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The Differences between Permanent and Term Insurance

This is a guest post by CFP,  Brian Poncelet.

Life insurance is a critical component to every family’s financial well-being. And yet, over 10 million Canadians are underinsured, leaving their loved ones vulnerable to out of control expenses and runaway debt.

To protect your dependents, you need to first know that there are two types of insurance available – permanent insurance and term. In order to select an affordable policy that addresses your needs, understanding the differences between them is key.

1. Length of Coverage

The main difference between permanent and term insurance is the length of coverage. Term insurance provides coverage for a specific period of time – generally 5 to 30 years. The coverage ceases once the term has ended or the premiums are unpaid. Permanent life provides coverage until you pass away or the premiums are unpaid and the reserves are insufficient to cover the premiums.

2. Premiums

Permanent and term insurance both have level premiums. The premiums are usually higher for permanent life because they are averaged over your lifetime. Meanwhile, the premiums for term are only averaged over the length of coverage. If you’re in good health and purchase term insurance at a young age, premiums typically start much lower. However, once term coverage ends, premiums can increase dramatically upon renewal.

3. Cash Value

Term insurance is your plain vanilla insurance policy with no savings component – buy term and invest the difference, as the saying goes. If you cancel your policy, the coverage ends and there is no cash value paid. Permanent life may or may not include a cash value. Whole life has a cash value, while some universal life policies have an investment option.

4. Convertible

Besides the death benefit, the most important thing to know about your term life policy is whether it’s convertible. If you get sick, a convertible term policy allows you to convert to permanent insurance at any time up to the end of the term with no medical exam. Permanent life is not convertible.

5. Death benefit

This is the most important factor when choosing life insurance – how much will my beneficiaries receive when I pass away? Term only pays out a death benefit if the policyholder dies during the term the policy is in effect (if you outlive the policy there is no payout). Permanent life provides a death benefit to your beneficiary or estate when you pass away as long as the premiums are paid up.

6. Renewable

Term life is renewable, permanent life is not (you won’t need to renew since coverage is for your entire life).  With term life, the premiums remain the same throughout coverage. Most term policies only allow renewal up to age 75.

 Summary of the pros and cons of both types of insurance

Permanent Insurance

Pros

  • Level premiums for life or a fixed period and coverage for live
  • Can borrow from policy tax-free  in a number of cases
  • Can be used to enhance retirement
  • Can be used to pay Estate taxes at death (cottages, business, etc.)
  • Insurance can be structured to grow every year

Cons

  • Initially costs more than term for coverage

Term Insurance

Pros

  • Buy a lot of coverage for premiums paid
  • Can Convert to Permanent later
  • Can “buy term and invest the difference”

Cons

  • Insurance costs go up every year
  • If one does not die during term, premiums are wasted and a lost opportunity cost

Final Word

Term and permanent life aren’t mutually exclusive – a combination of both can be used for meet your insurance needs. Term life is best suited for short-term term expenses, such as income replacement, mortgages and car loans. Permanent life is ideal for long-term permanent expenses, such as funerals and estate planning.   There will be more quantitative articles coming up describing which type of insurance is better with different circumstances.

About the Author:  Brian Poncelet is  an insurance specialist and independent certified financial planner (CFP) who has been working in the financial services industry for almost 20 years.







31 Comments, Comment or Ping

  1. Pretty much everything you need to know, right there. Great article.

  2. The way it should work is, you buy term insurance when you’re young and do not have a lot of savings, and are potentially have a young family that is vulnerable to a loss of an income generating parent. However, those parent(s) save and invest over time and by the time term life insurance becomes too expensive (50s and 60s), own their house and have enough savings/investments that they no longer require a $xxx,xxx life insurance payment because they have $xxx,xxx in net worth.

  3. 3. Steve

    This article reads a little too much like s sales brochure. I agree with the above comment. Insurance is insurance and shouldn’t be packaged with savings or investing, etc. Term makes a lot of sense when you have a young family and critical illness, injury or death could be catastrophic to the ESSENTIAL needs of your family. INSURANCE IS NOT INTENDED TO GIVE YOU FAMILY AN EASY LIFE SHOULD YOU HAVE A CLAIM.

    That said, by the time your kids are older and no longer dependents, your insurance needs are drastically reduced, they would be primarily limited to possible long-term future health costs that are not covered by other coverage.

