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Permanent Life Insurance Explained: How It Works

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What Is Permanent Life Insurance?

Life insurance is a financial product that aims to safeguard your household’s financial security in the event of the life-insured’s death.

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Permanent life insurance is a type of life insurance that provides lifetime financial protection to your loved ones. This means that the life insurance you buy is “in effect” for the rest of your life, as long as you pay your premiums or the policy is considered “paid-up”. 

In other words, there’s no expiry date on this policy. This is what makes life insurance “permanent”. When you eventually pass away at any point in your lifetime, your permanent life insurance makes the death benefit payment to your beneficiaries. Depending on how it’s designed, the death benefit either remains constant or increases over time, while premiums typically remain the same.

Compared to term life insurance, permanent life insurance, such as a whole life insurance policy also allows you to build equity or wealth inside the policy much like you would when you purchase a home, this is made possible through the policy’s cash value component, which is either invested in market portfolios (universal life), or left to earn policy dividends, 

includes savings or an investment component that allows you to grow your money tax-deferred from within your policy. The growth of this money may increase the death benefit payout, depending on how it’s designed.

Main Components of Permanent Life Insurance:

  1. Premiums, typically, premiums are level for most permanent insurance plans, except in certain cases when minimum contributions are made into universal insurance with a YRT or yearly renewable term cost.
  2. Death benefit, which is the amount that is paid to your beneficiaries upon your death. The death benefit is the primary purpose of permanent insurance plans, which may or may not increase depending on how the policy is structured.
  3. Cash values or underlying investment is a unique component of permanent life insurance and isn’t available in term insurance policies.

2 Types of Permanent Life Insurance Coverage:

Generally, there are two flavors of permanent life insurance:

  1. Whole Life, and
  2. Universal Life

Whole life insurance

Whole life insurance is the purest form of permanent insurance. It typically has a higher cost upfront and offers guaranteed cash values.

The most common type of permanent life insurance is whole life. It is designed to provide coverage and savings for the insured person’s lifetime. It combines a death benefit with a savings portion, which can grow at a guaranteed rate that is fixed when the policy is purchased. Whole-life policies are typically more expensive than term policies because they promise both a death benefit, guaranteed cash values, and equity accumulation through policy dividends.

The amount of premiums are guaranteed and will never increase while the face value increases over time.

In most instances, you can either pay it off in 15, 20-years, or for the rest of your life, in which case you have to keep on making your premiums to avoid losing benefit.

The investment element of a whole life policy is referred to as a cash value or cash surrender value which serves as an account that holds excess premium payments. This cash value can be borrowed, collateralized with a bank, or withdrawn in part or in full in the event of an emergency or when you feel that you no longer need the coverage.

Universal Life Insurance

Universal life insurance is considered permanent life insurance but has different premium structures, variable rates of return, and can behave like a term policy if not well-funded.

Universal life insurance is often considered less expensive because it does not offer guarantees, unlike whole life policies.

Instead of earning guaranteed cash values and dividends, the premiums are invested in market portfolios, much like how mutual funds are, and earn tax-free compounding returns based on market performance, and aren’t guaranteed.

Any agent or advisor promising guaranteed returns either in a universal life policy (IRP) or investments isn’t acting toward your best interest as a client.

Like any other assets reliant on market returns, the rate of return in universal life insurance policies may vary due to market fluctuation.

Similarly, you can borrow, withdraw or collateralize your universal life insurance equity in case of emergency or supplement your retirement funds.

When properly structured, you can build your entire retirement plan out of a universal life policy through the insured retirement plan concept.

Take note that universal life policies have a flexible premium structure, and if you’re only contributing the minimum premiums required or a bit higher premium than the minimum, it can be much like term insurance. When properly funded, however, it can be a great wealth accumulation vehicle or designed as a 20-pay or life-pay permanent insurance.

How Does Permanent Life Insurance Work

how permanent life insurance work

There are several factors that make permanent life insurance attractive to those who understand who it works and appreciates its benefits.

  1. Level Premium Contributions
  2. Cash Value or Investment Component
  3. Lifetime Death Benefit Coverage
  4. Tax-free or Tax-Deferred Asset Accumulation
  5. Increasing Death Benefit

Level Premium Contribution

When you purchase a permanent life policy, your premium contributions typically don’t increase over time. Unlike term life insurance where your premiums are expected to increase each time you renew your policy.

