The Most Expensive Mistake I See People Make With Whole Life Insurance
Disclaimer: The information provided is for general informational purposes only and should not be considered as professional financial advice. Please consult with a financial advisor for advice specific to your situation.
Whole life insurance might be the most polarizing topic in personal finance. I've been in a room with physicians where one person said it was the best thing ever, and the person right next to them said it was the worst thing ever. If you've ever tried to research it and come away more confused than when you started, that's not a surprise.
This episode is for you if you've heard about whole life insurance, you're wondering whether it's as good as some people say or as bad as others claim, and you're not sure what to believe.
In this episode:
Why whole life insurance is so polarizing and why that's actually a sign it's a nuanced decision
The specific type of whole life insurance this episode is about
The most expensive mistake I see people make
A framework for figuring out if it makes sense for your situation
Two real case studies: one where it didn't make sense, and one where it did
Why Whole Life Insurance Is So Polarizing
Part of the reason this topic creates so much debate is that people treat it as a yes or no question when it's really an it depends question. Any financial product is a tool. A shovel, a drill, a snowblower. None of them are good or bad on their own. Whether they're useful depends entirely on your situation. A snowblower makes no sense if you live somewhere it never snows. It makes a lot of sense if you live in Canada with a long driveway.
The same logic applies here. The emotion around whole life insurance, in either direction, usually comes from people generalizing their own experience rather than looking at whether the tool fits the specific situation in front of them.
One important note before going further: this episode is specifically about participating whole life insurance, not non-participating whole life or universal life. Participating whole life, often called "par", is the type most commonly discussed and debated, so that's the focus here.
The Most Expensive Mistake
The most expensive mistake I see people make with whole life insurance is buying it when they don't actually need it.
Before spending any time learning the ins and outs of the product, the first question to answer is whether you need it at all. Learning everything about a product you don't need is like spending a lot of time learning to pilot an airplane when you have no intention of ever flying one.
The purpose of this episode is to give you enough information to ask the right questions before going down that path.
A Framework for Figuring Out If You Need It
The primary long-term purpose of whole life insurance in the context I work in is estate planning, specifically addressing a tax issue at death.
Here's the decision tree I walk clients through:
First, is there going to be a tax issue? For example, RRSPs have a specific tax reality: when the last surviving spouse passes away, the full value of those RRSPs gets added to the estate in the year of death, and it doesn't take long to reach a 50% tax bracket in Canada. That can mean a significant portion going to taxes rather than to beneficiaries.
Second, do you care? Some people aren't concerned about leaving a legacy, or there are other assets that could address the tax issue, or they feel they're leaving enough regardless. If that's the case, the answer may simply be that whole life insurance isn't needed.
Third, can the problem be solved another way? Through tax-efficient drawdown strategies across different accounts, it may be possible to mitigate the tax issue without purchasing a policy at all.
Only if a tax issue exists, it matters to you, and it can't be solved another way does whole life insurance enter the conversation as something worth exploring.
Two Case Studies
Case one: it didn't make sense. A client came in with significant RRSP savings and a potential tax issue at death. After doing the math and looking at their life expectancy, they realized the likely tax bill wasn't something that concerned them. They felt confident they'd still be leaving enough, and through tax-efficient drawdown planning, the issue was manageable. Whole life insurance didn't make sense for them.
Case two: it did make sense. Another client, described as the most analytical person I've worked with in my planning career, was a self-directed investor who had their corporation and investments well figured out but needed help on the insurance side. After going through the same decision tree, it was clear there would be a surplus at death, it would be taxable, and they wanted to do something about it. Whole life insurance made sense, and the next step was structuring the policy properly.
The Second Most Expensive Mistake
If the first mistake is buying something you don't need, the second most expensive mistake is structuring it improperly. A lot of the criticism you'll find about whole life insurance is based on older ways of structuring the product that are less flexible and grow more slowly than more current approaches. How a policy is structured, how long you pay into it, how much, how much flexibility you want around premiums, and how it interacts with the Capital Dividend Account. That can make a substantial difference in the value of the death benefit and the cash value over time.
What to Do Next
If someone is encouraging you to look at whole life insurance, the right first step is to work with someone who will determine whether you actually need it before discussing the product itself. If the answer is yes, the next step is making sure it's structured in a way that fits your specific situation.
If you'd like to work through that analysis, book a free discovery call and we can figure out whether it makes sense for you.