Peter Boys, Boys Financial Services

Think of Life Insurance as Another Asset Class

asset class


There are many benefits of using life insurance as an asset class to compliment your existing investments. Providing an attractive return on investment is one, but it’s important to have properly structured coverage.

Life insurance payouts are tax-free, private and bypass probate. But just as importantly, most life insurance products in Canada come with premiums and a face amount that are guaranteed for life. Therefore, we can calculate an internal rate of return (IRR) on the premiums, and because the death benefit is paid out tax-free to the estate or beneficiary, the IRR is a tax-free percentage rate. The only variable is the insured’s age at death.

In the case of a minimum-funded universal life (UL) policy, the death benefit is level for life. The sooner one dies, the greater the implicit IRR and vice versa. For example, a healthy non-smoker male aged 50 would pay $13,296 annually for $1 million of life insurance. The following table illustrates the guaranteed after-tax IRR for different ages.

Age at Death              After-Tax IRR

70                                 11.4%

75                                  7.7%

80                                  5.4%

85                                   3.9%

90                                   2.9%

If in this example the insured man dies at age 85, the $1 million payout would be equivalent to the premiums earning an after-tax compounded return of 3.9 per cent. This is an attractive rate of return given today’s low interest rates. But is this a good investment? In addition to the unfortunate criteria that death is required, there’s no liquidity.

If premium payments are discontinued the policy lapses and the policy owner receives nothing. The solution is to overfund the policy above the base the insurance cost to the limits allowed by CRA. A range of investment options can build cash value that can either enhance the amount paid out at death or provide retirement income by leveraging the cash value.

Unfortunately, I find many people who have the wrong type of coverage for their needs and will end up paying out a lot of premiums only to see the policy eventually blow up!

For instance, many have purchased UL policies when interest rates were 8% or more, and the investment performance has not have kept up to what was projected! These may require significantly more cash infusion to keep them in force.

In other cases I find UL policies that were sold based on YRT (Yearly renewable term) insurance cost because the initial premium looks very attractive. The downside with these types of policies is that the cost of insurance goes up every year, eventually reaching the point that the premiums become very expensive. Most people quit paying and the policy lapses.

I also often find cases where an insurance salesman just picked an arbitrary amount rather than doing a needs analysis to establish an amount of coverage required. After completing a thorough review and needs analysis, it usually resulted in determining the need for a significantly greater amount of coverage.

With today’s ever increasing land and business valuations, it’s important that farmers and small business owners do regular reviews to insure their existing coverage is both adequate and properly designed for their situation.

Talk to an experienced financial advisor about all of your finances including life insurance, wills, investments, business structures, etc. to ensure they are structured properly for your individual protection, retirement and estate planning needs.
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