Insurance Planning

Life Insurance

Who needs it? If you haven't got life insurance, you're betting on one of two things: either that you'll live to a ripe old age, or that your family will have enough money to carry on without you. In either case, consider this:

Of the 215,000 deaths in Canada in 1997, 20 per cent of the deceased were between the ages of 20 and 64. With one-fifth of Canadians at risk of death before retirement, how lucky do you feel?

The management of the risk of death addresses the financial problems that dependents will face in the event of the premature death of their supporter.

Essentially, the risk is the loss of the income of the bread winner(s) of the family. However, the loss can be replaced by investment income from accumulated wealth and/or the proceeds from a life insurance policy.

A common mistake in managing the risk of death is to purchase some amount of life insurance that is affordable, but that has no bearing on the amount of capital required to support the deceased's financial dependents.

The amount of life insurance required to provide incomes for a surviving individual or family depends upon:   

►    the amount of after tax income required by each member

►    other sources of income including CPP survivor's benefits

►    average or marginal income tax rates

►    the duration over which the income will be required

►    an assumed inflation rate

►    a pre-tax investment return

In addition, capital may be required to pay:

►    final expenses including burial expenses and probate fees

►    debts including a mortgage on the family residence

►    the costs of post-secondary education

►    income taxes upon death

There may be other capital requirements.

Those who are retired or approaching retirement often become very concerned about paying income taxes in the year of death of a single person or the year of death of the last of a married couple. Many seniors purchase life insurance to provide funds to pay these income taxes after their death. Ultimately, there is no way to avoid the taxes, but simply a choice of paying the income taxes upon death or paying life insurance premiums every year until death.

There are principally 2 types of insurance products; Term Life Insurance, Permanent Life Insurance. Briefly, here are the characteristics of each:

Term Life Insurance

Term insurance is temporary, and good for covering short and mid term risks, such as dependents and debts. Term Life Insurance provides protection against financial loss resulting from death during a specified period of time or term. The policy only pays if the insured dies within the given period named in the policy. The period of coverage is usually 1 year, 5 years, 10 years, or 20 years, or until a specific age such as age 65. At the end of the period, the protection ceases unless the policy is renewed. As one ages, the risk of death increases and the premiums for term insurance increase accordingly.

Many Term Life policies contain a renewable clause that gives the policy-owner the option to renewing the policy for some predetermined period of time without a medical examination, usually at a higher rate of premium. Some policies have a conversion clause that give the policy-owner the option to convert the term insurance to a form of permanent insurance without a medical examination or other evidence on insurability.

Permanent Life Insurance

Unlike Term Life insurance coverage usually ending at the insured's age of 65 to 75, Permanent life insurance provides coverage for the life of the insured. There are three forms of permanent insurance: Whole Life, Term-100 and Universal Life.

Whole Life Insurance provides protection for the whole of the insured's life. Whole Life Insurance has a fixed annual or monthly premium that is payable for the entire lifetime of the insured. Premiums can be paid on a continuous payment basis over the insured's life or on any limited basis, such as a single payment or annually for 10 years. With Whole Life policies the premium rate is established at the time the policy is purchased and is guaranteed not to increase for the life of the contract. A Whole Life policy is not considered a capital property, like a stock or bond or building. Nevertheless, it is an asset and it does have a value, as measured by its cash surrender value. Investment income is earned on the accumulating fund that created this value.

The general principle in determining the taxation of the death benefit of life insurance policies is that the premiums paid for individual life insurance are not allowed as a tax deduction, or tax credit, and the proceeds from the death benefit are not taxable.

Term-100 Insurance is a form of permanent insurance that matures when the insured reaches 100 or dies, whichever come first. Unlike Whole Life Insurance, Term-100 does not usually build up any cash surrender value, has no loan value, is not participating and does not pay dividends. As a result, the premiums for Term-100 are lower that the premiums for Whole Life. Term 100 can be issued as a joint life or last to die policy. It is often purchased on a joint life basis with benefits payable on the last death, in order to pay income taxes on registered plans and capital gains. 

Universal Life Insurance The primary attraction of a Universal Life policy lies with its flexibility. Traditional life insurance polices were bundled meaning that, with the exception of dividends on participating plans, all the cash and coverage elements of the plan were inextricably tied to each other. The premium and cash surrender value were a function of the initial face amount and all were established at policy issue and could be predetermined for the life of the policy.

Universal Life on the other hand, unbundled these elements from each other and created the leading edge in life insurance flexibility. A Universal Life policy allows the policy-owner to:   

►    increase or decrease the face amount of insurance.

►    add additional lives insured.

►    substitute one life insured for another.

►    pay the cost of insurance based upon yearly term or level term rates.

►    have a guaranteed or variable cost of insurance.

►    had an accumulating fund plus other accounts

►    have a guaranteed or variable investment return on the accumulating fund and other accounts.

►    make any amount of contributions, as long as there is a minimum cash value.

Some policies do not offer all of these options.

Unlike traditional plans, where the policy account value was invested in a portfolio by the insurance company investment managers, Universal Life offer the policy-owner the option to choose the weighting of investments within the account from a wide range of options, including:

►    savings accounts.

►    guaranteed term deposits.

►    funds that track specific market indices.

►    mutual funds.

The use of the investment account is not limited to funding the death benefit. This investment component or cash surrender value (CSV) can be withdrawn, providing funds to supplement retirement income or for emergency situations. However, access to the investment fund through surrender or policy loans results in a disposition for tax purposes which may mean tax consequences to the insured.

An alternative and perhaps more effective method of accessing the CSV of an insurance policy- is by using it as security for a bank loan. Because this is not a policy loan, there are no immediate tax consequences. This loan can be used for any- purpose, including as a means to provide regular cash flow on retirement. If used for business or investment purposes, the related interest is likely tax-deductible. To provide a supplementary retirement stream, the policy's CSV could secure a bank line of credit. The insured could then draw on the line of credit at regular intervals or as needed and the agreement could be structured such that no repayments would be required until death, at which time a portion of the tax-free death benefit would be used to repay the loan. If the debt load exceeds the security limit, premature repayment could be required and where cash is limited, this may mean surrender of the policy, which could result in significant tax liability.

These products are complex and vary widely from insurer to insurer. Don't try to do this on your own. Ask a professional well-versed in Universal Life insurance to guide you.

The information contained in this commentary is designed to provide you with general information only, and is not intended to be comprehensive advice applicable to the circumstances of any individual. We strongly urge you to seek professional assistance before acting upon information included herein.