Term vs Permanent – Don’t Get Ripped Off On Life Insurance – Part 2

I discussed last month why to avoid mortgage insurance and the unfortunate situation where mortgage providers often push it to make a buck at your expense. (see here if you missed it) This month: I’m going to talk about Term Insurance vs. Permanent and where in some instances, Life Insurance providers try to make a buck at your expense.

So should you buy term insurance or permanent? Let’s consider the differences between the two and then what you actually need:

Term Life Insurance

Term Life insurance is coverage for a specific period of time (10 or 20 years being the most common). When you buy term, you get a level premium that stays the same for the term of the policy (say 10 or 20 years). BUT after the term is up the insurance will cost you more AND you don’t get anything back from the policy (no cash value). Term life insurance coverage usually expires before you do: but is much less costly than permanent.

Permanent Life Insurance

Permanent Life Insurance (Term 100, Whole Life or Universal Life) typically has a fixed premium for life,  and does accumulate “cash value” over time. If you cancel it you’ll get some of the cash value back. Some policies have other additional features like dividends or increasing insurance coverage.

On the surface: Permanent sounds pretty good doesn’t it? Well unfortunately this is usually how many life insurance agents sell it. “You want something that increases in value over time right?” “You don’t want to just be wasting money on term insurance do you?”

Pre-Retirement: Buy Term Insurance – Invest The Difference

Most people need life insurance during their pre-retirement years to cover their debts and protect their family should they pass away prematurely before they’ve built up sufficient assets. This is a temporary need: Therefore you need temporary insurance (aka term insurance). If you’re doing good financial planning, you’ll be able to build up the assets you need by retirement, so that if you did pass away unexpectedly your family would have the retirement assets you are no longer going to use to provide. You likely won’t need term life insurance in retirement to protect yourself, as if you are prepared well for retirement you’ll have sufficient assets available should anything happen to you.

Without boring you with a ton of numbers, let me also submit to you these two little gems:

1. Permanent life insurance often costs 10x the cost of term insurance.

Having done the math myself, I would rather spend 1/10 the cost of permanent life insurance on term insurance and invest the difference. That way I’ll be MUCH further ahead by retirement. My investments will be worth far more than the cash value of the policy would have been worth. Even with a low risk tolerance and very conservative investments this is still true.

2. The amount of life insurance you need (pre-retirement) should DECREASE over time.

The closer to retirement you are the more assets/investments you should have built up, therefore your need for life insurance decreases as your assets grow. Term Insurance is great for this as each time your term life insurance policy is up, you buy a new smaller policy (which will keep the price in check, as term insurance costs do increase as you get older).

Why Didn’t My Life Insurance Agent Tell Me This?

So why do people often fall into this trap? Well just like mortgage insurance we discussed last month the same issue happens here. Life insurance agents (such as myself) receive a commission based on the monthly premium and the term of the policy. So the higher the premium and the longer the term the bigger the commission. So if permanent life insurance costs 10x more, your agent’s premium will be at least 10x more. Unfortunately, there is a financial incentive to push (particularly younger clients) to purchase permanent life insurance when it really isn’t in their best interests to do so. Again it comes down to money.

There are a few other things to consider in making the decision about what kind of life insurance to purchase, but usually the most important debate is between term and permanent and in most cases if you’re pre-retired it’s going to be term.

So should anyone ever purchase permanent life insurance? – I’ll discuss that next month – The answer may surprise you.

Market Watch July 2014 – Still Concerned About How High Markets Are

Take a look at the graph below. This is the S&P 500 index going back to 1975. It is one indicator (among many) of how markets are doing.  As mentioned in June, it down-right scares me.  I’ve made some significant changes to my own portfolio and suggested the same to clients as to prepare for the inevitable “correction” or crash. I don’t know when it’s going to be; could be 2 years or 2 weeks, but it is coming. What changes you need to make all depends on how close to retirement you are. The closer to retirement you are the more you should move to safety. Past performance doesn’t always predict future performance, but if you can’t afford to wait out another major crash, you need to change things in your portfolio.

