Can Life Insurance Ever Be a Bad Investment?

Life insurance is, understandably, on many people’s minds these days. But making sense of the different types of policies available – term, whole and universal – can be confusing. For instance, some readers may be unaware that universal life insurance in Canada can be used as an investment vehicle and has a cash value that you can borrow against or withdraw.

To help you decide which type of life insurance you should be looking at, or if it might just be a waste of money in your situation, check out this helpful guide.

Do I Need Life Insurance in Canada?

Unlike car insurance, life insurance is not a requirement in Canada. In fact, unless you have dependents, like a spouse or children who rely on your income and would struggle without it, you probably don’t need life insurance. That’s because life insurance is meant to provide financial assistance to the loved ones you leave behind when you die.

Having said that, life insurance is easier to get and costs less when you are young and healthy. So, it may be worth looking into even if you are currently single and expect to be married and/or foresee kids in the future.

Which Type of Life Insurance is Best For Me?

First, decide on how much coverage you need, or whatever amount your dependents may need over the years without your income. Then, consider the type of insurance:

• Term life insurance with policies that last anywhere from 5 to 30 years. If you do not die during the period of coverage, or you cancel your coverage, no death benefit will be paid and the policy holds no cash value.

• Permanent life insurance, including whole life and universal life, which lasts for as long as you live, assuming you pay your monthly premiums. The policy has a cash value that builds up over time, and you can use this cash value as collateral on a loan or you may receive it as a payout if you decide to cancel the policy. It’s more like a long-term investment.

Generally, the longer your period of coverage is the higher your premiums. For most people, term life insurance is the best option because it is more affordable than other types.

For example, let’s say you are a 35-year-old non-smoker of average health with young children and 20 years left on your mortgage amortization. You might want life insurance coverage for at least two decades so your family will have enough money to cover the mortgage and post-secondary education if you die in the interim.

Let’s compare the cost for $750,000 of coverage in a 20-year term policy versus a permanent life insurance policy.

The premiums listed above are averages. Men pay slightly more since their life expectancies are shorter.

At more than 10 times the cost, permanent life insurance is simply out of the question for the majority of Canadian families, especially those in their high-expense years – paying a mortgage, daycare costs and/or saving for post-secondary education and retirement.

Permanent Life Insurance vs. Long-Term Investments

Is permanent life insurance a good investment? It depends on your circumstances and budget.

In general, most Canadian families who have an extra $400 per month in their budgets should first look to invest that money in a registered account such as a TFSA, RRSP, or RESP. These days, you don’t even need a financial advisor to start investing, thanks to the rise of low-cost online brokerages like Questrade and Wealthsimple Trade, both of which offer free ETF purchases. Here’s an excellent reason to sign-up: those who open a Wealthsimple Trade account will get a $25 cash bonus + $0 commission trades. All you have to do is fund at least $150. Plus, Wealthsimple Trade will reimburse an outgoing administrative transfer fee of up to $150 on investment account transfers valued at more than $5,000.

For a hands-off approach, you could also use a robo advisor like Wealthsimple, which will build you a personalized investment portfolio tailored to your risk tolerance and financial goals. Either way, you’ll save a bundle on fees going this route and you can invest whatever amount suits your budget. Plus, you can take advantage of our exclusive promo offer: open and fund your first Wealthsimple Invest account (min. $500 initial deposit), and get a $25 cash bonus deposited into your account.

If, however, a family has maxed out all their combined contribution room to available registered accounts, permanent life insurance can be an attractive alternative to non-registered investments. If you buy permanent life insurance, a portion of your premium is invested, which is called the cash value. How those funds are invested and whether or not you benefit depends on the type of permanent life insurance you have.

• Whole Life: The insurance company chooses how to invest the cash value portion of your premiums, and most of the time it keeps the proceeds earned on those investments. This is called a non-participating whole life policy. If, however, you buy a pricier participating whole life policy, the insurance company will share dividends with you when the investments they chose perform well. Either way, you cannot lose your original cash value contributions, and any dividend payments are sheltered from income tax.

• Universal Life: With this type of permanent life insurance, you get to choose from an array of investments. As is the case with any other investment portfolio, the cash value of those investments can go up or down, depending on how they perform on the market. Similar to registered accounts, any income earned on investments held within a universal life policy can accumulate and compound tax-free unless they are withdrawn.

If you have no intention of ever withdrawing money from a universal life insurance policy and expect to leave the cash value within it to your beneficiaries as part of the death benefit, then the investment income will never be taxed (since death benefit payments are tax-free in Canada). In that case, you may do best with a universal life policy compared to non-registered investments, especially if you are in a high-income-tax bracket. But given the cost of permanent life insurance, your best bet is to first start investing and take advantage of the tax-sheltered registered accounts (TFSAs, RRSPs, or RESPs).

The Best Life Insurance Companies in Canada

There are dozens of insurance providers in Canada that can sell you a life insurance policy. To find the best rates, consider using an online platform that lets you easily compare premiums from a variety of providers at the same time. Some of these online services, like InsuranceHotline.com, will then refer you to a licensed broker or an individual insurance provider to complete your purchase once you have decided on a policy. Others, such as PolicyAdvisor Life Insurance and PolicyMe (which went from broker to offering its product directly), use an online application process to simplify your purchase even further.

When looking at term life insurance, find out if your premiums are guaranteed or if they could increase, whether the policy is renewable at the end of the term or if you must reapply, and if there’s any possibility of converting the policy to a permanent one. These are important questions to ask because you may have a difficult time being approved for coverage as you age or if your health deteriorates. Read more about The Best Life Insurance Companies in Canada.

FAQs

Is Life Insurance Taxable in Canada?

So long as the beneficiary named in the policy is someone other than the deceased’s estate, all proceeds of life insurance are paid out tax-free—including any investment income earned in a universal or whole life policy.

Do I Need to Take a Blood Test?

Usually, blood and urine tests are mandatory for policies of $1 million or more. However, most providers reduced the need for medical samples to facilitate access to life insurance during the coronavirus crisis.

What Happens If I Lie About Something (Like Smoking) To Get a Better Insurance Rate?

Don’t do this. If the insurance company finds out you were not honest about anything on your application, it may legally refuse to pay the death benefit to your beneficiaries. In other words, all the premiums you paid would have been for nothing.

What If I Can’t Afford the Premiums for the Coverage I Need?

It’s always best to buy whatever coverage you can afford since some financial aid for your loved ones is preferable to having none. If you buy a policy that’s more than you can realistically afford, you might end up defaulting on it. That could make it harder and more costly to obtain life insurance in the future.

The Final Word

While the investment tax advantages offered by universal life insurance in Canada may only benefit the wealthiest among us, most families would be wise to have at least some term life insurance. Contact various providers or use online platforms to find out how much your premiums would be for various coverage amounts and terms. Don’t forget to ask if the policy is renewable or convertible.

If you’ve maxed out all available contribution room in your registered investments, you might do best with universal life insurance compared with non-registered investments.

Lastly, if you don’t already have a will, consider using a Canadian provider such as Willful to create a legal online will. Using Willful, it takes as little as 20 minutes and costs as little as $99 to make a legal will. Plus, sign up using our exclusive link and get 10% off any Willful plan. It’s money well spent: if you die without a will, it could take the courts months or even years to decide what happens to your assets. Read more about why you need a will.