People typically view life insurance as a safety net for their loved ones in case the worst happens. Participating life insurance, often called “par insurance,” is a type of life insurance that accumulates cash value over time.
To prepare this guide, our editorial team reviewed the Financial Consumer Agency of Canada’s life-insurance guide, OSFI’s participating-account and disclosure guideline, the Financial Services Regulatory Authority of Ontario’s policy-type guide, and the Canada Revenue Agency’s capital-dividend guidance.
Is Participating Life Insurance Worth It?
When considering a permanent policy, compare guaranteed amounts with non-guaranteed illustrated values.
A permanent policy may make sense if you:
- need lifetime coverage;
- can afford higher premiums; and
- understand that dividends can go down, possibly to zero.
It may not make sense if:
- premiums would interfere with meeting basic needs;
- paying down high-interest debt or building short-term savings makes more sense; or
- a less-expensive term policy would meet your insurance needs.
How Participating Life Insurance Works
Participating life insurance is usually a form of whole life insurance. The insurer maintains a participating account and may declare dividends from that account depending on its performance. Dividends are at the discretion of the insurer’s board and can go down if participating-account results are less favourable. Past dividends do not guarantee future dividends.
It is also helpful to review guaranteed-value tables, dividend options, the premium-payment period, surrender provisions, policy-loan provisions and any enhanced-coverage provisions. The insurance policy defines your rights.
| Usually guaranteed by the contract | Not guaranteed unless the contract expressly says so |
|---|---|
| Base death benefit while the policy remains in force | Future policy dividends |
| Premium schedule stated as guaranteed | Current dividend scale or dividend-scale interest rate |
| Guaranteed cash values shown in the policy | Paid-up additions not yet bought with future dividends |
| Contractual non-forfeiture options | Illustrated cash value and death benefit above the guaranteed column |
Read More: Compare Whole and Universal Life Insurance
What Participating Whole Life Can Provide Beyond the Death Benefit
The dividend-scale interest rate is one input the insurer uses when determining the dividend scale. It is not the rate of return on your investment.
If dividends are declared and used to purchase paid-up additions, they can increase the death benefit and cash value and possibly earn further dividends.
Look at illustrations showing guaranteed and non-guaranteed values. Examine the death benefit, premium and surrender value each year under a range of dividend scales.
Read More: Explore Whole Life Insurance Options
Using Policy Values to Supplement Retirement Income
Life insurance is not a defined-benefit pension. Using cash value for retirement income has costs. Withdrawals are dispositions and may result in taxable income. Policy loans accrue interest and may reduce surrender values and death benefits. Third-party loans secured against the policy have their own terms, including interest rates, conditions and possible repricing.
Evaluate other retirement options, including debt repayment, RRSPs, TFSAs and taxable assets. Life insurance has its own costs and benefits and should be evaluated accordingly.
| Access method | Immediate effect | Questions to model |
|---|---|---|
| Withdrawal or partial surrender | Reduces cash value and may reduce death benefit | Taxable portion, remaining guarantees and effect on dividends |
| Policy loan | Creates debt to the insurer and interest | Loan rate, compounding, repayment, death benefit and lapse risk |
| Collateral loan | Policy supports a third-party loan | Conditions of approval; interest-rate changes; margin; assignment; lender’s remedies |
| Surrender | Results in termination of insurance and payment of the cash surrender value | Tax consequences; lost death benefit; cost of obtaining comparable coverage |
Read More: See Whether a Life Insurance Retirement Plan Is Worth It
How Participating Dividends May Behave Over Time
Smoothing refers to practices insurers use with participating-account experience to avoid large year-to-year changes to dividend scales. Such practices are allowed by the Office of the Superintendent of Financial Institutions (OSFI) where justified and properly documented. However, smoothing does not guarantee dividends.
Ask for an illustration showing guaranteed values, as well as at least two other illustrations reflecting lower non-guaranteed dividends. If you’re counting on dividends to maintain your policy, keep an enhanced death benefit active or help pay interest and principal on policy loans, find out how much cash you’ll have to inject if dividends are lower or loan interest is higher.
Investment performance, mortality, expenses, lapses and other factors determine dividends for a class of policies.
How Participating Life Insurance Is Used by Business Owners
Just because a corporation can own the policy doesn’t mean it’s better than having an individual own the policy or using a regular investment.
Corporate ownership may make sense when there is a definite insurance reason, such as funding a buy-sell agreement, replacing a key person or meeting an estate-planning objective. The corporation must also understand its role, such as properly designating the owner and beneficiary, maintaining premium payments and obtaining professional advice about the consequences for shareholders, creditors and taxes.
Read More: Read Life Insurance Strategies for High Net Worth Canadians
Tax Treatment of Growth Inside the Policy
Under Canadian exempt-policy tax rules, cash-value growth is not taxed annually. However, taxes may be triggered by a withdrawal, cancellation, loan or change of ownership.
Protection for Shareholders
Seek tax and legal advice before incorporating such a strategy into a shareholder’s broader life-insurance plan.
The CRA has specific rules for calculating the amount of insurance proceeds that qualify for addition to the capital dividend account. Therefore, the entire death benefit may not qualify. The policy’s adjusted cost basis may reduce the amount.
A private corporation must elect to pay capital dividends to shareholders.
How Life Insurance Can Provide Estate Liquidity
Life insurance is not a magical tax eliminator. Dividends will not eliminate taxes.
There is no inheritance tax in Canada, but there may be a shortage of cash following the transfer of certain assets. Income taxes, probate fees, other costs and debts may create a liquidity issue.
Life insurance may be appropriate if your situation is complex, such as when dealing with a cottage, private company or charitable bequests. It won’t help if ownership and beneficiary designations don’t work as expected. Illustrated increases in the death benefit are not guaranteed.
Before purchasing permanent life insurance, work with your accountant and lawyer to determine how much money you’ll need and when.
Read More: Read Whether Whole Life Insurance Is a Good Investment