When making decisions, we often consider the pros and cons, then make the best possible decision with the information we have. The same process that applies to everything from choosing our breakfast to picking a movie also applies to financial decisions. One of the most common questions we get on the insurance side is how to decide between term or permanent Insurance.
What is term and what is permanent?
Term insurance is temporary and designed to cover the “if”. For example, if you die in the next X years, your beneficiaries will receive a payout through your term coverage.
Permanent insurance is forever (no surprise there) and covers the inevitable “when”. For example, when you die, your beneficiaries will receive a payout through your permanent coverage.
What are the pros and cons?
To determine these, we must look at the factors that influence them:
- Situation – Outstanding mortgages and loans, future earnings from income, buy-sell agreements for businesses, estate taxes, charitable giving are just some of the scenarios where insurance is necessary. To determine whether it is term or permanent, we can ask, is the situation an “if” or a “when”? In the eventuality we have a short-term “if” problem, the pro of term insurance is that it is lower in cost. Term can also be converted into permanent coverage if needed.
- Timeframe – When talking about the problem we are solving, how long that problem will be around for can determine our solution. The pro of permanent insurance is the younger you obtain it, the lower the cost. Even though term can be converted into permanent, the later it is done, the more costly it will be.
- Growth component – Will the problem continue to get bigger as time goes on? An example of this is estate taxes. The problem today might be much bigger 10-20 years from now. The con with term insurance is the amount of insurance is typically fixed, so if someone needed to add to their coverage, they would have to do so at a higher price and premium. Some permanent plans are designed to grow with your needs over time.
- Cash Flow Component – What type of cash flow do we have to allocate? Is it personal or corporate cash flow? Term is a lower cost and requires less cash flow to support it. Sometimes a combination of both term and permanent solutions can meet the conflicting needs of coverage vs. cash flow.
After assessing the breakdown, we can then apply the appropriate insurance to real-life scenarios.
Carol and John are business partners each owning a 50% share of XYZ company. They have a shareholder agreement in place with John expecting to retire in the next 10 years. The agreement states that, upon death, each partner agrees to buy the other partner’s shares. The agreement is not currently funded.
Currently, in the event of death, the surviving partner would have to get a bank loan or sell a portion of the company or assets in order to pay for the shares of the other.
Since John is planning to retire, and there is a timeline in place, Term would be a great solution for each partner “if” the other were to pass away. The term policy would be a lower cost and cover each partner’s concerns.
Mary has her own incorporated business. Over time, the business has done very well, and she has grown the assets considerably inside the corporation in order to benefit from preferable tax treatment. Mary has two children, and she will have more money in her corporation than she can spend. She wants to pass on as much as possible to her children while minimizing taxes. If Mary were to pass away today a large portion of her estate would be subject to taxation. The problem she has today will continue to grow over time.
A permanent whole life insurance policy provides the added benefit of annual policy dividends (not guaranteed) used to purchase additional life insurance protection that increases the total death benefit year after year.
If Mary passes away today, her estate is taken care of, and as it grows, her life insurance policy will grow with it to take care of future needs as well.
When looking at any insurance solution, the most important thing to consider is how it fits into your plan. At Tall Oak Private Wealth, we tailor your plan to fit your unique needs and find solutions for the short and long term. To learn more about how we can help start your plan today, please click here.
This material is provided for general information and is subject to change without notice. Although every effort has been made to compile this material from reliable sources; no warranty can be made as to its accuracy or completeness, and we assume no responsibility for any reliance upon it. Before acting on any of the above, please contact Tall Oak Private Wealth of Raymond James Ltd., for individual financial advice based on your personal circumstances. Raymond James Ltd. – Member – Canadian Investor Protection Fund. Insurance offered through Raymond James Financial Planning Ltd., not a member-Canadian Investor Protection Fund.