    - Your house should be paid off, you should moving into strong savings for retirement, and you should be totally debt free. If you’re not, you have more serious problems to address that do not including whole life insurance.

    I’ve always struggled to see any real value to whole life policies. If you can’t properly save for your future, insurance is not a solution, educating yourself about financial planning and executing that plan is far more effective.

  4. Hi Steve,

    I believe FT, will have an other part (related to life insurance) to this story. This is how to spend and enjoy your money in retirement, this is done with less risk, better protection and less taxes.

  5. 5. Peter

    I would add that the investment component in whole/universal policies is usually subject to higher management fees than for standard investment products held outside an insurance policy.

    The main reasons for choosing whole/universal seem to be:

    1. Have already maxed out RSP/TFSA, and are looking for further tax sheltered investment;
    2. Creditor protection;
    3. Transfer wealth to heirs in a tax efficient manner;
    4. Ensure coverage in the future when potential future health issues could bar term coverage; or,
    5. For some reason you need insurance coverage at an advanced age, when term policies would be prohibitively expensive.

    It also seems like buying a whole life policy for your young child would be a nice way to transfer wealth, assuming you’ve maxed out the RESP. You can buy a whole life policy, paid up in 20 years, for about $2,700/year for an 18 month old. They’d then have the benefit of the policy for the rest of their life. Most are of these policies are convertible, and the cash value can be borrowed against.

    Otherwise, if you’re a young parent who has trouble meeting current expenses, term life seems to be the correct choice.

  6. 6. thefiscallyfit

    great article. I hate when people start talking about how one type of insurance is typically “better” than another. They are simply different tools for different jobs. For myself, it came to cash flow and need. Given the guaranteed cash value, if my wife and i needed insurance longer than 12 years, the permanent insurance made sense for us. But every situation is different. Any way you look at it though, using insurance for estate needs is the cheapest way to do it almost without exception…. you just need the cash flow :)

  7. >>>I’ve always struggled to see any real value to whole life policies.

    Have a heart attack, you’ll see the value real fast. That’s why conversion on term insurance is so important – it lets you change your mind..

    If you’ve got a $500,000 family cottage with $150,000 tax liability upon death, some folks will tell the kids to sell the cottage and pay the $150K. Other people want the family cottage to stay in the family (is that wrong?) and the cheapest way to cover the $150K is going to be life insurance. Suggesting to people to people that want to keep the cottage in the family that they’re being foolish, well, you’re not having an insurance conversation at that point.

    In addition, some of the tax advantages of life insurance perform better than alternative vehicles in some very specific circumstances. The circumstances may not be common, but they exist. And they generally exist for people who watch their finances and build a decent estate. Like the people reading this site.

    The fact is, people buy insurance for non-insurance principles. It’s like suggesting you have a financial obligation beyond your death for your young family. Why is that? Heck, your dead, why do you care? Well, some people do care, and many of them buy term life insurance. Others don’t see the need, and suggesting they should be buying term insurance is as absurd as trying to tell a term-only advocate that permanent insurance might be useful in the future. Smart money says consider carefully your current and future likelihood of wanting insurance and purchase accordingly – and don’t take a hard stance that the insurance that’s right for you is therefore right for everyone.

    If you want to go down the rabbit hole on term insurance, you might consider that it’s a relatively westernized convention. There’s entire cultures where permanent insurance is the norm, because they don’t start with the premise that their insurance needs cease entirely at the arbitrary age of 65.

  8. >>>>INSURANCE IS NOT INTENDED TO GIVE YOU FAMILY AN EASY LIFE SHOULD YOU HAVE A CLAIM.

    In 25 years and thousands of clients and discussions with others in the industry, I have never seen this. The insurance companies have in place guidelines to prevent this exact problem, because if people’s families are better off if they’re dead, then there’s motivation to make that happen. So the companies don’t generally allow it. The idea that people have too much insurance is fearmongering and doesn’t happen. It stems from the idea that $500,000 is a lot of money. Well, it is, until it’s all you have to live for your family for the next 15 years.

    The much more common problem – in fact the single biggest problem in the life insurance industry – is not buying enough coverage.

  9. 9. Goldberg

    Only life insurance providers push whole life. Big commissions and profits on whole explains this fact.

