Ben Nguyen 
Cash value life insurance is a popular choice among Canadians looking to secure lifelong coverage along with a savings 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?
This comprehensive guide will explain everything you need to know about cash value life insurance in Canada.
What is Cash Value Life Insurance?
Cash value life insurance, also known as permanent life insurance, provides lifetime coverage and includes a cash value savings account that grows on a tax-deferred basis.
A portion of the premiums paid go toward the cost of insurance, while the remaining amount gets 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.
According to the CLHIA (source), over 22 million Canadians have some form of life insurance coverage. Cash value policies like whole life and universal life are common options.
The cash value belongs to the policyholder and can be used in various ways while the insured is still living, including:
- Taking out policy loans
- Making withdrawals
- Paying insurance premiums
- Surrendering the policy for its cash surrender value
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.
How Does Cash Value Life Insurance Work?
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 pay 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.
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.
Why Choose Cash Value Life Insurance?
There are four key reasons Canadians choose cash value life insurance:
Lifelong Coverage
Cash value life insurance provides permanent protection, ensuring your beneficiaries will receive a death benefit payout no matter when you pass away. This lifelong coverage gives you peace of mind.
Forced Savings
The cash value portion acts as a forced savings plan, helping policyholders set aside money that can be used down the road. The funds grow on a tax-deferred basis as long as they remain in the policy.
Access to Funds
Policyholders can access the accumulated cash value funds through withdrawals, loans, or full surrenders. This provides financial flexibility in case of emergencies.
Additional Investment Vehicle
For high net-worth individuals who have maximized registered accounts, the cash value can serve as an additional tax-sheltered investment vehicle.
How to Access the Cash Value?
Policyholders have four main options when it comes to accessing their cash value funds:
Withdrawals
Most policies allow partial withdrawals, which reduce the death benefit by the amount taken out. Taxes may apply if you withdraw more than what you paid in premiums.
Policy Loans
Rather than withdrawing cash, you can take out a loan against your policy’s cash value. Interest will accrue on the loan. If it’s unpaid at time of death, the loan balance gets deducted from the death benefit.
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.
Paying Premiums
Some universal life policies permit you to pay premiums via the built-up cash value rather than out-of-pocket. This option maintains coverage without additional payments.
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 also some drawbacks to weigh when considering these policies. Looking at the key advantages and disadvantages can help you determine if cash value insurance is the right fit for your financial situation.
Benefits
- Lifelong protection
- Cash value savings component
- Flexible access to accumulated funds
- Can serve as a supplemental retirement income source
Drawbacks
- More expensive than term insurance
- Lower returns compared to conventional investing
- Complex structure with many moving parts
- Risk of policy lapsing if cash value drops too low
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 into securities like stocks and bonds. The funds grow or decline based on performance of the investments.
What Happens to the Cash Value at Death?
The cash value belongs to the policyholder as a living benefit. At death, any remaining cash value returns to the insurance company’s general account. It does not get paid out to beneficiaries along with the death benefit.
For example, if you have a policy with a $500,000 death benefit and $50,000 cash value at the time of death, your beneficiary would receive the full $500,000 payout. The $50,000 cash value goes back to the insurer.
Is Cash Value Life Insurance Right for Me?
Cash value life insurance can be a suitable option if:
- You want lifelong protection for your dependents.
- You need a forced savings vehicle and like the tax-deferred growth potential.
- You want access to funds through withdrawals or loans if necessary.
- You’ve maximized registered account contributions and want another tax-deferred investment.
Typically, cash value insurance works best for those with higher incomes who are focused on wealth transfer and estate planning strategies.
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.
How Much Does Cash Value Life Insurance Cost?
Cash value life insurance is significantly more expensive than term insurance since you’re paying for the added cash value account on top of pure protection. Monthly premiums will depend on factors like:
- Age
- Health status
- Coverage amount
- Type of policy
For example, a healthy 30 year old male could expect to pay around $71 per month for a $100,000 whole life policy. A 20 year term policy may only cost $30 monthly. However, the term coverage expires after 20 years unless renewed.
