Seven key financial benefits of life insurance

How life insurance advantages go beyond protection

Life insurance can protect your family’s lifestyle should tragedy strike, taking care of your mortgage, replacing lost income, or putting your kids through college. But if you aren’t looking beyond its traditional role, you’re missing the big picture.

Think of the right life insurance policy as the Swiss army knife of your financial toolkit. It’s one seemingly simple, but multi-purpose tool, and can enhance your financial and estate planning in a number of ways, including a few you probably haven’t thought of. Here are seven reasons why you should have it in your corner.

1. Create a tax-sheltered investment

Insurance can help you build wealth and reduce taxes. When you think of life insurance, those aren’t the first things that come to mind. But with the proper policy, you can do both.

Under special provisions in the Income Tax Act, permanent life insurance – whole life and universal life – is generally considered “exempt” insurance. Premiums paid into exempt policies over and above what’s needed to keep insurance protection in force are eligible to accumulate in a cash or savings component of the policy, delivering two key benefits.

First, those dollars are free to grow tax-sheltered, similar to an RRSP, as long as they remain in the policy. That’s why permanent life insurance can be especially attractive as an investment option if you’re a high earner who routinely maximizes your RRSP and TFSA contributions, and you’re seeking additional ways to shield your income and capital from taxation. Plus, in the end, the policy’s proceeds, including the savings you’ve built up, can be paid out tax-free to your beneficiaries, estate, or to a charity of your choice.

2. Hedge against market volatility

Most whole life policies are "participating" – when you have one, you’re essentially sharing in the insurer’s earnings through a regular dividend that accumulates within the policy. These dividends help produce a steady and consistent rate of return that’s independent of the daily fluctuations of financial markets. In this way, whole life behaves as a separate asset class, with a different risk profile than a conventional investment portfolio.

3. Preserve and protect your wealth

Taxes are hard to avoid, even in death. Without proper planning, the estate you leave behind to your loved ones could come with a hefty tax bill.

Your death (or the death of your surviving spouse) automatically triggers any capital gains accumulated on unsheltered assets like your non-registered investment portfolio or rental real estate. If you own a vacation property south of the border you can face U.S. estate taxes. There’s also the sobering fact that a significant portion of the value of your RRSPs or RRIFs can be taxed away, since they’re now reclassified as income.

If your beneficiaries don’t have the means to cover your obligations, they might be forced to sell off property, including treasured assets like a family cottage, to raise cash. Even worse, it might be sold at a discount.

That’s where life insurance steps in. A policy’s proceeds can supply much needed liquidity to your estate – and do it immediately and tax-free – to settle your taxes, debts, and other expenses, preserving your legacy. Unlike property handed down through a will, which could be fought over during estate settlement or exposed to creditors, life insurance benefits can go directly to named beneficiaries, bypassing probate.

4. Share your estate equally

A vacation home. A business. A sentimental piece of jewelry. If the plan is to hold on to indivisible assets like these, you could have a dilemma when figuring out your future estate. Say, for example, that one of your children wants to carry on the family business. Chances are it has significant value, perhaps accounting for a large chunk of your legacy. Life insurance can provide the means to compensate your other heirs monetarily and equalize each beneficiary’s inheritance, helping keep peace in the family.

5. Tap into a source of cash and income

One advantage the cash value you amass in a permanent life insurance policy has is that it’s accessible, and can be used to cover expenses or supplement your retirement income.

There are generally three ways to tap into your policy’s cash value.

Leverage your policy: Your first option is to “leverage” your life insurance policy, using it as collateral to obtain a loan from a financial institution. While you’ll still be responsible for the loan payments, the borrowed funds are tax-free. If you’re asked to assign your policy to the lender, part of your insurance costs may be tax-deductible.

Policy loan: Alternatively, you can borrow from the insurer through a policy loan. Think of it as an advance against the death benefit of your policy. The funds are tax-free, provided the advanced amount doesn’t exceed the policy’s adjusted cost base (in a simple situation, your total premiums paid less the net cost of insurance).

Withdrawal: Finally, you can withdraw from the cash value of your policy. There are two key points to remember about withdrawals. The amount can’t be repaid, which may wind up reducing your death benefit. And, the withdrawn funds are taxable if the cash surrender value of the policy (amount net of any outstanding policy loans, interest and surrender charges) is more than its adjusted cost base.

Having the ability to utilize your life insurance policy’s cash value adds important flexibility in managing your finances. Bear in mind though, that the finer details around each option means it’s best to seek financial guidance from an advisor before you act.

6. Leave more to charity

Donating a life insurance policy to charity has the potential to be more rewarding for you and your favourite cause than simply giving cash.

For one, it may make it possible to leave a larger gift than you otherwise could, enhanced by tax-sheltered growth and a tax-free payout, all for a modest monthly premium. How you choose to give your gift – naming the charity as the owner and beneficiary of your policy, retaining ownership yourself, or taking out a new policy in the charity’s name – will determine if you’ll receive donation tax credits now or if they’ll go to your estate later. Your advisor can explain the pros and cons of each approach.

7. Secure guaranteed retirement income

For risk-averse and looking for a way to invest your taxable savings, annuities are a great way to secure guaranteed income tax-efficiently.

With an annuity there's no guesswork. It's an insurance contract that offers a steady, predictable stream of payments either for a specific time period or for life. These payments continue regardless of what financial markets or interest rates do.

When you use your non-registered savings to purchase a prescribed annuity, the income you receive and the accompanying tax obligation are spread evenly over the life of the annuity contract, rather than being naturally higher in the first few years when the annuity’s principal is greatest. This levelling-out process is a form of tax-deferral, which can help boost your after-tax income compared to using alternative interest-bearing instruments.

For those considering annuities, it can be a sticking point to know that once the funds are committed and the annuity is purchased that the money cannot be returned. If you die prematurely, that capital, which may have represented a good portion of your life savings, stays with the insurer instead of going to your estate. An insured annuity can solve this problem.

When you match an appropriate life policy to an annuity, there’s an important difference. When you die, the life insurance benefit will go tax-free to your beneficiaries, replacing the funds used to buy the annuity, letting you preserve more of your estate for your heirs.

Sample illustration for females age 65 using 1) single-life prescribed annuity (no guarantee period); 2) universal life policy at standard rates and level cost of insurance.

Understand all the advantages

When you’re weighing investment, estate planning, and risk management strategies, it’s important not to look past the multiple benefits of a well-selected life insurance policy.

At BlueShore Financial, our in-house wealth protection experts will explain your options and recommend solutions to help you reach your financial goals, with the peace of mind that comes with being properly protected. Contact your advisor to learn more.