Whole life insurance might not be right for everyone, but it provides guaranteed growth and can help boost your retirement income.

At first glance, life insurance seems straightforward: you pay regular premiums, and when you pass away, your beneficiaries receive a payout. However, whole life insurance has an added feature—a cash value component—that can make things a bit more complicated.

These policies grow with interest in a tax-friendly account and promise guaranteed returns. However, they can be costly and aren’t the best fit for everyone.

Whole Life Insurance: How Does it Work as an Investment?

Whole life insurance offers lifelong protection while building up cash value over time.

When you pay the premium, part of it is invested by the insurance company to build your policy’s cash value. This cash value grows steadily at a guaranteed rate. The best part? The growth is tax-deferred, meaning you won’t pay taxes on the interest earned as long as you keep the money in the policy.

After your policy builds enough cash value, you can borrow against it. While you don’t have to repay these loans—since it’s your money—any unpaid loans will be deducted from the payout to your beneficiaries when you pass away. It’s important to avoid borrowing too much to prevent future complications.

If you buy a policy from a mutual life insurance company, which is owned by its policyholders, you may earn dividends depending on the company’s success. You can use these dividends in a few ways—cash them out, apply them to your premiums, or purchase more coverage to increase the value of your policy. Choosing to reinvest in your policy will also grow your cash value.

When Does Whole Life Insurance Make Sense?

There are certain situations where whole life insurance can be a smart investment choice.

You’ve already contributed the maximum to your retirement accounts.

If you’re a high-income Canadian who has already maxed out contributions to your tax-advantaged accounts like RRSPs or TFSAs, a whole life insurance policy can help you further grow your tax-deferred savings.

Over time, your policy’s cash value will grow through dividends or interest. Later in life—whether your kids are grown, your mortgage is paid, or you simply no longer need life insurance—you can choose to cancel the policy and withdraw the cash. Keep in mind, though, that the amount earned may be taxed, and if you do surrender the policy, your beneficiaries won’t receive a payout when you pass away.

You have a dependent who will need care throughout their life, e.g. a child with a disability

Life insurance provides reassurance for anyone supporting loved ones financially. For parents caring for a child with a disability, whole life insurance could be a good option, as it offers lifelong protection and helps ensure your family’s financial security.

To make sure your child remains eligible for government benefits, like Supplemental Security Income, it’s best not to name them as your beneficiary. Instead, think about creating a special needs trust. An attorney can help you transfer your whole life insurance policy into the trust, and you can choose a trustee, like a guardian, to manage the funds for your child.

You’re looking to add variety to your investment portfolio

The cash value in a whole life insurance policy grows at a steady, guaranteed rate. It’s reliable and not affected by market fluctuations, meaning your money stays safe even if the market dips.

This is different from other permanent policies like variable universal life insurance and variable life insurance. In those plans, the cash value grows based on market performance, so your returns can change and aren’t guaranteed.

The cons of whole life insurance as an investment

Although whole life insurance has its benefits, it’s not the best option for everyone. Before committing to a policy, it’s important to consider these potential drawbacks.

The premiums can be costly

Whole life insurance is generally much more expensive than term life insurance. For example, a healthy 40-year-old in Canada would pay significantly more for a whole life policy compared to a term life policy. While whole life offers lifelong coverage and cash value, the higher premiums might not be affordable for everyone. In contrast, term life insurance provides coverage at a much lower cost, making it a more budget-friendly option for many.

If your main goal is just to have life insurance coverage, term life insurance might be a smarter choice. You can use the money you save on premiums to invest in other opportunities.

The cash value takes time to grow

In the early years, much of your premium goes toward fees, commissions, and administrative costs. Over time, more of your payments will start contributing to the cash value. However, it can take 10 to 15 years, or even more, before you’ve built up enough cash value to borrow from.

If you’re looking for an investment that delivers quick returns, whole life insurance might not be the best option. However, if you’re drawn to the steady but modest growth it offers, it’s a good idea to get a policy while you’re younger, giving your cash value more time to grow into something significant.

The rate of return on cash value can be low

Whole life insurance provides steady, guaranteed returns on your cash value. However, other investments like real estate, bonds, and stocks may offer higher potential growth. To explore tax-advantaged investments that match your risk level, it’s wise to consult a financial advisor.

You don’t have control over your portfolio

In whole life insurance, the insurance provider determines the interest or dividend rate and oversees the investment management for policyholders.

This makes whole life insurance a low-maintenance option. However, if you’re an experienced investor, you might prefer not to depend on your insurer’s investment team for your returns. Instead, you could look into policies that let you choose from a selection of investment subaccounts offered by your insurer. Options like indexed universal life insurance, variable life insurance, and variable universal life insurance usually come with higher risks but also the potential for greater returns.

Potential tax drawbacks in accessing the cash value

In Canada, when you withdraw cash from your whole life insurance policy, the tax implications generally depend on the amount accessed. Typically, withdrawals are considered a return of premiums first, meaning they are not taxable. However, if you withdraw more than what you’ve contributed (your adjusted cost basis), the excess amount may be subject to income tax. Additionally, if you take out a loan against your policy’s cash value, it is not considered taxable income as long as the policy remains active. However, if the policy lapses or is surrendered with an outstanding loan, any amount exceeding your premiums paid may be taxed. It’s also worth noting that death benefits from the policy are usually paid out tax-free to beneficiaries, provided the policy is in force. For personalized advice, it’s essential to consult with a tax advisor or financial planner, as tax regulations can vary based on individual circumstances and any changes in tax laws.

Final Word

Using whole life insurance as an investment can offer both stability and peace of mind, making it an attractive option for some individuals. While it provides lifelong coverage and a cash value component that grows over time, it’s crucial to consider the associated drawbacks. Higher premiums, slower cash value accumulation, and potential tax implications when accessing your funds may deter some investors. For those who prioritize quick returns or prefer a more hands-on approach to investing, other financial products might be more suitable. Ultimately, understanding your financial goals and seeking advice from a qualified professional can help you determine if whole life insurance aligns with your investment strategy.