Is Your Life Insurance Policy Just a Protection Plan?
Ray had thought of his life insurance as purely a protection plan. Taking a holistic approach to his finances prompted him to explore his current life insurance policy for tax deferral options.
The Universal Life Policy
His type of policy, called Universal Life (UL), separates the cost of insurance and the “savings” element/investment portion of the premium. Premiums are flexible, so you can choose how much goes into savings, within certain prescribed limits. The big bonus is that it receives more favorable tax treatment than a similar outside investment (similar to a TFSA).
Universal life policies have three major tax advantage features. They can allow your savings to accumulate tax-deferred. The interest can be used to pay for the insurance costs, tax-free. And the untaxed accumulation can be paid out tax-free at death.
After the cost of insurance is taken from the premium, the balance is invested at current interest rates. The interest earned is not taxed as long as the policy is “exempt” under the Income Tax Act. Most Universal Life policies are exempt. The life insurance company monitors these policies and warns you if there is going to be a change in tax status.
Investment Options Advantage
The first advantage of investing in a UL Policy is that it has investment options that may compound on a tax-deferred basis. This is illustrated by the insurance company for the client to assist in making an informed decision.
The Savings Element of Your Policy
The second tax advantage is that you can use the savings element of the policy to pay for the cost of insurance. Because the earnings within the policy are tax-deferred, you can actually pay the insurance costs with untaxed dollars. The investment portion truly comes in helpful in the future; should you forget to pay your premium for any reason, the payment will be taken from the investment account to ensure your policy does not lapse.
Your Policy is Passed onto your Beneficiaries With NO Taxes!
The third tax advantage is that upon death the total investment and face value of the policy can be passed on to your beneficiaries without any tax whatsoever. Life Insurance is typically exempt from probate in Ontario – that means, at death, it will be paid out quickly to your loved ones. Reminder: if possible, name beneficiaries on your insurance policies.
To be honest, most people don’t fully understand their insurance policies- and that’s okay! They can be complex and confusing. Please reach out anytime…We are here to help guide you.