Insurance 201: the “whole” thing
By Arnold Machel, CFP®
“A good person leaves an inheritance for his children’s children…”
– Prov 13:22 NIV
Last month we discussed the first step in considering Life Insurance – determining just how much insurance one needs. This month we’re looking at the second step – determining what type of insurance one might want.
When you are younger and have dependants, Life Insurance is a need, but sometimes in later years of life there might also be a place for it. It’s just not as critical then. It might make sense and you might want to do it, but it’s a want at this stage rather than a need.
In order to better explain how Life Insurance works, we can separate it into two basic categories: Term and Whole Life.
Term Life is like your car or house insurance. You pay for it, but if you don’t have a fire or break-in at your home, you can’t collect on it. In the same way, when you buy Term Life, if you don’t die within the term, you don’t collect on it either.
Typical Whole Life on the other hand is a type of policy that is designed to be there for the whole of your life, hence the name. You are covered for the whole of your life.
To make things more confusing there are other types of insurance, but ultimately I think you could place them in either of the two aforementioned categories. Just to bring up two of the most common examples: Term to 100 (not really Term, but rather a stripped down Whole Life) and Universal Life (also mostly a type of Whole Life, but can include term components and is much more transparent than typical Whole Life). For the purposes of this article I will consider both to be whole of life insurance products.
Why wouldn’t everyone want to get Whole Life, then? Well, Term Insurance is usually much less expensive, because the odds of the insurer paying out are low, so it’s ideal for younger families that need to maximize the amount of insurance they have. Whole Life Insurance, on the other hand, can be relatively expensive, because as long as you make the payments the insurance is guaranteed to pay out. The question is just, when exactly will it pay out? Will it be next week? Or next year? Or another 40 years from now? No one knows for sure, but we all know it will be paid.
For example, on a $100,000 insurance policy, while the insurance company knows they will have to pay at some point, they may not have to pay until you die at age 101, or they may need to pay out immediately following the first monthly payment of $100. Either way they are on the hook for the full $100,000, so they use actuarial calculations to figure out how much they need to charge.
There are groups out there that religiously and dogmatically espouse the view that no-one should ever own Whole Life and advocate for Term Life only. Nothing could be further from the truth. Neither type of policy is the right solution for every person. Circumstances, not dogma, dictate what type of insurance you should have.
Whole Life can be extremely valuable if you expect liquidity concerns at death. A common issue for business owners wanting to pass their business on to their kids is the fear that they will have to sell the business at fire sale prices just to cover off the tax bill. Or maybe you have a vacation property with a large capital gain, but it’s important to you that the kids are able to keep it.
Let’s look at the math. Let’s say that you own a vacation property in Whistler that you paid $100,000 for 25 years ago and today it is worth $3 million. Let’s also say that you figure that by the time you die, it will be worth double that, or $6 million.
If your family doesn’t care much about the property, it’s no big deal. When you die, they can sell it, pay the tax bill and divvy up the remainder. But let’s say that your two children and your seven grandchildren have spent a lot of time up there and make extensive use of the place, and it’s important to you that they be able to keep it in the family. That might be hard to do.
The income tax owing by the estate on just that property alone would be over $1.3 million. That’s based on a capital gain of $5.9 million becoming a taxable capital gain of $2.95 million being taxed at BC’s highest rate of 45.3 per cent Maybe there will be enough liquid assets in the estate to cover that off. But if not, and if you want to ensure that the property stays in the family, then getting a $1.3 million insurance policy might make sense.
The math is similar regardless of what the asset is. Instead of a business or a vacation property it could be art, jewelry or even a vintage car collection that causes a liquidity concern. The point is that where liquidity at death is an issue, insurance can be a very good tool to use.
There are many other instances where Whole Life insurance can make sense financially. Ensuring that a specific group or person receives a set amount on your death is another common use. Creating an estate bond is another.
Sadly, insurance was given a bad reputation years ago by poor and manipulative sales techniques, but don’t let a past bad experience prevent you from exploring all the best opportunities for your given situation. At the end of the day, having an insurance advisor who knows your circumstances, and that you can trust is key.
Arnold Machel, CFP(r) lives, works and worships in the White Rock/South Surrey area. He attends Gracepoint Community Church where he serves on the Leadership Team. He is a Certified Financial Planner with IPC Investment Corporation and Visionvest Financial Planning & Services and provides insurance services through Visionvest Financial Planning & Services Inc. Questions and comments can be directed to him at email@example.com or through his website at www.visionvest.ca.
Please note that all comments are of a general nature and should not be relied upon as individual advice. While every attempt is made to ensure accuracy, facts and figures are not guaranteed.