Cash value life insurance is a popular choice among Canadians, which combines lifelong financial protection for your loved ones with a tax-advantaged savings and investment component. As a type of permanent life insurance, it not only provides lifelong protection but also builds cash value over time.
But how exactly does it work, and is it the right option for you? The following article from Lifebuzz will explain everything you need to know about cash value life insurance in Canada.
What is Cash Value Life Insurance?
Cash value life insurance is a form of permanent life insurance that lasts your entire life and includes a cash value savings account that grows on a tax-deferred basis. According to the CLHIA, over 22 million Canadians have some form of life insurance coverage, and cash-value policies, such as whole life and universal life, are standard options.
With cash value life insurance, premium payments are divided up to cover three costs:
- Insurance charges to fund the death benefit
- Fees and expenses
- Contributions to the cash value account
In the early years, the bulk of the premiums paid for the insurance and administrative costs. Over time, as the cash value grows, less money is needed to cover the insurer’s mortality risk. This allows more funds to be deposited into the policy’s cash value account. This account earns interest at either a fixed or variable rate, depending on the type of policy.
If any cash value remains upon the death of the insured, it goes back to the insurance company. Beneficiaries receive only the policy’s death benefit payout.
For example, consider a cash value policy with a $100,000 death benefit. The policy has a current cash value of $20,000. Upon the death of the insured, the insurance company is only liable for $80,000, since the $20,000 cash value offsets their total payout amount.
As this example shows, the accumulating cash value reduces the insurance company’s risk over time. This is what allows cash value policies to remain in force indefinitely as long as premiums are paid.
How to Access the Cash Value Life Insurance
Policyholders have four main options when it comes to accessing their cash value funds:
Withdrawals
You can make a partial withdrawal from your cash value. This will permanently reduce your death benefit. If the withdrawal amount exceeds the policy’s ACB, the difference is taxed as income in that year.
Taxable Gain = Withdrawal Amount – ACB of the policy
Policy Loans
Rather than withdrawing cash, you can take out a loan against your policy’s cash value as collateral without requiring credit checks. The loan is not taxable as long as the amount borrowed is less than the policy’s ACB. Interest accrues on the loan, and if not paid, it’s added to the loan balance.
Policy loans reduce your death benefit because any outstanding loan balance gets deducted from the payout your beneficiaries would receive. If the loan exceeds your cash surrender value, the policy can terminate.
Therefore, if you intend to repay the loan and restore your full coverage, it’s wise only to borrow a portion of your available cash and pay back the funds when possible.
Surrendering the Policy
You can cash out and terminate the policy in exchange for its net cash surrender value. This ends the life insurance coverage permanently. Any amount received above the policy’s ACB is fully taxable as income.
If you sell your policy to a third party via a life settlement, any amount received above the cash surrender value is taxed as ordinary income.
Paying Premiums
Some universal life policies allow you to pay all or a portion of your premiums through automatic withdrawals from the built-up cash value. This can significantly reduce or even eliminate your out-of-pocket costs. However, it’s important to monitor cash value levels and interest rates closely to ensure you don’t overuse this feature and risk lapsing the policy.
Pros and Cons of Cash Value Life Insurance
Cash value life insurance can provide valuable lifelong protection and tax-deferred growth potential. However, there are drawbacks to consider when weighing these policies. Considering the key advantages and disadvantages can help you determine whether cash value insurance is the right fit for your financial situation.
Benefits
- Lifelong Protection: Guaranteed death benefit that never expires as long as premiums are paid.
- Tax-Deferred Growth: The cash value grows without annual taxation, allowing for more efficient compounding.
- Asset Diversification: Provides a stable, non-correlated asset class for a diversified investment portfolio.
- Creditor Protection: In many circumstances, the cash value and death benefit may be protected from creditors.
- Forced Savings: The regular premium schedule creates a disciplined savings plan.
Drawbacks
- High Cost: Premiums are significantly higher (5-15x) than term insurance for the same death benefit.
