We graduate university, start a career, get married, and next thing you know you have a kid… It is fairly straight forward to see the case for life insurance. Protect your family against the loss of future income if something tragic happened. Do you have any idea how much insurance would be appropriate for your loved ones to continue on with life without you? If you do know, you have probably done some level of financial planning. If not, you should probably take an hour and figure it out.

 

To keep this high level and to the point, I will touch on term insurance, but focus on and permanent insurance. With term, you pay an annual premium which covers you for a certain dollar amount over the course of a pre-determined term, say 20 years. Permanent insurance on the other hand, stays in place until you pass. But instead of paying a premium for 20 years and not building any equity in your policy like you would with a term policy, a permanent insurance policy actually builds a cash value, which grows at a rate of return.

 

The short of it, term is cheap and cheerful… If you need cheap temporary protection, it can be a good solution. Permanent is more expensive, but for the obvious reason that there will be a pay out, and it builds cash value which grows like an investment.

 

So what is “cash value”, and what good is it to you? Just like you can borrow against your home, or your investment portfolio, you can borrow against the cash value of an insurance policy – and banks will give you a really low rate to do so. Clients can use the borrowed proceeds for the down payment on an investment property, a vacation home, maybe a house for their kids. They can also use the proceeds for early estate planning wishes, you could borrow and gift the proceeds to whomever you like, and when you pass, whatever is borrowed will be paid off by the death benefit. Also, it can be used as a great emergency fund! Let’s say you are drawing from your retirement investment portfolio and the markets take a big fall, would you rather draw from your investment portfolio when most positions are in a loss, or would you rather borrow cheaply against your insurance policy and then pay it back when the markets recover? I would take the latter as you don’t want to be in a forced sale position.

 

So who is permanent insurance potentially a good solution for? We call the amount of money that you need to retire comfortably, and remain comfortably retired, primary capital. Anything additional we call secondary capital. Let’s say that after you go through the financial planning process, you learn you are going to have more than enough money to retire comfortably while using very conservative assumptions – we now need to start thinking about how to best manage your secondary capital. Often times it can be very clear from a young age that secondary capital will be a consideration, and the earlier you find out, the more you can do to maximize this for the next generation, or whatever legacy you want to leave. This is where permanent insurance becomes an asset class…

 

For simplicity, let’s use the example that based on your financial plan, you know that if you contribute 100K to your investments every year, by the time your desired retirement date comes around, you will be well looked after to live the dream life you’ve always wanted. But what if your cash flow justifies putting 150K into your investment portfolio every year? Should you just build up a massive investment portfolio, or should you think about diversifying into additional asset classes? Based on the return (currently 6.5% annually) and tax characteristics (tax free) of permanent insurance policies, we would argue that it should certainly be a consideration. The benefits get even better when you are an incorporated business. The business uses pre-personal tax money to pay the life insurance premiums, and when you pass, the death benefit flows almost entirely tax free out of your corporation to your beneficiaries through the “capital dividend account”. I will do a separate post on corporate insurance…

 

Permanent insurance is used often in comprehensive financial planning, and if it works for you, the benefits for your family and the coming generations can be massive. If you want to chat about if permanent or term insurance could be right for you and your family, I welcome the conversation. I am life insurance licensed, and being with the largest wealth management firm in Canada we have access to many life insurance providers in order to provide our clients with the best solutions to fit their situation, as well as the most competitive rates.

 

I hope you find this insightful!

 

Have a great week,

James