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The Ten Commandments of Whole Life Insurance in Canada
Curious about how to make the most of your whole life insurance policy? In this blog, we’ll explore “The Ten Commandments of Whole Life Insurance,” an insightful article that breaks down some key principles you need to know. If you’re considering a policy these ten rules will help you navigate the complexities and benefits of whole life insurance.
So, there’s this great article titled “the ten commandments of whole life insurance” and it is linked (https://earlyretirementnow.com/2018/09/26/the-ten-commandments-of-whole-life-insurance/) if you want to read along. One thing that’s different about this one, is that he doesn’t take a strong side of whether you should or shouldn’t do this, a very down-the-middle opinion with facts and data.
The part that’s even stranger about this, is that it comes from the FIRE community, FIRE meaning Financially Independent Retire Early and it’s a great concept from people who basically want to retire early and have their investments pay for everything for the rest of their lives.
Generally, this group considers whole life insurance the devil, they hate it, because there are higher fees and there are commissions paid and they often make the argument that you can invest somewhere else and make more money and that if you get to a high enough net worth that you can self-insure and have no need for insurance.
Let’s get into it.
1: Thou shalt first maximize all other tax-advantaged opportunities before even thinking about whole life insurance!
Yes, absolutely we actively recommend this as well, the only change I’d make is I wouldn’t maximize all opportunities but maximize all tax-advantaged opportunities that are suitable for you.
If you look at our other videos, like “Should business owners have an RRSP?” our theory is that business owners should put money into their RRSP on a case-by-case and year-by-year basis depending on a few factors. It’s not a flat, everyone and their mother should maximize their RRSP. TFSAs we generally say maximize those as the money is taxed before it goes in, but it comes out tax-free when you withdraw.
So, in general, it’s a good rule of thumb to follow before investing in whole life insurance.
2: Thou shalt not forget that longevity risk is the real problem in retirement planning!
This is important in any type of retirement planning and financial planning. Not knowing the day you’re going to die makes retirement planning very difficult.
If we knew that you were going to die 10 years to the day after you retire then it would be very easy to figure out how much you can spend every day, month, and year and not run out of money, but you might not die for 20, 30, or 40 years.
We don’t know how long your money has to last, this is why it’s important to have a good sequence of returns and a good withdrawal rate that can guarantee that you are not going to run out of money. We also recommend people have some cash-flowing assets in retirement so that you have some assets that are actively paying you.
In the article, he talks about one of the reasons insurance is good, is that the writer recognizes that if your spouse or someone important to you dies, that’s a traumatic event.
And yes, technically in a cold and logical world, you could finance and pay for things yourself but in the real world this is traumatic, you don’t know how you’re going to handle it and you don’t know what your bills are going to be like maybe they weren’t exactly half.
And the writer talks about how you probably aren’t going to move to a smaller house worth half and spend less, so having a life insurance check show up in a couple of weeks to allow you to keep living your life and grieve.
One thing the writer doesn’t mention, which isn’t mentioned a lot in these FIRE discussions, they usually only look at insurance for covering the risk of somebody dying and covering those expenses. What I haven’t seen anyone do is talk about insurance to pay for capital gains.
Say you do have enough money and assets to cover a self-insure. This may include businesses, buildings, stock portfolios, etc. Well, if you want those to pass to your children and for them to keep them and for them to carry on, your legacy and not sell them. When you pass away, there’s your final income tax return due and this is probably going to be the biggest one of your life and you’re going to have capital gains due on all these assets.
How do you pay for these capital gains? Well having a guaranteed life insurance check, that we can calculate based on your assets, we can estimate a capital gains ballpark number. This insurance can go to your kids, and they can cover this tax once you pass, and they can hold onto whichever assets you wanted them too like the family cabin.
Even if the calculation is a little off, like we calculate it as $600,000 and it turns out to be $650,000, even though it’s more than you prepared for, it’s much better to have the 600 and find the last 50,000 than to have nothing and have to come up with the whole 650,000.
