What is permanent life insurance in Canada and how it works (Cash value explained)

If you’re thinking about lifelong financial security or estate planning, you’ve likely wondered what is permanent life insurance and how it compares to term coverage. Permanent life insurance stays active for your lifetime, building a cash value that grows tax-deferred. This makes it both a protection and savings vehicle.

In this guide, you’ll learn how permanent life insurance works in Canada, how the cash value grows, and what to consider before choosing between whole life, universal life, or a conversion from term coverage.

What is cash value, and how does it work?

The cash value in permanent life insurance is a savings component within the policy that provides additional financial flexibility for the policyholder. As you pay your premiums, some money accumulates into this cash value account over time. The cash value typically earns interest or returns based on the insurance company’s policies and market conditions, allowing it to grow. Policyholders can access this cash value through policy loans, partial withdrawals, or surrendering the policy.

Policy loans

Policyholders can borrow up to a certain percentage of the cash value, typically 70% to 90%, while keeping the policy in force. 

The loan typically accrues interest at a fixed rate specified in the policy contract. The interest rate charged on policy loans is often lower than that of traditional loans or credit cards. However, interest is charged on any outstanding loans taken against the cash value, which can affect its growth over time.

Policyholders have repayment flexibility. They can make regular interest payments, pay the loan principal, or let the interest accumulate and be deducted from the policy’s cash value. Should the policyholder fail to repay the loan, the balance amount will be deducted from the death benefit when the insured individual dies. The beneficiary will pay the remaining amount upon the insured’s death.

Usually, taking a loan from your life insurance policy doesn’t count as taxable income. But, if you let the policy lapse or give it up with an unpaid loan, the loan amount might be considered taxable income. This depends on the tax rules in your jurisdiction.

When a life insurance policy lapses, the policyholder stops paying the premiums and, as a result, the coverage provided by the policy terminates. In other words, the policy becomes inactive or expires because the required payments are no longer being made. When a policy lapses, the insurance company usually offers a grace period, allowing the policyholder to reinstate coverage by settling the overdue premiums. However, if the grace period elapses without payments, the policy officially lapses, and the insurance coverage ends.

Policy surrender

Policy surrender refers to terminating or canceling a life insurance policy before its maturity or the end of the policy duration. When a policyholder decides to surrender their life insurance policy, they essentially request to terminate the contract and receive the surrender value. The surrender value is the amount of money the insurance company will pay the policyholder upon surrendering the policy. It represents the accumulated cash value minus any surrender charges or fees specified in the policy contract.

If you decide to surrender the policy before death, you will be eligible to receive the cash surrender value. This value is determined by subtracting any surrender charges or outstanding loans from the accumulated cash value. Choosing to surrender the policy results in the termination of your life insurance coverage. 

There are a few things to know before surrendering the policy: 

• Surrender charges are typically highest in the policy’s early years and decrease over time, eventually reaching zero.
• The surrender value of a permanent life insurance policy is determined by subtracting any surrender charges or fees from the accumulated cash value. The surrender value is the amount the policyholder will receive upon surrendering the policy.
• Surrendering a permanent life insurance policy may have tax implications. Any gains in the cash value component are generally subject to income tax if they exceed the total premiums paid into the policy. However, the taxes can vary depending on the policy’s basis, time in force, and the specific tax regulations in your jurisdiction.

Advantages of accessing cash value

• Financial flexibility: Policyholders can use the funds for various purposes such as emergencies, education expenses, a down payment, or supplementing retirement income.
• Tax advantages: Policy loans are often not subject to income tax, thus making accessing the cash value a potentially tax-efficient way to obtain funds when needed.
• No loan approval process: Policyholders can use the cash value without demonstrating a specific need. Unlike traditional loans, accessing the cash value through policy loans does not typically involve a credit check or a lengthy approval process. 
• Asset growth: The cash value in a permanent life insurance policy has the potential to grow over time, which can result in a larger pool of funds available for borrowing or withdrawal.
• Estate planning: Strategically accessing the cash value can be part of effective estate planning. It allows policyholders to use the funds during their lifetime while providing beneficiaries with a death benefit.

What is permanent life insurance in Canada?

