Permanent Life Insurance

This is a guest post by Robert, who lives in Calgary and worked as a financial adviser before retiring at age 35. He is married, has three kids and has returned to school with the goal of eventually living and working overseas. My excuse for posting this late in the day is that it’s a holiday. Happy Heritage Day, everyone!

Why does a person need life insurance? Mainly, to replace income in the case of premature death. This need exists during the person’s working years, but ends at retirement. When I retire, I no longer need to work for an income, so my family will have an income whether I’m living or not (although that’s not something I remind them of). That’s the reason I only sold temporary insurance, and it’s the reason that I cancelled my life and disability policies when I quit work.
So, if the insurance isn’t to address the risk of premature death, what else can it be used for? Just asking this question underlines the fact that it’s no longer really insurance, since it’s not insuring against loss. So let’s look at how permanent insurance works. Most present-day policies are made up of two portions: insurance (which becomes increasingly expensive as you age) and investments (which become increasingly valuable, if the market cooperates). The investment growth is intended to cover the cost of insurance over time.
But back to the question. What else could the policy be used for? If the insurance is no longer needed, the investments could be used. Here we find another big issue with permanent insurance. First, the investments are rarely a good idea. Most insurance is conservative and holds bonds, but the client has the choice to choose mutual funds (or seg funds) within the policy. These are more expensive to own than retail investment funds or direct stock ownership. They also don’t guarantee that the policy will retain its value, given that “cost of insurance” withdrawals during market crashes will quickly eat away at market value. And it’s not possible to withdraw the value of the investments. As the author pointed out, you could take out an offsetting loan. But financially, that would be silly. First, taking a loan against the investment increases the risk (despite the author trying to suggest the opposite). Second, I would have to pay somewhere between 2.5% and 3.5% for a loan right now (I think), but long-term bonds are yielding only 1.5% to 2.5%.
Finally, the author suggests that you could spend more of your other investments, knowing that your family will receive the insurance income at your death, needing none of your investments. I have two problems with this. First, many of my clients either wanted to spend their last penny the day they die, or pointed out that their kids were financial more successful than they were. In most cases, there was little desire to leave a huge inheritance. And spending down your capital (because you know there’s insurance for your family) suffers from the same problem as trying to spend your last penny the day you die: we don’t know when we’ll die.
My conclusion is that a person who took the author’s advice would produce a huge commission for the salesperson, but (potentially) get themselves in big financial trouble. The only benefit to the advice to buy permanent insurance is that, like a mortgage and CPP, it is a forced savings plan. Worst case, they’ll spend down their capital, borrow against their home and spend down their equity and end up with no way to support themselves (except CPP!) in their old age. It will be little comfort (and potentially worse) knowing that their spouse stands to inherit a large sum on their death.
My advice: what permanent insurance is really good for is planned giving. If I wanted to bequeath $1 million to the Church’s perpetual education fund on my death (or to a museum or art gallery or anything else that produces a charitable receipt), I can buy a permanent life insurance policy (if I’m in good health) and name the charity as the beneficiary. Every month that I pay my insurance premium, I get a charitable receipt for tax purposes. Then, at death, the entire amount passes outside of my estate (quick, cheap and tax-fee) to the charity.