policies.
While it’s true that, in its 2017 tax reform, the federal government clearly indicated that it wanted life insurance products to serve primarily for protection and not as “tax shelters,” it could still be useful for some individuals to sit down with their advisors and do the math. For example, if the goal is to clear a million-dollar death benefit for the estate, it could be a matter of calculating which of the two vehicles would be the most efficient: a life insurance policy that would provide a tax-free payout, or a diversified investment portfolio that would generally be taxable.
Furthermore, a high-income individual who has run out of RRSP and TFSA room might turn to life insurance as another tax-efficient option to consider within the context of estate planning or a planned giving strategy.
There are many other factors that would also have to be taken into account when making this decision. In particular, an insurance policy will typically be less liquid than an investment portfolio, and it would thus be harder for the actual policyholder to use as a source of emergency funds. As well, the need to provide capital for survivors could change, or even disappear, over time.
An investment for oneself
Obviously, an individual could also use permanent life insurance as an investment for him- or herself.
With universal life insurance, for example, the protection and investment components can be adjusted over time, with the latter available for use at the insured’s discretion. With whole life insurance, it’s the cash value accumulated in the policy that would be used. It should be noted, however, that this money would be partially taxable as a capital gain when withdrawn. To avoid this tax impact, some people might prefer to take out a loan secured by the accumulated cash value. Such a loan would not be taxable, but it would accrue interest.
In any case, the advice of a professional will often be essential.
An investment for one’s business
Lastly, in the context of a business, whole life insurance could be both a tool for protecting partners and a vehicle for accumulating value. Unlike an investment portfolio, this accumulated value might not result in income or capital gains to declare every year, which, in light of the new rules on passive income, could be an attractive prospect. Of course, many other financial and tax factors would need to be weighed before considering this type of approach.
As we can see, even though life insurance is a tool for protection above all, it might also meet some investment needs as part of certain more or less complex strategies.
This article only provides a brief overview; for more details, talk to your financial security advisor.
The following sources were used to prepare this article:
Actualis, “No More RRSP or TFSA Contribution Room?.”
CLHIA, “Canadian Life and Health Insurance Facts, 2019 Edition.”
Comparer Assurance Vie, “Comprendre l’assurance vie et la fiscalité.”
Conseiller, “L’assurance vie entière, une stratégie d’optimisation fiscale.”
Investopedia, “Is Life Insurance a Smart Investment?.”
Investopedia, « Strategies to Use Life Insurance for Retirement ».
La Presse, “Modifications fiscales en 2017 : que faire?”.
Les affaires, “Un dépôt garanti à plus de 10%? Non mais... presque”; “Les mauvaises raisons de souscrire une assurance vie.”
Mom and Dad Money, “Why Whole Life Insurance is a Bad Investment.”