Consider Life Insurance as an Investment This Year
This year, try thinking ‘outside of the bank’ for your New Year’s Resolutions. Consider using a whole life insurance policy as a long-term investment.
New Year’s Newsflash: When it comes to keeping our yearly resolutions, we humans don’t score very high. In fact, if we’re anything like our American counterparts, about 80% of Canadians will not be keeping our 2024 resolutions beyond the first three months (source).
So what does that mean for people who are resolving to save money to fund important life milestones, like a new addition to the family… or even retirement?
With soaring prices and online retailers tempting us at all hours of the day, saving money can often feel like an impossible feat. And for many people, shopping is an activity that sparks joy – in the moment, anyway. If you’ve ever suffered from buyer’s remorse after a spontaneous purchase, you know what we’re talking about.
So when it comes to quitting habits we don’t necessarily want to quit – cutting out chocolate, for example – sometimes it’s as simple as playing a trick on ourselves. We hide our chocolates in the highest cupboard – or, even better, we don’t buy them at all. Out of sight, out of mind, we tell ourselves.
The same type of trickery could be useful when it comes to saving money. In fact, there’s concept called forced savings that literally makes it impossible for us to access our hard-earned dollars if we find ourselves in the middle of a late-night Amazon shopping spree. Like the chocolates that are just out of our reach, our money becomes untouchable if we do things right.
Force yourself to save with “forced savings”
So what is forced savings? It’s the idea of putting your money into an account where you are unable to access it, no matter what. And while many of us place our money in a typical Savings account at the bank with the intention of leaving it there to grow, there are two problems with this scenario:
- Your money is still readily available; and
- The interest you’re making is peanuts.
Time to think outside of the bank: Life insurance as a long-term investment
For many Canadians, the idea of using a whole life insurance policy as a long-term investment is an alien concept. But in reality, it’s an incredibly efficient way to save and grow your money – and that’s in addition to its primary purpose (i.e., ensuring your loved ones are taken care of financially after you’re gone). How it differs from a long-term investment at the bank is as follows:
- It’s a safe, low-risk way to grow your money quite significantly over time.
- If you die, the money (any earnings + the coverage amount you signed up for) goes to your loved ones, tax-free.
So how does this work? There are three pieces of a participating whole life policy that come together to create an ideal investment scenario for many Canadians, and we’re about to explain them to you – so read on!
1. Cash Value
The cash value is a portion of a whole life insurance policy that is guaranteed to grow at a fixed interest rate each year until it is equal to the coverage amount of the policy, typically at age 100. Any earnings are tax-deferred while the funds remain inside the policy. That means no yearly T5 slips and no impact on the money you owe to the CRA!
2. Dividends¹
Unlike the cash value portion of a whole life insurance policy, the earnings are based on the performance of the organization’s financials as well as a number of things outside of the organization’s control. For that reason, dividend earnings can go up or down each year. Any earnings are also tax-deferred.
3. Total Cash Value (cash value + dividends)
Think of your total cash value as the output of a nicely balanced portfolio. Your cash value is a safe investment that is guaranteed to grow slowly over time. While your dividends are higher risk, they can have a more significant financial impact over the long run.
The secret to making your money grow more quickly
In most cases, the cash value on a whole life insurance policy doesn’t begin to accrue for the first two to five years. Why? Because life insurers generally invest a portion of your payments into low risk-investments, where growth is initially slow. As you continue to make payments on your policy and earn more interest, the cash value continues to get bigger over the years.
That said, there is a secret to making your money grow more quickly within a participating whole life insurance policy: Paid-Up Additions (PUA). That’s right, with PUA, you can start earning money in your very first year.
What are Paid-Up Additions (PUA), and how do they work?
As a policyowner, you can use PUA to buy yourself an extra layer of coverage that is “paid up.” In other words, this extra insurance won’t cost you extra. Why? Because your dividends are paying for it. But the good news doesn’t end there. The financial benefit is three-fold: (1) your death benefit increases, (2) your payments will never go up, and (3) the cash value increases considerably and at a faster rate. And you won’t have to undergo additional medical underwriting for your additional coverage!