SP500July112014S&P 500 graph. (Live Here)

Why are the Market’s so Volatile Now?

I’d like to point out something else perhaps a bit more subtle, which you may have missed while considering the implications of the right side of the graph. I’d like to point out the not so subtle change in how markets seem to behave that happened in the late 90’s. Before that time, markets seemed to gradually grow with the occasional dip (crash), but all in all certainly didn’t seem to be as volatile as today. The “booms” and the “busts” seem to be much more pronounced now and amplified as compared to earlier years. Market cycles will always happen but why do they seem to be so much more drastic now?

How GM’s supply chain mirrors the global economyFreedomVehicle_600px

Libraries could be filled with books that analyze this topic; Let me use one fairly straight-forward example. Consider for a moment the GM plant in Oshawa. As some of you are aware, they use a “Just In Time” (JIT) inventory system. Meaning the car parts that are needed roll into the plant often within the hour of being put on the new vehicle. Imagine for a moment the co-ordination that is required to do this! It’s really very incredible when you think about how many small parts make up a car. GM’s supply chain can operate very efficiently because they don’t have to have massive warehouses full of the automobile parts they need. This saves GM (and other manufacturers) huge amounts of money, fewer warehouses, less security, less staff, less working capital tied up! But now consider the effect of a strike at one of the (many) suppliers of parts. GM holds no inventory so if their supplier stops it can stop the whole plant, which not only can halt GM’s production, but all the other suppliers too! 30 years ago it wouldn’t have been such a problem. GM would have had a warehouse full of inventory and could last for a while even if a supplier was on strike. They’d have time to try and source things elsewhere. But today with the sophistication of computers assisting in coordinating, problems can spread and are amplified as there is less and less “slack” in the system to absorb shocks. Granted this example is somewhat simplified, but conceptually I think you see where I’m going.

The Global Economy Is Getting Tighter and More Integrated

Now consider for a moment the global economy and how it is only getting more integrated and tighter as companies cut the slack to be more efficient and lean! Companies have to do this to not only stay competitive, but to survive. In a steady-state world economy these efficiencies are good for (almost) everyone!  But the global economy is anything but a steady-state-system. Small problems can grow into very big problems as there is less and less slack in the system. These problems aren’t contained any longer by industry or geography; economies are even more integrated globally! When a big enough domino falls, it brings a lot more down with it today than it would have 30 years ago.

So what does it mean? Well I don’t believe the markets are going to go back to the “glory days” when all they seemed to do is go up, I think the new economic realities are swings like we’ve seen in the past 15 years. This doesn’t have to be a bad thing, there is still great opportunity for investing, you just have to be disciplined (that hasn’t changed at least). When markets are up, starting to take some of your money off the table is always a good idea, if we expect major market swings; all the more so. Markets are way up right now.

Next Month – We’ll look at the impact of high frequency-trading and how it can contribute to rapid crashes.

Mortgage vs. RRSP vs. TFSA – Where Should I Put My Money? – Part 2GreenPigBlueHatTFSAsmall

Carrying on from last month’s Mortgage vs. RRSP let’s throw TFSA’s into the mix. TFSA like RRSP’s can hold a variety of different investments. Generally anything you can put into an RRSP you can also put into your TFSA. Be it stocks, bonds, mutual funds, GIC’s, any of these can be put into a TFSA.

Many clients I bring on have virtually ignored their TFSA in favor of their RRSP. But more and more I find myself encouraging clients to max-out their TFSA before using their RRSP. Here are some thoughts to consider:

1. TFSA’s let you save your RRSP room until you’re in a higher tax bracket

As discussed previously, RRSP’s are most effective when you put money in when you are in a higher tax bracket than when you take it out. So if you’re expecting to be in a higher tax bracket at a later date, and you’ve decided to invest, a TFSA may be the better alternative.

