I’m a fan of Dave Ramsey. He’s the host of the aptly named “Dave Ramsey Show”, an American radio- call-in show on over 500 stations where he talks about “You Life and Your Money” and helps people get out debt and invest wisely. Ninety-nine percent of what Mr. Ramsey says is right-on and applies as much to Canadians as it does to Americans but there is one thing that he is completely wrong on. At least wrong for the thousands of Canadians who listen to his show every day, and that is his take on Permanent Life Insurance.
You see, the American marketplace and the laws surrounding Life Insurance are different in Canada and Canadians need to understand that difference before they go making any decisions based on the opinions of Dave Ramsey, Suze Orman or any other foreign commentator on the subject. So before you go taking advice from people who don’t live or work in Canada, here are three and a half things Canadians need to know about Permanent Life Insurance.
Thing #1 – The cash value can be ADDED to your death benefit.
Permanent Life Insurance is a bundled product with both an insurance and investment component. When you purchase the product you start with a basic death benefit and over time the value of that death benefit increases depending on the dividend rate of return in the investment component. Your dividends can be reinvested inside the policy to purchase more insurance or paid out in cash. For example, according to one of Canada’s largest life insurance companies, if a 40 year old male purchased a $50,000 policy and got hit by a bus on his way home from the insurance agent’s office his beneficiary would receive a $50,000 pay out, but if he lived for a year his dividend would be $209. If he reinvested that dividend and purchased additional coverage his beneficiary would receive approximately $51,094.
According to Mr. Ramsey, and other American financial gurus, the cash value in a permanent life insurance policy is only accessible if you take it out as a loan while you are living and once you die you are only paid the face value of the policy. While that may be true in the United States, I don’t know, it is categorically false in Canada. When the dividends are used to purchase additional insurance it is actually worth even MORE if left inside the policy until you die. If you do need cash throughout your life you can access it by surrendering only the additional insurance without reducing the original face value of your policy.
Thing #2 – The rate of return on your investment is (currently) 6.26%.
This is a bit more complicated to understand. For that same 40 year old the cost of the $50,000 coverage for a year is $1403. The dividend in the first year is $209 you can either take the cash and treat as a refund or purchase additional coverage. To really see the value here you need to contrast that against what the same level of coverage would cost on a term basis (i.e. without the investment component).
Now term insurance is a lot cheaper than permanent insurance. The same amount of 20 year term insurance would cost $216 per year. So really what you are doing is investing the equivalent of $1187 per year with the insurance company. Over the course of 25 years this 40 year old would have invested the equivalent of $29675 over and above the cost of insurance and received cash dividends of approximately $47342. That’s an annualized rate of return of 6.26%. According to Mr. Ramsey the average American can only expect to receive 1.9% on their investment in a permanent policy, again, that may be true in the USA but definitely not in Canada.
Thing #3 – Permanent insurance is, well permanent!
Aside from the difference in cost and the ability to build cash value the other main thing Canadians need to understand about permanent life insurance is that it is permanent. As long as you continue to pay your premiums, which are guaranteed never to increase, you will receive your payout and unlike a traditional investment, once the dividends are paid into the policy they can never be clawed back, (i.e. they are not subject to market volatility). Sure some traditional investments are returning better than 6%, I’ve seen some mutual funds as high as 15% lately, but you could just as easily lose money in the market even after several years of growth. Not so with a permanent life insurance policy, once the dividends are paid, they’re paid. With a term insurance policy on the other hand, at the end of the term the premium always increases and if you don’t continue to pay the higher premium your coverage goes away. In short if you don’t die during the term of the policy your beneficiary doesn’t get paid.
Back to our 40 year old example, when he turns 60 the cost of insurance increases to $2424 per year, that’s an increase of more than a 1000%! And he hasn’t received a cent in investment value. Our fictional 40 year is now paying 58% more per year for $50,000 of coverage than if he had purchase the permanent policy. By contrast the permanent policy has increased the death benefit to over $90,000 and he would be sitting on over the $32,000 in cashable dividends.
Thing #3 ½ – Canadian’s should never take financial advice from Americans.
This should go without saying and that’s why I only give it half a point. We are a different country after all, with a different culture and different laws, but in our heavily integrated continent it’s hard to get away from the influence of the American media. So here is my modest appeal; for every minute you spend watching CNN, MSNBC or Fox News, Canadians should spend at least 2 minutes on CBC Newsworld, CTV News Channel or BNN. I promise you’ll still know what’s going on south of the boarder but you’ll at least get it from a Canadian perspective and you’ll learn what it really means in the context of our laws and our culture.
One last thing; according to Mr. Ramsey, the only people who have anything good to say about permanent insurance are the people who sell it. In the interest of full disclosure, I do make a portion of my income off of the sale of permanent insurance but only a portion. I also sell term insurance and mutual funds, in short I sell it all. Depending on your needs, goals and dreams, permanent insurance can be an important part of a comprehensive financial plan. But don’t take my word for it, as the speed read disclaimer at the end of Mr. Ramsey’s radio show says, “Because the details of your situation are fact dependent you should additionally seek the services of a competent professional”.