Today I want to discuss a product that is heavily marketed and most people, especially immigrants fall for because of the way it is packaged, and the pressure tactics employed by the salespeople that sell this product. They claim it’s a tactic used by the wealthy. But is it really a good investment? The short answer is NO.
Key Takeaway:
I have a simple rule of thumb: don’t mix insurance and investment. It is much better (cheaper) to buy a low-cost term life insurance coverage and invest the difference in a good growth ETF or mutual fund.
Purpose of Life Insurance:
The primary purpose of life insurance is to replace your income if you pass away, ensuring your loved ones are financially secure. Term life insurance is effective for this purpose, providing a payout if you die during the policy term at a reasonable cost. In contrast, whole life or cash value insurance, which combines insurance with an investment component, is more expensive and often provides poor returns.
Types of Whole Life Policies:
Whole life policies come in various forms, including basic whole life, universal life, variable universal life, and indexed universal life. These policies involve paying premiums, part of which goes into a tax-deferred investment account. However, withdrawing or borrowing from this account can reduce the death benefit and may incur taxes. Overall, using life insurance as an investment strategy is generally not recommended due to its high costs and low returns.
Universal life insurance combines lifelong coverage with tax-advantaged investment components. Here’s an overview:
- You select an initial death benefit amount (e.g., $1 million).
- A portion of your premium covers pure insurance costs.
- The remainder goes into a cash value account within your policy, which grows tax-deferred.
- You earn variable interest based on selected investments.
- The death benefit and cash value are adjustable.
- You can access funds via loans or withdrawals.
Pros:
- Lifelong coverage: Remains active if premiums are paid.
- Tax-deferred savings: Cash value grows tax-deferred.
- Adjustable premiums: Payments can be raised, lowered, or skipped.
- Loans and withdrawals: Access cash value when needed.
- Market participation: Investments provide upside potential.
Cons:
- Cost: More expensive than term life insurance.
- Investment risk: Potential for cash value losses.
- Complexity: Many moving parts to manage.
- Lapse risk: Underfunding can cause loss of coverage.
- Surrender penalties: Fees for early cancellation.
- Tax implications: Loans and withdrawals may be taxable.
Who is Universal Life Insurance Good For?
- High net worth Canadians: If you have maxed out all your registered tax-deferral accounts (e.g., TFSAs, RRSPs), then you can consider universal life for additional perks.
- Business owners: Useful for buy-sell agreements or partner compensation.
- Those with lifelong dependents: Ensures care for special needs children.
- Advanced estate planning: Creates a growing, income tax-free legacy for heirs.
Why Life Insurance is a Bad Investment
- Poor Investment Returns: Insurance companies often invest in low-performing assets and take a significant portion of the profits through fees.
- High Fees: These include premium payments, surrender charges, and ongoing management fees, which reduce your overall returns.
- Policy Lapse Risk: If your cash account doesn’t have enough funds to cover policy fees, your coverage could lapse.
- Tax-Deferred Earnings: While tax-deferred earnings can be beneficial, there are better investment options like Roth IRAs or Roth 401(k)s that offer higher returns and more control.
- Massive Premiums: Whole life policies are much more expensive than term life policies. Investing the difference in a good mutual fund can yield significantly higher returns.
My opinion:
Mixing insurance and investment is complicated and in most cases a disaster waiting to happen. They are expensive to maintain, so they are usually only beneficial for high-net-worth individuals. If you lost your job and could no longer afford it, you risk losing all your previous premiums and contributions.
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