2. TFSA’s Don’t Give You A Tax Refund – And that’s a good thing

Let’s assume you are going to be in the same tax bracket from now until you die (pre and post retirement). Yes that’s a stretch but bare with me I’m going to make a point. Let’s say you invest $10K into both your TFSA and RRSP and put them in identical investments. Upon retirement and withdrawal of those funds you’d have exactly the same amount of money (after you pay the tax on the RRSP). This is because when you invest money into your RRSP you get a tax deduction (often a refund), but you have to pay tax when you withdrawl funds from your RRSP in retirement. TFSA gives no tax refund upfront, but are tax-free upon withdrawal. Assuming you’re in the same tax bracket now and later when you deposit and withdraw the funds from your RRSP you’ll be no better off with either the TFSA or the RRSP. Your RRSP will “look” bigger than your TFSA as it grows, but it has a hidden tax liability that the TFSA doesn’t.

But: This assumes you are investing your tax refund with the original investment. This is another reason to consider your TFSA before your RRSP; does anyone actually invest their tax refund? Therefore most of us would actually be better of using our TFSA first as it doesn’t give us the temptation to spend our refund. (also let’s us save the RRSP room until we are in a higher tax bracket than when we retire, where the RRSP does in fact outperform a TFSA)

TFSA vs. Mortgage

I stressed last time depending on your risk tolerance; you may want to consider paying off your mortgage before using your RRSP. But is it better to use a TFSA rather than paying off your mortgage? Well it’ll depend on your individual circumstances, but consider that TFSA and your mortgage are identical from a tax perspective. $1,000 in your TFSA doesn’t have any tax implications (no tax on interest (or other gains) earned) just as $1,000 against your mortgage will save you interest without tax implication (no tax deduction for interest paid). So they are equivalent tax-wise. Here are some things to consider:

1. Flexibility – Conventional mortgages generally don’t let you access your money if you make additional payments. So in this case a TFSA would provide you more flexibility than if you need the funds. You can easily get them out of a TFSA without having to refinance your home. (this would not be the case if you were using a Home Equity Line Of Credit (HELOC) for your mortgage as it provides amazing flexibility to rapidly pay down your mortgage, yet access the equity as needed – If you have a HELOC it is just as flexible possibly even more flexibly given the larger limit than a TFSA)

2. Risk Tolerance – Your mortgage represents your risk free rate of investments. If you have a low risk tolerance and would normally invest in GIC’s, you’re going to earn less than your mortgage is costing you (even if in a TFSA) so don’t bother; pay down your mortgage first. If however you more of an appetite for risk and the returns it often brings, a TFSA will likely provide a better rate of return in the long run for you if you’re invested in mutual funds or other market related investments.

Why Doesn’t Anyone Want Me To Pay Down My Mortgage?

Mortgage 10125

– Consider for a moment how your financial advisor gets paid. Mortgage providers are typically compensated or bonused based on the size of your mortgage, so there is a natural incentive to encourage client’s to remain in debt and even increase their debt! Likewise; investment advisors are also paid on the size of the investment regardless of their performance. So we don’t often hear industry professionals telling people to consider if paying down their mortgage rather than investing is the best option. Nobody “wins” when you pay down your mortgage…. Well except obviously you!

About Mike:

Face1Mike is a Financial Planner, tri-licensed to serve clients with Mortgages, Life Insurance and a variety of Investments including Mutual Funds, Seg Funds and GICs. Mike also holds both a Masters and Bachelor degree in business from Wilfrid Laurier University.

Mike had the privilege of teaching several courses at the university level while working towards his Masters Degree. Mike taught topics including the Canadian Investment Environment, the Canadian Tax System, Corporate Finance, Entrepreneurship, Accounting and Managerial Statistics. Mike also worked at former tech giant Research in Motion (now BlackBerry)

Mike takes a long-term, holistic approach to financial planning and believes in treating people the way he’d like to be treated. His calling is to serve others with honesty and integrity and help educate his clients so they can be shrewd managers of their financial matters and good stewards of what they have.

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