For Canadians there are multiple benefits of including life insurance as an asset class to compliment your existing investments. Providing an attractive return on investment is one, but it must be structured properly.
Tax Free Death Benefit
Most permanent life insurance policies sold in Canada are issued with the premiums and face amount guaranteed for life. Therefore, we can calculate the internal rate of return (IRR) on the premiums. For policies where the death benefit is paid out tax-free to the estate or beneficiary, the IRR is a tax-free percentage rate. The only variable is the insured’s age at death.
Minimum Funded Universal Life Insurance
In the case of a minimum-funded universal life (UL) policy, the death benefit is level for life. The sooner one dies, the greater the implicit IRR and vice versa. For example, consider a healthy non-smoker male aged 50 paying $13,296 annually for $1 million of life insurance. The following table illustrates the guaranteed after-tax IRR for different ages at death.
As an example an insured man dies at age 85, the $1 million payout would be equivalent to the premiums earning an after-tax compounded return of 3.9 per cent. This is an attractive rate of return given today’s low interest rates. But is this a good investment? In addition to the unfortunate criteria that death is required, there’s no liquidity.
Over-funded Universal Life Insurance
If premium payments are discontinued the policy lapses and the policy owner receives nothing. The solution is to over-fund the policy above the base insurance cost to the allowable limits. A range of investment options can build cash value that can either enhance the amount paid out at death or provide retirement income by leveraging the cash value.
What's The Right Life Insurance For You?
Unfortunately, many people have the wrong type of coverage for their needs and will end up paying out a lot of premiums only to see the policy eventually blow up! For instance, for those who purchased UL policies when interest rates were eight per cent or more, the policy investment performance has not kept up to what was projected. This results in requiring significantly more cash infusion to keep the policies in force.
In other cases I run across UL policies that were sold based on yearly renewable term insurance cost where the initial premium looks very attractive. The downside with these policies is that the cost of insurance goes up every year, eventually reaching the point that the premiums become very expensive. Most people end up quit paying the premium and the policies lapse.
Before establishing how much coverage is the right amount for your situation, we can do a full needs analysis. With today’s ever increasing mortgages and debt levels, it’s important that families do regular reviews to insure their existing coverage is adequate and properly designed for their individual situation.
Take the time to talk to us LifeInsurance-Orleans.ca about all of your finances including life insurance, wills, investments, business structures, etc. to ensure they are structured properly for your individual protection, retirement and estate planning needs.
Also published on Medium.