Depending on the type of permanent insurance, your premiums either earn dividends, purchases additional death benefits, or are invested in the market.

Cash Value or Investment Component

One of the most attractive aspects of permanent life is its cash value component.

This helps you build up equity over time and not waste money on life insurance premiums.

The cash value of a permanent life insurance policy may continue to increase until the insured’s death is maintained according to plan.

I always compare the purchase of permanent insurance policies to purchasing real estate.

As an asset class, your monthly contributions help you build equity over time, which you can use later on to either supplement your retirement income or to fully retire on, depending on how much you’ve built inside your policy.

These savings accumulate over time and are not usually impacted by factors such as market conditions (whole life), as they are with mutual funds, and similar investments.

Permanent policies may provide the insured with an income during his or her lifetime and a tax-free lump sum payout

Lifetime Death Benefit

Life insurance is an effective financial risk management solution, and most people implement one for the tax-free death benefit that their beneficiaries will receive in the event of their death.

All life insurance policies would pay out a death benefit, but as long as you do your part of your life insurance policy, your permanent life insurance is guaranteed to pay out the death benefit as long as it remains in force.

The problem seniors encounter with their term life insurance is that they often outlive their term coverage. Mind you, renewing your term life insurance at 70-year old is quite expensive for most retirees, and sadly, they have to let go of their coverage. This is because your premiums are underwritten at your attained age at renewal.

If you outlive your coverage, then there is no death benefit payout. However, if you die while the policy is still in force, then a tax-free sum of money (usually up to 20 to 30 times the amount of your premiums) is paid to your beneficiaries.

Tax-free or Tax-Deferred Asset Accumulation

In Canada, you have a couple of registered investment options that allow you to grow money tax-deferred or tax-free.

You may have heard of the Tax-Free Savings Account (TFSA), and the Registered Retirement Savings Plan (RRSP).

Both allow you to take advantage of compounded asset accumulation, however, if you’re looking for a permanent life insurance policy. A participating whole life policy or a universal life policy can help you have the same feature, without of course the tax credit that the CRA rewards you from contributing to your RRSP but your asset can accumulate tax-free inside our policy, all the while having the life insurance protection.

There’s not much flexibility as to where you can invest your premiums with a whole life policy, the important thing to keep in mind is to purchase a participating policy from a mutual company so your policy earns dividends on top of your guaranteed cash values.

In the case of universal life insurance, the premium contribution can be invested in a variety of funds, including:

a) Stock market portfolios

b) Municipal bonds or government securities, and

c) Guaranteed investment certificates (GICs)

If you’re risk-averse, I suggest that you go with a participating whole life policy.

Increasing Death Benefit

The death benefit with most permanent life insurance policies typically increases over time.

So, the older you get, the higher the death benefit that your beneficiaries will receive.

This effect is typically observed in participating whole life policies that are paid up in 20-years, and universal life insurance policies that add the accumulated cash values on top of the initial death benefit. This gets paid tax-free to your loved ones.

Understand What You're Buying

understand permanent life insurance - light bulb

There are generally two types of permanent life insurance, whole life, and universal life.

Whole life offers guaranteed death benefit, with guaranteed premiums, and guaranteed cash values.

Universal life insurance, on the other hand, offers flexible premiums, cash value accumulation, underlying investments but has no guarantees.

I often see some agents exaggerate the returns on universal life insurance policies; guaranteeing between 9% to 10% average rates of returns.

Anyone claiming this is more concerned about what they’re going to make on the deal instead of your benefit.

If it’s too good to be true, it probably is.

I’m not saying that you won’t average between 9% to 10% because you may, depending on your policy’s underlying portfolio, and future performance but what if you don’t?

As you may know, market returns are not guaranteed, and no one has control over the market to guarantee such returns.

Realistically, your account may average to about a 5% rate of return in the long run, and I always tell my clients that with a universal life policy, it’s important for you to have your cake first. If you make more than 5%, then that’s icing on the cake.

If your policy contribution was computed under the presumption that your policy is going to earn a higher than average rate of return, your universal life insurance may be at risk of lapsing.

This is due to the fact that for your policy to stay in force permanently, it has to average the assumed average rate of return.

The Insured Retirement Plan (IRP) Concept

insured retirement plan facts

An insured retirement plan is a life insurance policy that is designed to serve as a personal retirement plan for an insured individual.

