What is Participating Life Insurance!!!!!

This is an edited version of an article that was originally published for subscribers in the June 9, 2017, issue of Investor’s Digest of Canada. 

Mark Halpern is a Certified Financial Planner (CFP), Trust and Estate Practitioner (TEP) and one of Canada’s top life insurance advisors. 

With interest rates low, tax rates high and equity markets unpredictable, you’re probably struggling to find the right place to put your money.

During those struggles, have you overlooked a relatively ignored asset class that nevertheless has an established history and a well-known name? It’s life insurance.

This is where life insurance comes in. It satisfies the sensible investing definition by balancing risk in your investments, preferential tax treatment and the added peace of mind knowing that your heirs and other beneficiaries will be looked after.

I’ve always considered life insurance to be central to any estate-planning portfolio.

A whole life insurance policy backed by a participating account (that is, the pool of premiums collected from clients holding the policy) is also an excellent way to reduce risks in the fixed-income portion of your portfolio. It provides liquidity and dividends with excellent returns. In addition, you can use it as part of a corporateinvestment portfolio.

Fixed income is an essential asset class within most diversified portfolios, often increasing in proportion as people grow older and desire less risk in their lives.

There are basically two kinds of permanent life insurance, participating (or par) and non-par (which includes universal life).

While both have their strong points, a recent report indicated that participating life insurance beats out universal life insurance in terms of greater cash surrender values and liquidity, even though par has a higher initial premium commitment than universal life.

The icing on the par life cake includes added protections and guarantees for the level of premiums you pay, the death benefit, and the growing cash values within the policy.

These safety measures are essential in volatile markets and a low interest rate environment; they also have a major impact on the amount of wealth ultimately transferred to your heirs and beneficiaries.

Par policies are also important during your lifetime. Over the past 25 years, the dividend scale interest rate for par whole life insurance from a leading Canadian insurer has remained relatively stable and attractive when compared to alternatives (such as a five-year GIC rate over the last 25 years).

The advantages of participating life insurance

The death benefit is also greater for par insurance than for the alternative, non-registered fixed income investment.

The funds in a par insurance policy are professionally managed, just as they are in an average balanced portfolio.

While focused on stability, the investment returns from par insurance funds sometimes outperform those of balanced funds. That’s because life insurance companies are large and diversified in their holdings, investing in a conservative mix of assets that include government and corporate bonds, real estate and equities.

Canadian par accounts have existed for more than a century and some now exceed $26 billion. The large size of these pools allows management costs to be spread out over a greater number of people, keeping them low. A unique feature to whole life is that their returns are ‘smoothed’ over time, removing some market volatility on par life insurance policyholder dividends.

Participating insurance packs an extra punch

‘Profits’ from the par account are distributed to par policyholders via dividends.

These dividends can be used in a variety of ways. Three options are:

■ Leave dividends to compound within your policy on a tax-exempt basis, increasing your cash value as well as your death benefit;

■ Take the dividends in cash; or

■ Leave the dividends in cash within the policy and earn interest.

The par policy has accessible cash value that accumulates similarly to interest-bearing investments.

Even if the markets take a tumble, your policy cash values will not decline with the markets.  This essentially means that there is very little risk to your investment capital.

And, as long as the funds remain in the life insurance account, they are sheltered from tax—a meaningful bonus at any time.

Many insurers have enjoyed a long history of providing dividends. It’s important to remember, though, that because these dividends are based on future events such as costs and earnings, they are not guaranteed.

While performance in par accounts is relatively stable and predictable, it is difficult to determine how any asset class will perform in the future. If interest rates rise in the future, this could influence how you value current returns from par life accounts.

The corporate side

Let’s not forget that at the end of the day, the policy provides a tax-free death benefit to the insured’s beneficiaries without the hassle of going through probate.

On the corporate side, life insurance proceeds make the most sense.

Besides using lower-taxed 15 per cent after-tax corporate dollars to pay for the policy versus 53.53 per cent personal after-tax in Ontario, insurance proceeds at death create a credit to the capital dividend account of a private corporation and are then paid to the deceased’s estate or shareholders with little or no tax.

This can mean considerable tax savings since dividend tax rates have increased to 39.34 per cent (eligible), 45.3 per cent (non-eligible) and the personal marginal income tax rate to 53.53 per cent in Ontario.

Additional strategies are available to cut the tax bite to your corporation during your lifetime; these should be explored with an insurance and estate planning professional.

For readers 65 and over, a life insurance policy can be added to a life annuity to create what is known as an insured annuity. These annuities can provide a high-yield investment for your retirement income. This strategy can also be used advantageously in a corporation.

Life insurance is the most cost-effective way to preserve and transfer wealth to your heirs tax-free. A participating account-backed whole life insurance policy provides unique benefits to enjoy during your lifetime, and should be considered as part of your comprehensive tax, retirement and estate planning.

Don’t do this alone. Work with a certified financial planner or trust and estate practitioner to get the reliable advice you need.