What are some other ways to cover this cost would be to sell one of these buildings to cover the cost of capital gains, but we don’t know what is going to happen in the future, so is it a good time to sell a building when you die, as of the filming of this video in 2024 commercial real estate is not selling as well as it was a few years ago.
It’s kind of in the toilet across North America except some markets, so do you wait until the market is better then sell it for more? You can’t pay the taxes now, not only that you may not get enough to cover the tax, but it may not sell at all.
3: Thou shalt consider policies with the shortest possible premium period!
On this point, some people want this, some people don’t but we generally side towards trying to make the premium periods as short as possible.
There are a couple ways you can do this; one is in a guaranteed way with what is called a 10 pay or a 20 pay then you pay the premium for that length of time then you don’t, and it’s guaranteed that the policy won’t ever lapse.
All the premiums that need to be made are already made and you’re done, generally a more conservative planner types love this as they get to pay it all and never think about it again.
Another way to do this is through what’s called an offset, and an offset is not guaranteed. So, you can run quotes with the insurance company that say these future premium payments are going to be this much, then if we put this much cash value into the policy and the dividend continues to pay at whatever rate it is today, it should cover the minimum premium payment for the life of the policy, the rest of your life.
Although it’s not guaranteed, you can make this number comfortable and pad it well. Some people do try to get very close to that offset, which is not what we do, we generally look at the offset and recommend paying it an extra 2, 3, or 4 years to make sure.
The last thing you want to do with one of these policies is come back years later and say hey the numbers didn’t work out how we wanted, and you need to pay more premiums. And whenever that happens, it’s usually a bad time because they HAD the money and now, they’re older and maybe retired and spent money on other things and weren’t expecting to need to cover it so they may not have it at that time.
So, you want to be careful on the offsets, and if being more conservative and being safe is important then go with a 10 pay or 20 pay where you know exactly how long you need to pay.
The writer also mentions, ideally, they would have preferred to make one payment up front and forget about it.
4: Thou shalt not over-extend yourself!
This is pretty good standard financial advice for anything. Especially counts here, as you definitely want to minimize the risk of future cashflow problems. (i.e. not being able to afford your premium payments.)
Having to surrender your policy or lapsing your policy is basically the worst thing you can do. Make sure that whatever you think your number is for a monthly or annual premium, make sure you know you can afford it even if everything that can go wrong goes wrong.
Make sure cancelling is the thing that never happens.
5: Thou shalt not fall for the sunk cost fallacy
The writer of the article speaks about how in the FIRE community there’s so much hate and bad press there is for these whole life policies.
And that there are people who join this community and have a policy that they started a long time ago for whatever reason and they read that these are terrible and want to cancel them.
Now there’s no right or wrong answer for this, it depends. Generally, our rule of thumb is if you have more cash values in the policy than premiums you’ve put in then you get all that cash back, but you lose the insurance and you probably got it for a reason so ensure that whatever you got it for is either dealt with or doesn’t matter anymore. But that’s also why we generally recommend not cancelling the policies especially if you’ve had them for a while.
The writer in this section also writes about an Internal Rate of Return calculation. Again, these policies in Canada in the lifespan of age 100 they generally have an Internal Rate of Return of three to four percent after tax.
There’s not a lot of things that you can do that will get you that on such a consistent basis.
6: But thou shalt not fall for the Loss Aversion bias either
They would be correct to mention in the article that yes, there are some advisors that set these up poorly or in a way that’s not totally advantageous for you.
As an advisor, you really have to know what you’re doing and understand what the client is trying to do so that you set up the policy in a way that achieves those goals.
So, if the policy is not set up correctly for the client, you do want to quit it as quickly as possible so that you are not throwing good money away, and you may have to set up a new one. Ideally, you realize this early enough that it doesn’t sit and cost you too much.
7: Thou shalt not compare WLI with equity returns!