Permanent life insurance in Canada is a policy that provides lifelong protection as long as premiums are paid. Unlike term life, which expires after a set period, permanent policies never end and include a cash value component that grows tax-deferred over time. Policyholders can access this value through loans, withdrawals, or policy surrender, offering flexibility for emergencies or retirement planning. Additionally, the death benefit from permanent life insurance is typically paid out income tax-free to beneficiaries.

Permanent life insurance comes in several types, whole life, universal life, and variable life. Whole life provides fixed premiums and guaranteed growth; universal life allows flexible payments and investment choices; variable life links cash value to market performance. Whole life policies typically have a guaranteed cash value growth at a fixed rate, while universal life policies have cash value growth that varies based on market interest rates.

Premiums are higher because the insurer guarantees lifetime coverage and invests part of your payments. Permanent life insurance can support estate planning, final expenses, or intergenerational wealth transfer, making it a strategic tool for long-term stability.

Types of permanent life insurance

Whole life insurance

Whole life insurance is the classic and most traditional form of permanent life insurance. It provides a death benefit to the beneficiary upon the insured’s death, as long as the premiums are paid while building a cash value over the policy’s duration.

Whole life insurance is part of the broader category of permanent life insurance and is distinguished from other policies like universal and variable life insurance. It typically involves level premiums, meaning policyholders pay the same amount over a specific number of years or until age 100. However, the premiums are generally higher than those of term life insurance.

Whole life insurance often comes with guaranteed cash value growth at a predetermined interest rate. 

Universal life insurance

Universal life insurance adds a dynamic twist to permanent life insurance, featuring flexibility in premiums and death benefits. Policyholders can tweak premium payments and adjust the death benefit amount within specific limits. Unlike the fixed premiums of whole life insurance, universal life insurance allows adjustments in premium amounts and payment frequency. 

Additionally, policyholders can use accumulated cash value to cover premiums if sufficient funds are available. 

Cash value in whole life insurance grows at a fixed rate determined by the insurer; universal life policies permit policyholders to allocate cash value to various investment options, affecting its growth based on market performance.

Unlike whole life insurance, which provides a guaranteed amount regardless of cash value, universal life insurance offers flexibility in adjusting the death benefit during the policy’s life. While whole life insurance typically requires premiums until a specified age, universal life insurance provides more flexibility in the premium payment duration, allowing adjustments based on policyholder preferences within certain limits.

Variable life insurance

Variable life insurance (VUL) differs from universal life insurance (UL) in handling cash value. UL policies offer more flexibility, allowing adjustments within certain limits. At the same time, variable life insurance (VUL) typically mandates regular fixed premium payments, although the policyholder can use accumulated cash to cover costs. 

The cash value in UL policies grows at a specified interest rate set by the insurer, offering tax-deferred accumulation and flexibility for premium coverage or withdrawal. VUL policies, however, provide more control over investment options, allowing the policyholder to allocate cash value among various investments like stocks or bonds. 

While UL policies have fewer investment options, VUL policies offer greater flexibility, albeit with higher investment risk due to market fluctuations. UL policies offer stable growth with lower potential returns. In comparison, VUL policies present the possibility of higher returns coupled with increased investment risk tied to market performance, and that is why policyholders need to consider their risk tolerance and financial goals.

Cost of permanent life insurance premiums

The average cost of permanent life insurance is based on several factors, including the insured person’s age, health, coverage amount, policy type, and the specific insurance company. The younger you are, the less you will pay for life insurance premiums. Here are a few examples of the estimated monthly premiums for permanent life insurance in Canada:

The above figures are rough estimates for a whole life insurance policy, and premiums may vary based on individual needs and specific policy details. 

Tax considerations in cash value(1)

Cash value growth accumulates tax-deferred. However, suppose you surrender the policy and receive the cash value. In that case, any gains or interest earned may be subject to tax depending on the adjusted cost, the type of investment vehicles within the policy, and the tax rules in effect at the time of withdrawal or surrender.

However, universal life insurance has a limit on the amount of cash value that can accumulate without triggering a tax liability. If you withdraw funds or surrender the policy, the growth portion of the cash value may have tax consequences. Consult with a tax professional to understand the implications.

