Advisor to Client: How to pick permanent vs. term insurance

Life insurance can protect your loved ones financially after you’re gone, but picking the right kind can protect your wallet even while you’re alive.

Generally, there are two kinds of life insurance: term life insurance and permanent life insurance.

Permanent life insurance provides lifelong coverage, which can come with tax benefits and dividends but has higher premiums. Term life insurance aims to provide income replacement for a specific period and can be more affordable.

Brooke Dean, founder of BMD Financial Ltd. at Raymond James, likens the two options to renting versus owning.

“Term life insurance is like renting an apartment,” she said.

Similar to renting, people pay for coverage for a set period. When the time is up — similar to a lease ending — the consumer walks away without any ownership or equity in the policy.

“Permanent life insurance is like buying a house,” Dean said. This type of policy has a higher upfront premium, but over time, it can accumulate equity, and people can borrow against it, similar to a home.

Each serves a different purpose in financial planning, and deciding which one is more suitable depends on individual needs.

Jeffrey Talor, director of sales at CanWise Life Insurance Services, says a permanent life insurance policy could be one of the cleanest ways to transfer wealth.

For example, when adult children inherit their parents’ assets — such as a home, cottage or business — the assets are assessed at fair market value and any capital gains are subject to taxes. A permanent policy could provide the cash to settle tax bills without the need to sell any of those assets.

“If you don’t have the cash flow, this is one of the items of strategy that we’re noticing is a great way to mitigate taxes,” Talor said.

A permanent policy can also offer dividends. Dean said a portion of the premiums are typically invested on behalf of the policyholder, with a goal to maximize dividends.

But it may not work as an investment strategy for everyone — especially younger people.

Dean said her clients under the age of 50 often ask about permanent life insurance after hearing it could be an investment strategy.

“If you’re looking at it as just an investment strategy and you don’t have a lot of investments already saved up, then no, that’s probably not the best way to do it,” she said.

Instead, she recommends using it as an investment only after topping up registered savings accounts and exploring other ways to put disposable cash to use.

Talor said some people also buy permanent policies to leave a legacy.

For example, he has seen grandparents buy permanent policies as gifts to their grandchildren, establishing a nest egg for them to leverage or borrow against when they enter adulthood. He said the younger the policyholder, the more time the policy has to accumulate cash value.

Term insurance appeals for being more affordable and accessible, offering large-enough coverage for a set period for young families who may have a mortgage and kids.

Talor said term life insurance can be 10 to 15 times cheaper than a permanent policy.

“The average Canadian cannot afford to buy the amount of permanent insurance they need,” he added.

He often sees clients opt for a blend of both term and permanent policies, which protects them in the short term while building equity in the long term.

Dean said some insurance companies allow rolling or converting a term life policy into permanent life insurance without losing the premiums already paid.

But she said it’s important for people to ask why they need both at the same time.

“Is there still a mortgage outstanding? If you were to pass away, do you still have kids you have to provide for?” she asked. “But you also are making a good income and your RRSPs and TFSAs are topped up.”

“You want that term because it’s cheap, you have the coverage, but you also want to start investing in this other product and diversifying a bit more.”