Read more: Life Insurance with Pre-Existing Conditions
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.
How Do Cash Value Policies Build Savings?
A portion of each premium gets directed into the cash value account after deducting fees and insurance charges. Earnings come from:
Interest Crediting
The guaranteed rate your cash value grows annually, such as 3-4% for whole life policies.
Dividends
For participating whole life policies, dividends from the insurer’s surplus are added to the cash value.
Index Credits
With indexed universal life, cash value is credited based on growth of an index like the S&P 500.
Investment Returns
For variable policies, gains and losses from the underlying investments flow into your cash value.
Over time, as expenses take up less of your premium, the cash value allocation percentage rises. Many policies offer very limited cash value in the early years, as most of your premium is consumed by high acquisition fees.
Typically, you’ll see meaningful cash value accumulation start around year 5-7 and increase from there. Taking loans or withdrawals in those early years usually isn’t advised because your cash reserves remain low.
Using Cash Value to Pay 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.
This strategy provides the most benefit for policies that have accumulated substantial cash value. Withdrawing funds when the cash value is still minimal can jeopardize the policy.
For example, if your annual premium is $2,000 and your cash value grows at a 4% net rate of return after fees, you may be able to start using cash value to offset some premium payments after 10-15 years.
Paying premiums via cash value withdrawals can allow you to maintain your desired death benefit while minimizing new 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.
Borrowing Against Cash Value Via Policy Loans
Policy loans allow you to borrow funds using your cash value as collateral without requiring credit checks or approval.
Benefits include:
- Access to funds for any purpose
- Typically low loan rates of around 5-8%
- No required loan payments
- Interest compounds but isn’t taxable as long as policy remains in force
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 to only borrow a portion of your available cash and pay back the funds when possible.
Tax Implications of Cash Value Life Insurance
One of the appeals of cash value life insurance is the tax-deferred growth potential. However, certain actions can trigger tax bills:
Withdrawals
Amounts exceeding your premiums paid are taxed as ordinary income. Withdrawals decrease your death benefit.
Surrendering
Net cash surrender value is taxable to the extent it surpasses total premiums you paid. It terminates the policy.
Policy Loans
Loans aren’t taxed directly. However, loan interest is generally not tax deductible. If you surrender the policy with an outstanding loan, taxes will apply to the net cash value received.
Death Benefits
The life insurance death benefit is income tax-free to beneficiaries. But the policy’s cash value is forfeited back to the insurer at death.
Mortality Gains
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.
Is Cash Value Life Insurance FDIC or CDIC Insured?
Cash value life insurance accounts are not insured by the FDIC or CDIC. Life insurers manage general investment pools to fund cash values and back future claims.
Policy cash values and death benefits are not guaranteed by any government agency. The financial strength and claims-paying ability of the insurance company issuing the policy will impact their ability to honor 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.
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 death benefit and premium if needed
- Favorable 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.
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.
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.
What types of policies have cash value?
The main policies offering cash value are whole life, universal life, indexed universal life, and variable life. Term life insurance does not have cash value.
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.
How can I access the cash value in my policy?
You can access cash value by taking policy loans, making withdrawals, surrendering the policy, or using the funds to pay premiums. Each option has pros and cons.
What happens to the cash value when you die?
Any remaining cash value returns to the insurance company upon death. Your beneficiaries only receive the death benefit amount, not the cash savings.
Is cash value life insurance FDIC or CDIC insured?
No, cash value accounts are not insured by the FDIC in the U.S. or CDIC in Canada. The financial strength of the insurer backs the policy benefits.
How much does cash value life insurance cost?
Cash value life insurance costs significantly more than term insurance since you pay for the added cash value account. Costs vary by age, health, amount of coverage, and type of policy.
What are the drawbacks of cash value life insurance?
Drawbacks include higher costs, lower returns compared to conventional investing, complexity, and risks if you tap into cash value too soon.
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.
