By Peter Boys, CAFA The Financial Coach
Many affluent individuals in Canada and around the world see life insurance as an important part of their financial planning tool kit. But often the question is asked, if the money isn’t needed, then why buy life insurance? Here are the most common reasons, which can apply to many of us, not just the wealthy.
To enhance investment returns
Investments inside a policy grow on a tax-sheltered basis, which can improve returns, particularly where the costs of managing those dollars inside the policy are reasonable. With many whole-life policies, the fees charged by the insurance company to manage the portfolio of investments are low with very reasonable returns. You can also borrow the funds to pay your life insurance premiums, even when you don’t have to. Since you aren’t putting up much of your own money when buying the policy, the cash-on-cash return is very high when the death benefit eventually pays out. Borrowing is not for everyone, but it can make good sense in certain cases.
To equalize an estate
Some assets may be better left to a certain heir, rather than being shared by all of them. A farm or a business are two prime examples. But, what will your other heirs inherit? If you think it is important to leave your heirs with assets of the same value, life insurance can be a great equalizer. For example, you leave the cottage worth $800,000 to one child, and have $300,000 of investments to leave another. You could buy life insurance of $500,000 to top up the inheritance for the second child so both inherit equal value. You will also need to take into consideration how different taxes may impact the amounts inherited by each of your heirs.
To donate to charity
You can donate to a charity by investing in a life insurance policy to fund a gift upon your death. You can do this in different ways. You could have the charity purchase a policy on your life while you donate the cash annually to pay the premiums and you’ll receive a donation tax credit for the cash donated for the premiums. You could donate an existing policy to the charity today and continue to pay the premiums on behalf of the charity. In this case there could be a taxable event when transferring the policy, but you’ll receive a donation tax credit for the fair market value of the policy today. This is generally the cash value of the policy. You will get a donation receipt for the value of the premiums you pay each year. My preferred method is to invest in a policy that you continue to own, and name the charity as the beneficiary. Another way to do this would be to name your estate as the beneficiary and leave instructions in your will to donate the proceeds to charity, but this will give rise to probate fees in most provinces.
To cover taxes on death
If you have illiquid assets that will give rise to taxes on death, such as a farm, small business, real estate, or other capital property, give thought to buying life insurance to cover those taxes. This way, your estate doesn’t run into a shortage of cash when you pass away.