Buy term and invest the difference: does it beat permanent life insurance in Canada?

"Buy term and invest the difference" usually wins if three conditions hold: you actually invest the premium difference every month for decades, you earn a reasonable return inside a tax shelter such as a TFSA, and your need for insurance really ends when the term ends. It loses when you die after the term has expired but before your invested fund has grown past the permanent policy's death benefit, or when you stop investing. In the worked example below, a 35-year-old comparing a $500,000 Term 20 with a $500,000 term to 100 policy builds a fund that overtakes the permanent death benefit only in her early 80s, assuming a steady 5% return. Before then, the permanent policy leaves more to her family. The right choice therefore depends on whether you need coverage after the term, not on which product is "better".

This guide is part of the calculations section led by how much life insurance do I need.

The setup

All figures are illustrative. Nadia, 35, non-smoker, needs $500,000.

Difference: $250 - $35 = $215 a month, invested in her TFSA at an assumed 5% a year, compounded monthly.

Phase 1: ages 35 to 55

Future value of monthly deposits = deposit x ((1 + r/12)^(12n) - 1) / (r/12).

With r = 5% and n = 20: (1.0041667^240 - 1) / 0.0041667 = (2.7126 - 1) / 0.0041667 = 411.0.

Fund at 55 = $215 x 411.0 = about $88,400, from $51,600 of deposits.

During these years, if Nadia dies, both strategies pay $500,000; the term strategy also leaves the TFSA to her heirs.

Phase 2: ages 55 to 85

At 55 the term policy ends. Nadia no longer pays $35, so to keep the comparison fair she now invests the full $250 a month that the permanent policy would still cost.

• The $88,400 fund grows for 30 years (compounded yearly here for simplicity): 88,400 x 1.05^30 = 88,400 x 4.322 = about $382,000.
• New deposits of $250 a month for 30 years: factor (4.4677 - 1) / 0.0041667 = 832.2, so 250 x 832.2 = about $208,000.
• Fund at 85: about $590,000, versus the permanent policy's $500,000.

Who wins, by age of death

The fund crosses $500,000 at roughly 82 under these assumptions. Death between 55 and about 82 favours the permanent policy; death before 55 or after about 82 favours term plus investing. Life expectancy for a healthy 35-year-old Canadian woman is well into her 80s, which is why the two strategies end up surprisingly close.

Test other inputs with the term vs permanent projection. At a 3% return, for example, the crossover moves much later; at 7%, much earlier.

What the numbers leave out

• Discipline. The term strategy only works if the difference is invested automatically. Money that is "invested" in a chequing account is spent.
• Tax. In a TFSA, growth is tax-free; contribution room is limited and shared with your other savings goals. In a non-registered account, tax on growth lowers the result.
• Risk. A 5% return is not guaranteed. Permanent coverage guarantees its death benefit if premiums are paid.
• Need. If Nadia's family will not need $500,000 when she is 60, the "loss" in that row is not a real loss. If they will, for example to pay tax on a cottage or support a dependent adult child, only permanent coverage meets it with certainty.
• Cash value policies. Whole life and universal life add cash values and, for participating policies, dividends. Compare the guaranteed values first and treat illustrated dividends as non-guaranteed.
• Health. If Nadia becomes uninsurable at 50, the term strategy's lack of coverage after 55 is permanent, unless she uses the conversion right before its deadline.

A middle path

Many households combine the two: term for the large temporary need and a small permanent policy for the lifelong part, as shown in term length and laddering. Others buy a convertible term policy and decide at 50, when the lifelong need is clearer.

Frequently asked questions

Is permanent insurance ever a good investment on its own?

It can be one conservative component for people who have used their TFSA and RRSP room and want tax-sheltered growth with a guaranteed death benefit, often in corporate or estate planning. As a substitute for basic retirement saving, it rarely is.

What if I cannot afford enough permanent coverage?

Then term is the answer. Being underinsured during the years your family depends on you is the more serious risk.

Can I use an RRSP instead of a TFSA?

You can, but the tax picture changes: deductions now, taxable withdrawals later, and an RRSP left at death is taxable unless it rolls over to a spouse or eligible dependant.

Who can run these numbers with my real quotes?

A fee-only financial planner, or a licensed advisor who shows the guaranteed figures alongside any illustration.

Sources

• Canada Revenue Agency — TFSA contribution room and RRSP rules
• Financial Consumer Agency of Canada — saving and insurance basics
• Canadian Life and Health Insurance Association — permanent life insurance explained
• Related: term vs permanent life insurance