Highlighting the difference between Term, and Whole-Life InsuranceMay 22, 2020
Article written by:
Rob Lamka, CPA, CA
The Targeted Strategies Group
Many Canadians would consider David Chilton, author of The Wealthy Barber and former panelist on Dragon’s Den, one of the most influential financial advisors of all time. I remember reading his first book, highlighter in hand, taking in much of what I believe remains to be sound and practical financial advice.
However, in the world of financial planning—where complexity and confusion often rule the day—there is very rarely one right answer that applies to all situations and objectives.
One of Mr. Chilton’s key tenets, as part of a wealth-building strategy, is to buy term insurance rather than “costlier” whole-life, or permanent insurance. I followed this advice for years. But now, I wish I hadn’t.
TOO GOOD TO BE TRUE?
In my role as a tax advisor to high net-worth clients, for over 25 years, I have met more financial planners than I can count. Most of them recommended some form of permanent insurance for my clients. They would present tables full of impressive numbers and forecast phenomenal results but most of the hard questions went unanswered. Many clients did not purchase insurance, even though most of them had a need.
I finally “caved” and bought a whole-life policy myself when I could no longer ignore the math. Some participating policies yield a dividend of 6.25%. “6.25%?!”; “Guaranteed?!”; “In a tax-sheltered investment?”; “Really?!” As I explain to my clients, yes, really. However, calling the yield in the policy a “dividend” is a bit misleading. The return in a whole-life policy is not a dividend in the way most people think of dividends.
HOW PAR POLICIES WORK
Owners of whole-life policies offered by Canadian insurance companies participate in the insurers’ PAR (for participating) funds. These funds purchase conservative investments including equities, fixed income products and real estate. Therein lies the confusion. In today’s investing environment, conservative and 6.25% are rarely found in the same sentence.
In reality, the performance of the investment portfolio of the PAR funds is only one component of the dividend formula the insurers use.
Insurance companies tend to use very conservative assumptions with respect to mortality rates and lapse rates when they price their insurance products. When the ‘gains’ from improved mortality, lapses, etc. are realized, they are shared with PAR policy owners. This, along with ROI of the portfolio, support the dividend yield in the policies.
The dividend yield is tax-free within the policy and each insurance company provides several alternatives on how the dividend is treated – from purchasing additional insurance coverage, to being paid out in cash.
BUT DO I NEED INSURANCE AT ALL?
Mr. Chilton’s advice on buying “cheap” term insurance is based on the short-term need for insurance, as people build wealth. Once wealth is amassed and the need for insurance decreases, there is little concern about the increasing cost of term insurance as you age. That is a well-reasoned position. However, for many, there are insurance needs that do not go away. These will likely increase, as you accumulate wealth. From estate tax liabilities to buy/sell needs and philanthropy, there are many reasons for permanent insurance.
Personally, my primary need for insurance was short-term protection for my family. Mr. Chilton’s advice served me well, for that specific need. However, one of my objectives is to leave some level of estate for my family. Whole-life insurance provides a mechanism to meet my short-term insurance needs and my longer-term objectives in a very efficient and effective manner. That is why I bought a whole-life policy, and that is advice I wish I had received much, much earlier.
WHAT TO DO NEXT?
Tax, estate and financial planning are complex areas in which one-size-fits-all solutions do not exist. The only good advice is to work with trusted advisors who understand your true needs and objectives. Advisors is plural, intentionally. There are many different specialties involved, and one advisor may not have a deep understanding of them all.
How do you know if you are getting good advice? Albert Einstein famously said, “If you can’t explain it simply, you do not understand it well enough.” The right advisor is patient and provides clear, concise explanations and answers to your questions, ensuring that you have a full understanding of the pros, cons and risks of any plan. And they won’t mind if you bring your highlighter.
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