- Lower Returns: The guaranteed portion of returns is often lower than what could be achieved through long-term equity investing.
- Complexity: The products can be complex, with various fees (premium loads, management fees, cost of insurance) that can be difficult to understand.
- Illiquidity & Surrender Charges: Accessing cash value in the early years (first 10-15 years) is often penalized by high surrender charges.
What Types of Policies Offer Cash Value?
The most common cash value insurance policies include the following:
- Whole Life Insurance: With whole life insurance, the premiums, death benefit, and cash value growth rate remain fixed over the life of the policy. It offers a guaranteed minimum rate of return and the potential for dividends.
- Universal Life Insurance: Universal policies provide more flexibility. The death benefit and premium amounts can be adjusted, and you can choose from a selection of investment accounts to fund the cash value.
- Indexed Universal Life: Indexed universal life links cash value returns to a market index. This allows for potentially higher growth while guaranteeing a minimum rate if the market underperforms.
- Variable Life Insurance: These policies invest your cash value in securities such as stocks and bonds. The funds grow or decline based on the performance of the investments.
Who Is Cash Value Life Insurance Right For?
Cash value life insurance is not for everyone. It is a specialized tool best suited for specific individuals:
- High-income earners: Individuals who have already maxed out their RRSP and TFSA contributions and are looking for an additional tax-sheltered vehicle to grow wealth.
- Business owners: It can be used to fund buy-sell agreements, provide key person insurance, or serve as collateral for business loans. Corporate-owned policies offer significant tax advantages.
- Estate planners: Those who want to leave a guaranteed, tax-free inheritance to their heirs, cover future capital gains taxes on other assets (like a cottage or investment portfolio), or make a significant charitable donation.
- Individuals seeking stability: Those who want a conservative, guaranteed component in their overall financial plan that is shielded from market volatility.
For most Canadian families simply needing income replacement for a set period, a “Buy Term and Invest the Difference” strategy is often more practical and cost-effective.
The added costs and complexity don’t make it practical for those simply needing temporary coverage. For most Canadians, a renewable term life policy is the most cost-effective way to secure protection for your loved ones.
Cash Value Life Insurance Costs and Fees
Beyond premiums, cash value life insurance policies also come with various internal fees and expenses, which impact your overall costs. Common fees include:
- Premium load: This is an upfront fee deducted from each premium payment, averaging around 10-15%. It covers the insurer’s distribution expenses.
- Monthly expense charge: This covers administrative costs for maintaining the policy, around $5-10 per month.
- Cost of insurance: A monthly fee based on your age and risk class to cover mortality expenses. This increases annually as you age.
- Surrender charges: If you cancel the policy in the early years, surrender charges apply. They often start around 20% and decline over 5-15 years.
- Partial withdrawal fee: Some policies charge a $25 fee or more for each partial cash withdrawal taken.
- Loan interest: You’ll pay interest on any loans taken against the cash value, usually around 6-8% annually.
- Mortality & Expense Charge: For variable and indexed universal life policies, fees for insurance costs and managing investments.
Is Cash Value Life Insurance CDIC Insured?
A common question is whether your policy is “insured.” The answer is that your policy cash values and death benefits are not insured by the CDIC or any government agency. Life insurers manage general investment pools to fund cash values and back future claims. The financial strength and claims-paying ability of the insurance company issuing the policy will impact their ability to honour promised benefits.
However, life insurance policyholders in Canada have a robust safety net: Assuris. Assuris is a not-for-profit organization that protects Canadian policyholders if their life insurance company fails. If your insurer goes bankrupt, Assuris arranges to transfer your policy to a solvent company and guarantees you will retain at least a portion of your promised benefits.
Be sure to carefully assess the financial stability of providers when purchasing cash value life insurance. Review ratings from agencies like AM Best and Moody’s to screen for insurers with strong balance sheets and a history of meeting obligations.
