Participating Life Insurance – The Third and Final Chapter
For those of you waiting with bated breath, here is the third and final installment in my series on Participating Whole Life Insurance aka “Par Policies.” The first and second chapters of this exciting story describe what these things are and how they work, including some information on what the insurer considers when determining what to pay you in policy dividends each year, and exploring your different choices for what to do with these things, along with the tax consequences. Today, we get practical. I’ll talk about some of the different types of Par Policies currently available, how you can use them to help fund your retirement and, perhaps most importantly, what to consider when you’re looking to buy a policy. With no further ado, here goes . . .
Different Options within Par Policies
Just like car companies offer different versions of the same car, insurers offer different versions of Par Policies tailored to suit different clients. Here are two of the most common options:
- Limited pay policies. Rather than signing on to pay premiums for life, some people may want to cap how long they need to pay into their policies, even if this means paying higher premiums until the policy is “paid up.” This means a lower return on your investment if you die earlier, as you will have paid more into the policy by that point than if you selected a pay for life option. It may also result in building a cash value inside the policy quicker, since you have paid more into the policy. You may also be able to continue to pay into the policy after it is paid up, if you have the necessary cash and you want to grow the death benefit or have more funds available for retirement funding strategies.
- Cash value options. Some polices may offer a higher guaranteed cash value sooner but less growth later on while others may prefer policies with a lower cash value in the early years but which has the potential to grow both the death benefit and cash value to higher levels over the long term.
Retirement Funding By Using the Cash Surrender Value as Collateral
I plan another article entirely on using life insurance for retirement funding purposes, but, for now, I just want to ensure that you are aware of this option. This strategy involves using a personally or even corporately-owned life insurance policy as collateral for a bank loan. Some institutions will require you to make annual interest payments on the loan while others will simply add the interest to the outstanding balance. Ultimately, the plan is to continue borrowing against the policy for life and then using the tax-free death benefit to pay off the debt at death.
Many people like this strategy because allows them to access tax-free money during retirement that won’t screw up their OAS pension or other income-related benefits, or shoot them into a tax bracket located in the upper stratosphere. In other words, they expect their money will go further if they pay interest on the loan to the bank rather than paying tax on other investment options or from pulling money out of the policy in other ways.
While this option may be a wonderful opportunity for many people, it is also important to understand the pros and cons in greater detail before taking the plunge. I’ll save that analysis for another day.
Things to Consider When Comparing Par Policies
If you are looking at purchasing a par policy, here are a couple suggestions or things to keep in mind before signing on the dotted line:
- Compare the dividend scales. Obviously, the higher the better, which can mean a higher cash value or reaching premium offset sooner if nothing changes.
- Look at history rather than just the present. Just like when looking into a dividend-paying stock, check out the company’s past performance. I suggest that you opt for a company that has historically provided high and relatively stable rates over time rather than just looking at the current payout.
- Compare the companies’ own financial history. I prefer dealing with the bigger insurance companies with a good reputation that have been around for a while. You want reputable companies that will stand behind their policies and have solid balance sheets.
- Compare cash values. Although most of us don’t buy permanent life insurance with the intention of cashing it down the road, life is full of surprises. Accordingly, it matters to me how much the different policies are guaranteeing a different times if I want to cancel my policy or borrow against this cash value. Most policies will provide you a schedule of the guaranteed cash value for the life of the policy. Although you can increase the cash value if you keep some of your policy dividends inside the policy and buy “paid up additions” as discussed in my last article, they will be added on top of the cash value provided to you in the original schedule issued with your policy.
- premiums, premiums. Regardless of the dividend scale and cash values, don’t forget to compare premium costs. Although one company may offer a higher dividend scale, this may lose some of its lustre if you discover that you have to pay a higher premium in order to get it. This may simply mean that the higher payer was even more pessimistic when first calculating premiums rather than doing a better job managing money and its investments. As well, different companies may have different opinions about your current health. Even if a company offers a higher dividend scale and lower premiums for clients in top health, this may not be your best choice if another insurer charges you standard rates while your first choice wants to increase your premiums because they think you should work out more and eat less bacon.
- Run multiple illustrations. When an advisor shows you the potential performance of the policy over time, this is called an illustration. The fine print says that they can’t guarantee what the dividend scale will be going forward. Noting today’s low interest rate environment and because I want all of my surprises to be good ones, I suggest getting your advisor to illustrate the policy’s dividend scale is lower than today’s in the future. This helps you plan and prepare for unpleasant changes and give you some wiggle room when making your future plans. I suggest getting illustrations done at both 1% and 2% lower than the policy’s current dividend scale. Perhaps the dividend scales will stay around the same point or even increase over the long term, but I suggest erring on the side of caution, especially if you are comparing potential returns to other investment choices or planning on using the cash value to help fund your retirement.
Although Universal Life Insurance Policies may offer more features and flexibility than Par Policies, I strongly suggest making Par Policies part of the discussion when deciding which type of permanent insurance works best for you. Although they are hard to understand and how their payouts are determined remain something of a mystery, most companies have a solid track record of providing solid returns over a long timevframe. While they might not be right for every situation, the only way to know for sure is to ask the right questions and determine this for yourself, along with the advice of a good financial planner or insurance advisor.
As always, I welcome your comments, questions and suggestions for future articles. Stay tuned for my next article, which will probably be on Universal Life Policies, although just like insurance companies, I can’t guarantee future performance.