Along with their main purpose of financial protection, some life insurance products can become part of a broader wealth management strategy because they incorporate an additional component: investment. 

Here are five points providing some insights. 

1. Life insurance: primarily for protection  

To begin with, it might be useful to recall that the primary role of life insurance is to provide financial protection for your loved ones. Buying a life insurance policy is generally recommended as soon as you become wholly or partly responsible for the well-being and living standards of the people who depend on you. In the eventuality that you weren’t there to provide for them, the tax-free capital made available by life insurance could prevent their financial security and standard of living from being compromised. 

2. Two families of life insurance 

There are two main types of life insurance. 

• Term insurance  
  This is “pure” insurance covering a fixed period. The only purpose of the premiums is to furnish a benefit that will be paid to the policy beneficiaries after the death of the insured person. These premiums are lower than those for other types of insurance, but be aware that they increase over time, whenever the contract ends and you choose to renew it. Note also that some insurers offer 100-year term insurance – which, in practice, generally means “for the rest of your life.” 

• Life insurance with a savings and investment component  
  These are solutions that allow the insured to use the policy to save and grow wealth in a tax-sheltered environment once the need for protection is covered. There are two main types: whole (or permanent) life insurance and universal life insurance. Here, the premiums will be higher since these policies serve a twofold objective. But in the case of whole life insurance, the premiums will remain level and never increase. 

3. Whole life insurance: to build wealth within the policy 

Whole life insurance usually includes a predetermined “cash surrender value” that increases over the years. This value, which comes from the insurance company investing your premiums, is the amount you could receive if you decided to end your coverage at some point by asking to “surrender” your policy to the insurer. Note that, unlike the death benefit, this money would be partially taxable.  

There are various strategies for using your cash surrender value. You could choose to stop paying premiums while retaining a reduced amount of insurance coverage: this is known as reduced paid-up insurance. You could also use the cash surrender value as collateral for a loan, which could provide for your needs in retirement. This money would not be considered taxable income, but of course you would have to pay interest on the loan. 

One notable variant of this type of insurance, known as participating whole life insurance, allows you to participate in returns on the capital invested by the insurer once your protection needs and the cash surrender value have been covered. If applicable, your “participating account” might pay “dividends” that you could cash in, reinvest or use to increase your coverage, reduce your premiums or buy additional insurance. For more information, read this article. 

4. Universal life insurance: for more flexibility 

Universal life insurance also has an investment component, but its relationship with the protection component is more fluid. Once the amount of the required insurance premium has been determined, you can add a monthly amount of your choice to be invested for you in investment vehicles that you also choose. If these investments appreciate, your capital will grow in an accumulation fund. You can use the money in your accumulation fund whenever and however you wish. You can withdraw it, reinvest it, or use it to reduce or even suspend your premium payments altogether. In that scenario, the insurer would draw money from your accumulation fund to cover the cost of your insurance.  

Thus, universal life insurance gives you more control over your investments and how they are used over time. Note that this type of policy does not usually provide a guaranteed cash surrender value. Your returns would fluctuate, and your premiums would not be level: they would increase over time, as with term insurance. 

The following chart summarizes how the investment component of universal life insurance differs from that of the other types of life insurance presented here. 

5. One more tool for yourself… and a good investment for others 

A number of factors must be taken into account when deciding whether these insurance solutions are worthwhile compared with an approach that draws a clear boundary between the need for insurance and tools for investing. The two most important factors are the anticipated rate of return and the tax payable, with life insurance generally offering some advantages in the latter area.  

There are at least three situations where the potential to accumulate tax-sheltered wealth along with life insurance has obvious appeal. The first involves individuals who have maxed out all other tax-efficient investment tools, such as the registered retirement savings plan (RRSP) and the tax-free savings account (TFSA). The second involves entrepreneurs whose investment income, or “passive income,” is above the $50,000 threshold that reduces their eligibility for the small business deduction. In both of these cases, life insurance could offer a way to build wealth with no immediate tax implications. Lastly, life insurance – of any kind – is always a worthwhile tool from the beneficiary’s point of view. If you look at the cost of premiums versus the tax-free guaranteed lump sum paid out at death, the rate of return often compares favourably with that of other investment vehicles. As well, the beneficiary is likely to be paid promptly, bypassing the estate settlement process and without being subject to probate fees in the provinces where these apply. 

In every case, it goes without saying that the choice of life insurance works best as part of a big-picture approach to ensure that the most suitable tool is used to cover each of your financial needs. Your advisor can help you with these decisions.