Pros of permanent life insurance

• Lifetime coverage: Permanent life insurance ensures lifelong coverage, as long as premiums are paid, guaranteeing beneficiaries a death benefit regardless of when the insured person dies.
• Accumulation of cash value: The cash value component that grows tax-deferred can be accessed through loans or withdrawals for various purposes without immediate tax implications.
• Low-interest policy loans: Policy loans often have lower interest rates than traditional loans, providing a straightforward and flexible borrowing process. This feature allows policyholders to access funds for emergencies, education expenses, or supplementing retirement income.
• Estate planning benefits: Permanent life insurance policies can be integral to estate planning. The death benefit can cover estate taxes, ensure financial stability for heirs, and facilitate the smooth transfer of assets to the next generation, contributing to a comprehensive estate strategy.

Cons of permanent life insurance

• Higher premiums: Permanent life insurance policies generally have higher premiums than term life insurance policies because of the lifelong coverage and cash value component. The higher price can make it more challenging for individuals with limited budgets to afford sufficient coverage.
• Complex policy structure: Permanent life insurance policies can be more complicated than term life insurance. Understanding the various components, such as the cash value, policy loans, and investment options (in the case of variable life insurance), may require more financial knowledge or the assistance of a financial advisor.
• Limited investment options: Some permanent life insurance policies, such as universal or variable life insurance, may offer investment options within the cash value component. However, the investment options are usually limited and may provide different flexibility or potential returns than other investment portfolios.
• Potential overfunding: Overfunding a permanent life insurance policy, mainly to accumulate cash value, may result in diminishing returns or inefficient use of funds. Balancing the desired death benefit, cash value growth, and affordability is essential to ensure the policy remains sustainable.
• Surrender charges and penalties: Surrendering a permanent life insurance policy or making significant changes to the policy early on can result in surrender charges or penalties. These fees can reduce the cash value or result in financial loss, especially if the policyholder decides to terminate the policy shortly after purchase.

Can I convert term to permanent without a medical?

Yes, many Canadian term life policies include a conversion privilege, allowing you to switch to permanent coverage without a new medical exam. This feature can be valuable if your health changes after your initial purchase.

Conversion deadlines vary by insurer, often available until age 65 or before the term expires. The new premium will be based on your age at conversion, not your original purchase date. It’s best to review your policy early to avoid missing the conversion window and ensure the transition aligns with your financial goals.

What happens to the death benefit if I have a policy loan?

If you borrow against your policy’s cash value, the outstanding loan balance and interest will reduce your death benefit. For example, if your death benefit is $250,000 and you owe $20,000 in policy loans, your beneficiaries receive $230,000.

Keeping loans modest and repaying interest helps preserve the full payout. If the loan grows too large, it can cause the policy to lapse, potentially triggering taxes on the loan amount. Always review loan provisions and interest rates with your insurer before borrowing from your policy.

Is a permanent life insurance policy worth it?

Permanent life insurance policies typically offer conservative investment options within the cash value component. These options are designed to provide stable, predictable returns over the long term. While this can offer security, it may result in lower returns compared to more aggressive investment strategies.

By allocating funds to a permanent life insurance policy, you may miss out on other investment opportunities that could provide higher returns. Comparing the potential returns of a permanent life insurance policy with different investment options is crucial to determining the opportunity cost of the policy.

While the returns from the cash value component may be less significant, one of the other advantages of permanent life insurance is the tax-deferred growth of the cash value. The ability to accumulate savings on a tax-deferred basis can be advantageous for individuals in higher tax brackets.

When evaluating the returns of a permanent life insurance policy, it’s essential to compare them with alternative investment options and consider factors such as risk tolerance, investment goals, and overall financial strategy. If maximizing investment returns is a primary objective, exploring other investment avenues outside a permanent life insurance policy may be more suitable.

What’s permanent life insurance – Conclusion

Permanent life insurance provides lifelong coverage, predictable savings growth, and tax-advantaged flexibility. It can be an excellent fit for families planning inheritance, retirement income, or long-term security.

To find out how much coverage fits your situation, get a personalized life insurance quote with Oneday. Plans are available for eligible applicants, subject to underwriting and provincial regulation.

Frequently asked questions about permanent life insurance

Sources:

1. Justice Laws (ITA s.148), “Income Tax Act”
2. CRA, “Policyholders, Income from Life Insurance Policies (archived IT-87R2)”