Over the years, insurance companies have realized that when life insurance policies are held by insured individuals with long-term goals in mind (usual retirement), they create a need for additional growth opportunities and tax-deferral vehicles that can be used to fulfill those needs.

The insured retirement plan concept responds to insured individuals’ needs for additional growth options and tax-deferral vehicles as a way to ensure a comfortable lifestyle in retirement.

There are pros and cons to an insured retirement plan. It can be designed using both whole life and universal life insurance policies. If you’re risk-averse, and you want to take advantage of this concept, you can use whole life as your IRP, if on the other hand, you’re someone seeking to maximize growth and don’t mind market fluctuations, universal life insurance will serve you well.

Some words of caveat when implementing IRP with a universal life insurance policy:

  • market returns do fluctuate, so you have to be in for the long haul,
  • insurance companies do have a charge period of between 7 to 15 years. This means that if you surrender your policy before the charge period is done, you lose a portion of your cash values.
  • You can implement a universal life policy with a minimum premium but it’s not going to be a permanent plan, nor is it an IRP. I’ve met people making $50 a month premium payments and they think that they have an IRP.
  • The insurance component of an IRP isn’t free. You still pay your cost of insurance (COI)
  • A universal life that isn’t well-funded, may behave like term insurance, which means that it will eventually lapse.

A well-designed universal life IRP helps you hit 3 birds with one stone, and they are as follows:

  1. You’re insured while you’re actively working
  2. You can use your policy account value to retire or supplement your other income sources at retirement.
  3. Leave a legacy when you pass away at old age, provided that your policy wasn’t cashed out.

The two keys to keep in mind, when looking to implement an insured retirement plan are the structure and funding. If it’s an IRP, you have to consistently save up and fund it well to make it work. As a reward, your money grows tax-free, which can then be utilized tax-free through a bank collateral loan strategy.

Book an appointment here to ask us about how you can implement a properly designed insured retirement plan.

Why do I need Permanent Life Insurance?

why do i need permanent life insurance

You need permanent life insurance to protect your loved ones against your permanent financial obligations such as final expenses, capital gains taxes at death, tax-free legacies to your heirs, or charitable giving.

There are typically two types of financial obligations:

  1. Temporary, and
  2. Permanent

Permanent life insurance aims to protect your loved ones against the latter.

The reason why you may need permanent life insurance is to protect your loved ones against immediate cash needs that may arise as a result of your death at old age, and any of the above-mentioned obligations.

If you have, say for example a cabin or a couple of rental properties that you’re going to pass on to your kids or any other benefactors, keep in mind that they may have to pay capital gains taxes at your death.

Any investments you have other than your primary residence may be subject to capital gains taxes. We suggest that you talk with your lawyer and accountant to estimate these amounts; you can then book an appointment with us, and we’ll help you design a solid plan.

How Does Permanent Life Insurance Work

Permanent life insurance works differently than term life insurance because it has two properties: a death benefit and equity accumulation.

A permanent life insurance policy typically combines the death benefit with the savings portion. The death benefit is what pays out when you die, and the savings can grow at a guaranteed or non-guaranteed rate.

The two primary types of permanent life insurance are whole life and universal life. Whole life offers coverage for the full lifetime of the insured, while universal offers coverage plus savings.

Universal life features different premium structures and variable rates of return depending on how you choose to invest your money.

Most people complain about throwing away money in their life insurance policies. Permanent life insurance allows you to grow wealth instead of wasting money. The important thing here is the ability to maintain your monthly or annual contributions to the policy.

how it works

Whole Life vs. Universal Life

In general, permanent life insurance policies will fall into one of two categories:    premium-based, or cash value-based.  

If you’re looking for guarantees, and security, I would recommend whole life but if you’re looking for growth, and you don’t mind market fluctuations, Universal life will serve you well.

Benefits from policies in both of these categories offer owners the ability to borrow against their policy, collateralize it with a bank, as well as withdraw funds directly.  The difference is that with whole life insurance, any money borrowed or withdrawn will affect the death benefit (and cash value). With universal life insurance policies, you can take loans against your policy and even withdraw from cash value without affecting your death benefit amount. It may, however, shorten the coverage years.

