Permanent vs. Term Life Insurance

While I was on The Wealthy Barber podcast, David Chilton asked me whether I had analyzed cash value insurance.  Mainly, I’ve looked into projections from those selling cash-value life insurance.  They’re like puzzles to try to see where the mistake is.  Usually, they fail to take material cash flows into account, like ignoring tax on certain amounts, or they add dollar amounts from periods decades apart without taking into account inflation.  I haven’t looked at many of these projections, but the ones I’ve seen are flawed.

Too much of the life insurance industry tries to confuse people into buying life insurance with premiums that are too high and coverage that is too low.  The truth is that almost everyone is best off with term life insurance with a death benefit large enough to properly protect their families.

Here are the broad types of life insurance.

Term life insurance

Term life insurance is quite simple.  You pay a fixed premium for some period like 20 years, and if you die, your beneficiary gets the death benefit.  This is the cheapest form of life insurance by a wide margin, and it matches most people’s needs.  Your family needs your income for 20 or 30 years, and if they lost your income, they might need more than a million dollars to get by without it.  I give some examples below of the cost of different types of life insurance.

Cash-value life insurance

Cash-value life insurance is a type of permanent insurance that lasts for your whole life.  The two main types of cash-value insurance are whole life and universal life.  Both types combine a basic death benefit with complicated investment components and cash-value rules.  Few people need any of this.

The investment component of cash-value insurance is typically not as good as what people can do using a simple RRSP or TFSA.  Those rich enough to use all of their RRSP and TFSA room can usually afford to hire a fiduciary financial planner to analyze whether they could benefit from cash-value life insurance.  A specific circumstance where cash-value life insurance may apply is covering capital gains taxes on a family cottage so your children won’t have to sell it.

Term-to-100 life insurance

Between term and cash-value is term-to-100 life insurance.  You pay fixed premiums your whole life and leave a fixed death benefit.  This might make sense if you have a special-needs child, but consider an RDSP first.

Bequest motive

If you want to leave a specific amount as an inheritance, some form of permanent life insurance might make sense.  Just be sure to understand the effects of inflation.  A million dollars might be the cost of a modest car in 50 years.  I often see beneficiaries receiving death benefits of something like $15,000.  This starts when parents were young and $15,000 was a lot of money and a wonderful legacy to leave to their children.  Fast forward several decades and that inflation-decimated $15,000 isn’t life changing.

The plan I chose when I was young was to use term life insurance in case I died young, and to save in RRSPs and TFSAs.  The legacy I will leave my children will be much larger this way than if I had chosen permanent life insurance and the death benefit I could afford back then.

Some people worry that if they plan to save a legacy in RRSPs and TFSAs that there will be nothing left by the time they die.  For this reason, they want life insurance.  But those under financial pressure often let their life insurance lapse or they take out the cash value and their beneficiaries get little or no death benefit anyway.

Monthly Premiums

The following table gives a rough idea of the cost of a million dollars of coverage for a healthy person.  The amounts shown are the best information I could find and are not guaranteed.

Age	20-Year Term	Term-to-100	Universal Life	Whole Life
30	$35–$55	$400–$500	$300–$600	$500–$800
40	$65–$110	$550–$800	$450–$900	$700–$1200
50	$150–$260	$800–$1200+	$800–$1400+	$1200–$2000+

The cost of term life insurance is a tiny fraction of the cost of the permanent options.  Faced with a salesperson pushing permanent life insurance, people often choose coverage for a smaller death benefit than they need, because they can’t afford the high premiums.  For most people, term life insurance with a large death benefit is the best option.

Conclusion

Permanent life insurance is costly and not suitable for most Canadians.  Term life insurance matches most people’s need to protect their families for 20 or 30 years.  Those who still need life insurance beyond this point can often satisfy that need by renewing their term life insurance.  I have yet to see a reasonable projection of the investment component of cash-value insurance where the investment performs as well as simply investing in an RRSP or TFSA.  If you think you need permanent life insurance, you likely need an expert fiduciary to do the analysis.