Whole Life: A Whole New Investment Class

The recent developments in investment markets and the poor performance that has resulted have brought about a new appeal to an old workhorse. For investors looking for a diversification in their investment portfolio and a more tax efficient fixed income investment alternative, a compelling argument can be made for the use of Whole Life Insurance.

Whole Life is a permanent insurance contract with level lifetime guaranteed premiums and tax advantaged cash value growth. If the contract also pays the policyholder annual dividends the Whole Life contract is referred to as participating. These dividends can be taken in a number of different ways but the option most often selected to provide the maximum tax advantaged growth is “paid-up additions”. Paid up additions are blocks of single premium life insurance which also pay an annual dividend so these blocks contribute to the building of both significant cash value and estate value (death benefit). In a participating policy all policy owner premiums are pooled under a “participating account”. From this pool certain expenses and taxes are deducted along with death benefits paid to beneficiaries. In addition to the annual premiums of policyholders, investment gains and other income (such as policy loan interest) are credited to the participating pool. The assets of the participating pool are professionally managed and largely in fixed income investments. Management fees are extremely low (one company charges 0.072% management fee) and the funds have very little volatility. This combination of guaranteed cash value and the non-guaranteed portion from the dividend account grows tax-deferred and, if paid to the beneficiary as a consequence of death, tax-free.

During the life time of the insured, the cash values can be accessed by way of partial or total surrender or policy loan. Income tax may be paid as a consequence. One alternative to avoid paying income tax is to use the policy as collateral and borrow from a third party lender. If structured properly, the interest on this loan may be tax deductible.

This tax advantaged steady growth combined with the significant estate benefits to the beneficiaries upon death are the primary reasons why Whole Life (particularly Participating Whole Life) is now being viewed as a new investment class. Unlike other accumulation policies (such as Universal Life), mutual funds and other equity investments, the cash and dividend value of a Whole Life policy cannot decrease as long as premium payments are made (and once made, increase the value even further). As a result these policies are being favourably compared to a long term, high yield bond. Today most portfolio managers recommend that a prudent investor have a diversified portfolio with a significant portion in fixed income investments, such as bonds, term deposits, etc. Many investment managers suggest one third to 40% of an investment portfolio be in these types of investments for balanced growth and reduced overall volatility. Including participating whole life in that portion of the portfolio can produce some significant results.

Below is a table which compares the results that can be achieved using a participating whole life policy versus a fixed income investment paying a 3.5% taxable interest rate. The alternate investment values are shown after tax. Since there are strategies to avoid paying tax when accessing the cash values of the Whole Life policy, those values are shown pre-tax. There is no income tax payable on the death benefit.

With results like these it is no wonder that Whole Life is now being looked upon as a new investment class. For those that have corporations and are accumulating surplus, the use of Whole Life in the corporation not only provides the same enhanced returns but also provides opportunities for Capital Dividend Account planning. Whether investing as an individual or via a corporation, the significant results that can be achieved by using Participating Whole Life are worth investigating.