When Should I Buy Permanent Life Insurance

Like retirement planning, the best time to start cash-value permanent life insurance is the moment you earn your first paycheck. If you’ve missed it, the second-best time is now!

when should you buy permanent insuranceThe contributions required by permanent life insurance policies are dependent on the amount of coverage you decide to buy, your attained age, and your lifestyle.

So, the younger you are, the better.

Buying a whole or universal life policy with cash value can be costly upfront if you buy a large sum of coverage. You can, however, buy permanent life insurance in a smaller coverage amount, then top it off with a term life rider to cover your non-permanent financial obligations.

This helps your monthly contributions at bay while making sure that you have the right amount of coverage at the same time taking advantage of compounded cash value growth.

If you’re a parent and you have young kids, it’s wise to gift them with a participating, 20-pay whole life policy, so they need not worry about their permanent coverage in their adult years, any further financial obligations can be secured with a joint-first term life policy with their future spouse.

On average, a $100,000.00 whole life policy for kids aged 10 and below wouldn’t cost you more than $50 for a 20-year contribution period. After that, your child will have the basic $100,000.00 of coverage for the rest of his or her life, with the option to cash out cash values that are higher than the total amount of money that you will put in.

Ask us about whole life for kids here.

Who Can Buy Permanent Life Insurance?

Any Canadian resident of legal age, and has a source of income can buy permanent life insurance for themselves, their spouse or common law (the life insured needs to sign), and their underaged children. It does require a higher initial investment compared to a term life insurance policy but offers compounded cash value growth either through guaranteed cash values and policy dividends or through market investments in the case of universal life insurance.

What are the benefits of a permanent policy?

Permanent life insurance has several advantages over term life insurance. One is that it has a savings or investment component. Savers can contribute to an account attached to their policy and earn tax-free compounding growth on their contributions, just as they would with a certificate of deposit or a stand-alone investment account.

The permanent life insurance savings can be invested by the insurer in mutual funds and other investments that earn interest and dividends. This allows you to grow wealth inside your policy over time. “You are not confined to one investment in order for it to grow tax-deferred (universal life).

If you’ve contributed to your policy for a period of time, your policy can provide you with a living benefit in case of income loss or reduction thereof due to disability or job loss by borrowing from the account values, withdrawing funds, or collateralizing the policy.

That’s an important consideration since studies show that many people take out loans or withdraw funds from permanent insurance for this very reason.

In cases of financial emergencies, with more traditional term policies, policyholders have to come up with cash to continue their death benefits if something prevents them from working to earn a living. But people who have enough cash value in their permanent life insurance policies can stop contributing to their policies and remain covered.

permanent life insurance does not expireAnother advantage is that permanent insurance does not expire, unlike term policies which either expire or renew with more expensive premiums.

You can buy it and keep it for life.

When you outlive your term policy, you may need to prove insurability at old age to either renew or apply for another policy. The insurer reviews your medical history and determines whether or not to offer coverage. If your health has declined, you could be denied coverage or asked to pay higher premiums for non-medical coverage.

Permanent policies are more cost-effective than traditional term life insurance, in the long run.

Superficially, it looks more expensive because it does require higher contributions but oftentimes, you only need to contribute for 20-years. After that, your policy will cover you for the rest of your life, or until when you cash it out.

Should you decide that you no longer need your policy, you can get your money back, or at least the majority of it, and if you started young, more than what you’ve contributed into the policy.

The policy’s face value remains unchanged or it can increase over time, your premium contribution stays level, and you don’t have to pay any extra premiums during the life of the policy to keep it in force if it’s paid up for a limited number of years (i.e. 20-years).

If designed properly, permanent insurance is actually a better deal than term life insurance most of the time.

A study by pricing company Nationwide Financial found that permanent life insurance was an average of 74% less expensive than a comparable amount of 20-year level term life insurance. These policies are aimed at people who want the security of knowing they will have a death benefit for an extended period but do not require premiums year after year.

Again, if you’re risk-averse and want to keep your money secured, you can have a more conservative portfolio like GICs or CD, instead of equities, or you can just go with your whole life, and earn dividends instead of market returns.

As with traditional term life policies, the death benefit is the most important feature of permanent life insurance. You can use it to replace lost income if you die or for any other purpose. Also, it will provide a tax-free death benefit that won’t be subject to estate taxes.

In addition to the death benefit, most permanent life insurance policies also have a savings component. You can use the funds for any purpose, including covering living expenses in case you are sick or no longer able to work.

