Last time we took a look at term life insurance and its most common applications. The other major type of life insurance is permanent life insurance. This week’s post looks at permanent life insurance and its 5 most common uses.
1. Pay off final expenses
Similar to term insurance, permanent life insurance can be put in place to pay for final expenses such as funeral costs, final medical bills and tax return. A big part of the tax you pay comes from your RRSPs and RRIFs, which is fully taxed on the second of you and your spouse’s death. Capital gains tax on your investments and properties also have to be paid before they are passed on to your beneficiaries. The tax bill on these accounts and gains may be very significant, and for some people could be hundreds of thousands of dollars!
As the average Canadian lives until his late 70’s to early 80’s, your term insurance policy is likely to have been cancelled by this time. Therefore, permanent insurance is more suitable for paying off these final expenses. In fact, a joint last-to-die permanent life insurance policy is designed for this specific use case. It is a policy based on two lives, and pays out a death benefit only after the second person has passed away.
2. Investment and insurance hybrid
A unique feature of certain permanent insurance such as universal life and participating whole life (also known as par) is that there is an insurance portion as well as an investment portion. Part of the premium paid in a par policy is invested by the insurance company in a conservative portfolio, where dividends earned are credited to the policy and can grow in a tax-sheltered environment, similar to an RRSP. Years down the road when money is needed, the cash value can be withdrawn (tax may be applicable on withdrawal).
Universal life insurance provides more flexibility by allowing you to deposit above and beyond the minimum amount required for the cost of insurance up to a certain amount, allocating the excess into an investment account. There is more choice in the investments such as different funds or an interest account, all of which grow tax-sheltered.
Because of the tax treatment of these permanent policies, they provide a good supplement for people who have maxed out their RRSPs and TFSAs.
3. Leave a legacy
For some people, this is an important thing for them. Whether they leave it for their grandchildren, their church or gift it to a favourite charity, permanent life insurance is a way of leaving a large sum of money when they have no other means of doing so.
4. Estate equalization
If a business owner is planning to leave the business to one of his child because the other children aren’t involved in the business, he can use permanent insurance that matches the value of the business to ensure all his children are treated equally and fairly.
Estate equalization doesn’t just apply to business owners. Maybe a child is living with the parent and the parent want to leave the home to this child to continue living there after the parent passes away. In this case, a permanent insurance policy can be used to equalize the estate for other children.
5. Business applications
Just like with term insurance, permanent insurance is a way of funding buy-sell agreements and providing key person coverage. Buy-sell agreements ensures business succession transfers smoothly by letting the remaining partner use the proceeds to purchase the shares of the deceased, while key person insurance compensates the business for the financial loss that would arise if a key person in the company was to die.
Now that you know the most common uses of term and permanent life insurance, next time we’ll pit the two against each other and see which one comes out on top. For more information on permanent life insurance, please be sure to visit its page for its basic description.
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