shorter of breath
and one day
closer to death
--- Pink Floyd, Time
Back To Basics
When you buy insurance on your car or home, you pay premiums which get adjusted annually (usually upwards) based on claims experience. That model doesn't work with life insurance. As closet actuaries Pink Floyd correctly observe, we get closer to death each day. Even if we take care of ourselves, our mortality rates continually increase and increase. If you pay-as-you-go, coverage becomes less and less affordable as payment of the death benefit becomes more likely. Term insurance becomes unavailable.
The government uses tax incentives to encourage behavior which reduces burdens on society. For example
- saving for retirement (pension plans, RRSP, Tax-Free Savings Account)
- saving for a child's education (RESP)
- saving in general (TFSA)
Increasing mortality rates make affordability a big problem. The solution is pre-funding. The government encourages you to invest extra money in your life insurance contract by allowing tax-sheltered growth.
The amount you can invest depends on the cryptic Maximum Tax Actuarial Reserve (MTAR), which varies with the amount of coverage, your age and your health. Since our probability of dying is 100%, you can essentially invest any amount of money --- even millions of dollars.
But why would you?
Because the tax savings on the investment growth are often more than enough to pay for the insurance charges. The government effectively pays for your insurance if
- you're healthy
- you make large deposits in the early years
- you allow time for tax-sheltered compound growth
Tax-sheltered growth is great but what happens if you take money out? As with an RRSP, you pay tax on the investment growth. But you have several advantages over an RRSP
- you can make much larger deposits
- you aren't forced to make any withdrawals
- you can get tax-free access to the savings
Thanks to tax savings, you can benefit from mortality during your lifetime.