Who Is Cash Value Life Insurance Right For?
Cash value life insurance is not for everyone. It is a specialized tool best suited for specific individuals:
- High-Income Earners: Individuals who have already maxed out their RRSP and TFSA contributions and are looking for an additional tax-sheltered vehicle to grow wealth.
- Business Owners: It can be used to fund buy-sell agreements, provide key person insurance, or serve as collateral for business loans. Corporate-owned policies offer significant tax advantages.
- Estate Planners: Those who want to leave a guaranteed, tax-free inheritance to their heirs, cover future capital gains taxes on other assets (like a cottage or investment portfolio), or make a significant charitable donation.
- Individuals Seeking Stability: Those who want a conservative, guaranteed component in their overall financial plan that is shielded from market volatility.
For most Canadian families simply needing income replacement for a set period, a “Buy Term and Invest the Difference” strategy is often more practical and cost-effective.
Alternatives to Cash Value Life Insurance
Cash value life insurance isn’t the only way to gain tax-deferred growth and access funds. Some alternatives to consider include:
Term Life + Invest the Difference
Rather than overpaying for unneeded cash value, buy lower-cost term life insurance and invest the premium savings for retirement.
Whole Life + Term Blend
A smaller whole life policy to cover final expenses, paired with term insurance for income replacement needs, can maximize protection at the lowest cost.
Annuities
Annuities share tax-deferred growth features without the higher fees or mortality charges inherent in cash value life insurance.
RESPs, TFSAs, RRSPs
Make the most of registered accounts for tax-free or tax-deferred investing before considering permanent life insurance.
Finding the Right Cash Value Life Insurance Policy
If you decide cash value life insurance aligns with your financial priorities, your choice of carrier and specific policy will play a major role in the cost and benefits you receive.
When comparing options, look for providers that offer:
- Competitive premiums for your age and risk class
- Strong credit ratings and financial performance
- Solid returns on cash value with minimal fees
- Flexibility to adjust the death benefit and premium if needed
- Favourable policy loan interest rates and withdrawal provisions
Working with an experienced independent insurance broker can help you navigate the process and identify the most suitable policy for your situation. They will provide quotes tailored to your needs while considering a wide range of insurers and products.
Summary
Cash value life insurance can be a useful asset for high-net-worth individuals who have maxed out registered savings and want to supplement their retirement investing. It provides lifelong coverage along with tax-deferred cash value growth.
However, permanent policies carry higher costs and complexity than term life insurance. Carefully weigh your needs and alternatives before committing, as cash value insurance isn’t practical for most average Canadian families simply looking to protect their income temporarily.
Consult an independent broker to review your specific situation. They can provide options tailored to your budget and goals so you can make an informed decision.
Frequently Asked Questions About Cash Value Life Insurance
How does cash value life insurance work?
Cash value life insurance policies have two main components - the death benefit and cash value account. Part of your premiums go to insurance costs and the rest accumulates in a cash value account that earns interest.
Why get cash value life insurance?
Reasons to consider cash value life insurance include wanting permanent protection, using it as a forced savings plan, and accessing the funds through loans or withdrawals.
What are the benefits of cash value life insurance?
Benefits include lifelong coverage, tax-deferred savings growth, ability to access cash value through loans/withdrawals, and serves as an additional investment vehicle.
What happens to the cash value when you die?
The cash value belongs to the policyholder as a living benefit. At death, the cash value reverts to the insurance company. Your beneficiaries receive the policy's stated death benefit, not the death benefit plus the cash value.
Is my cash value life insurance protected in Canada?
Yes. While not covered by CDIC, it is protected by Assuris. If your insurer fails, Assuris guarantees you will retain up to $1,000,000 of your death benefit and $100,000 of your cash value.
Who is cash value life insurance best for?
Cash value insurance works best for higher net-worth individuals focused on estate planning and wanting permanent coverage plus tax-deferred investment growth potential.