Over time, the PUA will have a compound effect (i.e., you’ll be earning interest on your interest), which helps speeds up growth even more.
Accessing your earnings
When you do finally need the money, you can dip into your total cash value in one of three ways. Keep in mind that accessing the money can impact your policy; always discuss your options with an advisor you trust before moving forward. We’ve listed the options and their impacts below (in order of smallest to greatest) for your consideration.
1. Dip into the cash value via a withdrawal². Impact: Small.
This will reduce your death benefit by the amount you withdraw from the accumulated cash value in your policy. While this will impact your beneficiaries in the sense that they will not benefit from your policy’s growth, the initial coverage you signed up for is guaranteed. So it’s kind of win-win. You can benefit from the cash value while you’re living, and your loved ones will get the guaranteed death benefit when you’re gone. Also, if the amount you withdraw is less than what you’ve paid into the policy, you may not have to pay income tax. Another win!
2. Take out a loan³. Impact: Medium.
As with any loan, you will need to pay this back – unless you’re comfortable knowing the amount (plus interest) will be deducted from the death benefit your loved ones will receive. Another thing to keep in mind? If you haven’t paid the loan back, and the interest you’re accumulating is higher than the dividends you are earning, your policy could lapse. Remember, that interest has a snowball effect over time. If you do plan to pay the loan back, you can do so at your own pace and on your own time. But keep in mind, the quicker you pay off a loan, the less interest you will owe.
3. Cancel the policy. Impact: Large.
The technical name for this is a full surrender⁴. In this scenario, you will no longer have life insurance coverage in place in the event of your death, leaving your loved ones in a financially precarious situation when the time comes. Note that you may be charged a “surrender fee,” plus any unpaid premiums or outstanding loan balances, if any. Not to mention, if the amount you receive includes interest or investment gains, that portion will be taxed. (Note that you also have the option of a partial surrender⁴, which will reduce the value of the death benefit by the amount you’ve withdrawn.)
Back to your New Year’s resolution
If your New Year’s resolution revolves around saving a certain sum of money with a future goal in mind (e.g., supplementing retirement), using a whole life insurance policy as an investment is a smart way to trick yourself into saving for the long term.
Want to be one of the 20% who actually stick with their resolutions this year? Get in touch with your Serenia Life advisor to talk about how you can use life insurance as an investment. Don’t have an advisor? Fill out this short form to get the ball rolling.
¹ Dividends are not guaranteed and are paid based on the overall experience of Serenia Life Financial, considering all risk factors. Dividends may be subject to taxation. Dividends will vary based on the actual investment returns in the participating account as well as mortality, expenses, taxes, lapses, withdrawals, and other experience of the participating block of policies. These factors have the potential to increase the value of your policy above the guaranteed amount, depending on the dividend option selected.
² Policy withdrawal is an option to withdraw money from the accumulated cash value of the policy if Paid-up Additions or Accumulated Dividends is the selected dividend option. Withdrawals reduce the total cash value, affects future growth, and reduces the death benefit. If the withdrawal is only up to the amount that is paid in premiums (known as the adjusted cost basis), there won’t be taxes. Otherwise, there would be taxes on the portion that is more than the adjusted cost basis.
³ Policy loan is an easy way to access the accumulated cash value of the policy. A variable interest is charged on the amount borrowed. This may result in taxable consequences. Loan can be repaid at any time. Upon death and the loan is unpaid, the outstanding balance including any accumulated interest will be deducted from the total death benefit, with the remainder paid tax free to the beneficiary(ies).
⁴ Policy surrender can either be partial or full surrender of the cash value of the policy. A partial surrender will reduce the value of the policy. A full surrender means cancelling the policy and receiving the cash value less any surrender fees. Beneficiaries won’t receive any death benefit upon full surrender. There may be tax on the amount received that is above the adjusted cost basis.