Take note however that any cash value withdrawals from whole life will reduce the death benefit, so you should carefully consider how the money will be used.

The Difference Between Whole and Term Life Insurance

whole life vs term life insurance

Whole life insurance coverage remains in force for the life insured’s lifetime, unless canceled or cashed out. It features lifetime guaranteed death benefit, guaranteed cash values, policy dividend earnings, and tax-free equity accumulation.

Whole life insurance does require a higher upfront monthly contribution compared to term life but your contributions build equity over time and don’t go to waste.

Term life, on the other hand, starts you off with lower monthly premiums but it doesn’t build any equity, you’re only paying for the life insurance protection, and not building equity.

When you outlive your term, and you still need the coverage, you have to renew it at a much higher rate based on your attained age by the time.

Who should consider getting permanent life insurance?

You should consider getting permanent life insurance if you want to ensure that you will not run out of life insurance coverage regardless of how long you live because if it’s not cashed out, it will remain in force up to age 100.

Most seniors run out of life insurance coverage at old age, since most Canadians are covered with term life insurance, which tends to get expensive at each renewal, when you turn 70, term life insurance premiums tend to be restrictive.

You should also consider getting permanent life insurance if you don’t want to waste money on your life insurance premiums or if you want to leverage the policy to build wealth, leave a legacy, or as an estate-planning solution for tax-free wealth transfer.

How To Buy Permanent Life Insurance?

how to buy permanent life insurance

You can buy permanent life insurance by talking with a life-licensed advisor who deals with all major insurance companies.

Consider setting up a consultation with us, and we’ll help you implement the best permanent insurance that fits your needs, goals, and situation.

The buying part is easy, the planning process may take time depending on your current situation and goals.

Permanent insurance may serve many different purposes, some clients implement permanent policies for estate planning purposes, while some for final expense.

Whatever your situation is, we can help you get the policy that best suits your needs.

You can book a free, initial consultation with us here.

Why do I need to purchase a policy now, instead of later in retirement?

It might be tempting to put off buying a permanent life insurance policy because you figure, you can better fund it at retirement or at a later point when all debts are paid off and the kids are grown. However, this can be a costly mistake because older people pay more for coverage than younger ones.

An average 67-year-old female will have to pay $361 a month for a 20-pay, $100,000.00 coverage of a whole life policy. The same basic coverage is offered to a 27-year old female for $62.85.

Because rates increase with age, you will pay less if you purchase a permanent life insurance policy now than when you’re older.

The younger people are, the better rates they get when it comes to insurance policies.

In Summary

Permanent life insurance is an insurance policy that does not expire. Typically, it will provide life insurance coverage for up to age 100, when paid up (15 or 20-pay) or the premiums are maintained.

There are two types of permanent life insurances, as follows:

  1. Whole Life, and
  2. Universal Life

The purest permanent life insurance type is the whole life. It isn’t flexible but it’s set and forget. If you plan to pay it off in 20-years, it’s paid up in 20-years, and no further premium contributions are deducted after the 20th year.

If you want to grow equity inside your whole policy, you have to implement a participating life insurance policy, preferably from a mutual company. Since a mutual company does not have investors, you can earn more policy dividends compared to demutualized companies.

Universal life insurance on the other hand is a flexible type of permanent insurance. As such, it has flexible premiums, which allows you to start your policy with the least amount of premium. One thing that you have to keep in mind, however, is that your policy may lapse if you’re only putting in the minimum or a little higher amount than the minimum required.

If you want to pay it off in 20-years, ideally it has to be designed using a 3% assumed rate of return to safeguard your policy from the risk of lapsing.

The best way to take advantage of a universal life insurance policy is to use it for wealth accumulation because it lets you participate in market uptrends without tax implications as long as your funds remain inside the policy.

Compared to term life insurance, permanent insurance policies tend to cost lesser in the long term, because, provided that you don’t smoke and you implement your policy at a younger age, your cash values will be higher than your total contributed capital.

I say this a word of caveat when you’re looking to implement universal life insurance because the premiums are flexible, so you have to over-fund it, and if you’re middle-aged or older, the universal life portion of your policy should be kept at the minimum coverage amount to keep your cost of insurance as cheaper as possible.

Finally, if you’re considering permanent insurance, please don’t hesitate to book an appointment with us so we can help guide you to implement the right one for your need.

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