I see this one all the time with people saying, “well I get a higher return if I invest in the S&P or real estate or something else” and yes of course you do.
This is an insurance policy this is made up a majority of bonds and long-term real estate holdings.
And it’s absolutely not apples to apples to compare an equities portfolio return can be compared to a whole life insurance policy, they are completely different.
They mention that you should look at this against bonds or other guarantees like GIC in Canada.
And goes on to say that you could even have a portion of your bonds portfolio be put towards a whole life policy as it is majority bonds, and you get the insurance that way.
8: Thou shalt only work with a highly rated mutual insurance company!
Now, this is an American article, and I would say that’s actually pretty good advice and here in Canada I’d love to take that advice, but we have way less choice.
There is one highly rated mutual insurance company that offers these types of policies, and that’s Equitable Life of Canada. We love them, we work with them a lot.
But that doesn’t mean that the other companies that offer whole life insurance are bad, we also work with the other publicly listed companies as well.
As we match the policies to client and their needs, so yes Equitable fits in a lot of places and sometimes other companies fill others.
Might be something like underwriting, like this company might not want to take you on as a client because they see you as a risk for health reasons. Another might take you on as a client to take that risk.
Or maybe the insurance company might financially underwrite you differently, like this person is asking for too much insurance and we think it is too high a risk and another company might say that it’s the correct amount.
These companies have capacity and reinsurance capacity, so they might not have room for the risk of your policy, or they don’t have enough reinsurers.
But if you can work with a mutual insurance company, great! We highly suggest it, and the main reason why is because these whole life policies grow with the dividend and when you have a mutual company the owners of these policies are the shareholders. So, they are working in your best interest.
As the company is publicly traded, they don’t have all these eyes on them to hit quarterly results, this allows them to take on longer investments.
9: Thou shalt consider all tax consequences of whole life insurance
Of course, you should consider tax consequences of any financial decisions you make.
But the writer mentions something that’s a little different between Canada and the United States. So, policy loans in Canada are not always tax free, they are as long as the loan amount is below the adjusted cost basis or the ACB.
Once it is above the ACB, a way to get around that is what we have all over our YouTube channel, you’ll see that we say get loans from third parties like a bank. Those loans are always tax-free regardless of size.
They also mention in the article, the tax-free payout of insurance when there is a death benefit paid, that is completely tax-free to your beneficiaries.
There are a few other ways to lose the tax-advantages of the policy, like if you withdraw funds from the policy, the initial money would be considered a repayment of premium but again once you withdraw above the ACB then those withdrawals with be taxed.
There could be some tax-payable if the ownership of the policy changes, corporately. If you built it up in an operating company and now you moved it to a holding company, there would be a “sale” to your company which will be taxed.
10: Thou shalt avoid all opaque and overpriced “riders”
I’m not sure that I’d make this a commandment, you know there are pros and cons.
Riders are essentially like a bolt on addition that you can add to your policy, like a critical illness rider.
A big one that is often used with these policies called a disability waiver of premium, which means if you get sick or injured and can’t work then the insurance company will cover the minimum payment of the premiums for the years you can’t work.
In the infinite banking book, they recommend that you do this so that you lower the risk that you can’t pay for however long.
The article mentions the accidental death rider as one to not get, I agree, we generally don’t use it. They’re cheap but generally useless as most people don’t die in that fashion.
We generally leave these whole life policies as standalone and if you want other coverage like critical illness we would say get a stand-alone critical illness policy.
That way it’s not all tied together and if you want to make changes, you can change one without having to change the other.
There’s some additional cost for having them standalone but the flexibility outweighs that.
So, we generally don’t add riders other than the disability waiver rider and if you want coverage for other things we will set that up for you.
Final Notes
So that was the 10 commandments of whole life insurance, it’s a great article, linked below. I think it’s very rare to find anyone in the FIRE community saying anything nice about the whole life policies as they hate them.
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