    Get term until the kids are out of the house. And invest in ETFs or a diversified portfolio… not in whole.

  10. >>>Only life insurance providers push whole life.

    Most of the anti-whole-life rhetoric posted online is a) 25 years out of date and b) used as a proxy for permanent life insurance by the uninformed.

    Pointing out commissions and profits is a good example. That bit of misdirection gets posted all over the place by people that have absolutely no clue about what the profits or commissions are on these products, nor do they followup with how that has anything to do with what you should buy. Basing a fixed-price purchase decision on how much someone else makes from the sale is ridiculous. Buy a product because it’s beneficial to you and quit worry about how much someone else makes.

    if this was 1989, I’d have probably agreed with you. In 2013, this kind of rhetoric merely exposes the uninformed.

  11. 11. Al

    Agree with Golberg – one kids are out of the house and the house is paid off what do I need insurance for?

    Looking forward to seeing the tax planning / estate planning sequel to this article…

  12. Life insurance is sold as a “need” product. It should be a “want” product.

    For example many insurance calculators will get someone to add their RRSPs etc. To be subtracted from the total. This means RRSPs are assumed to be cashed in (paying taxes) to support the family. Is that what you want?

    Let’s assume you like to live in a nice house in a nice neighbourhood. Do you want your family to sell the house and move out because you are gone?

    In general many people view life insurance as an expense and because it is insurance, they see that dollar never to be used again and it lowers their lifestyle. Also many people have had a poor experience with insurance companies’ life, auto or home insurance so all types of insurance is the same, it is a pain to pay for so they get the cheapest.

    Fiscallyfit said it the best, in a nutshell he/she said different strokes for different folks. There is no right answer, cashflow is important. Like renting, not everyone can own their own home and there is no shame in that.

  13. 13. Peter

    Re Not requiring insurance once the kids have left

    You have to look at your needs when the term product expires, and obtain an estimate for re-upping your term at expiry for comparison.

    If you’re the primary breadwinner, your family may need insurance coverage to have a decent retirement. Buying more term may be unavailable, or too expensive, once the current policy has expired. It’s not just the living expense, but whether you’ve saved enough when your term policy expires for your partner to have a decent retirement.

    In my case, I’m going with term and hope to have enough cushion at the end to not require a renewed policy, as the rates will be too high at that point to make sense. For someone else, it may make sense to go with whole life to provide coverage over the time period when your family needs it.

  14. >>>>For someone else, it may make sense to go with whole life to provide coverage over the time period when your family needs it.

    Just to clarify, it should be ‘permanent life insurance’. Whole life is only one fo three types of permanent life insurance. Unfortunately it carries so many negative connotations that the entire product line of permanent life insurance products get painted with the same brush. there are perfectly viable permanent life insurance policies like Term to 100 or minimum funded universal life that do not generate any investments or cash values. They simply provide protection for life with level premiums.

    That should boil the question down to quite simply, do you want/need coverage for life? If so, term, if not, permanent. No need to get entangled with any other discussion.

    Unfortunately not only are consumers confused about these differences, but the insurance industry seems to quit happily continue to propagate

  15. 15. Paul

    I agree with Steve (if it’s CFA Steve then congrads on passing CFA Exam 3!!!), this largely read like a sales pitch for perm Insurance

    I also think the article is very misleading…

    The author states under life insurance advantages that “Level premiums for life or a fixed period and coverage for live”. Yet under Term insurance they say ‘Insurance costs go up every year’.

    Could that statement be more misleading????

    Term insurance, life perm life insurance, typically operates on a level premium basis, so your premium is the SAME for the term of that policy.

    After that term is up (be it 10/15/20/30 years later), then that policy will expire. If you want a new term policy, you will face a much higher premium but that’s fair enough since you have aged a lot and the risk of death is much higher. Hopefully by that time, the risk you initially wanted to insure against has also expired (ie you’re wealthier, have paid off the mortgage, the kids are now working etc), so life insurance is actually no longer needed.

    The author also failed to mention that insurance agents receive a huge commission for selling perm life insurance. Typically they get a front-end commission of 60% to 80% of the first year’s annual premium (so on a $4k policy can make $2,400 to $3,200!!!!). Plus they commonly get an annual trail commission of 2% to 4% too – that trail commission is sent to them every year. That has to be paid for – guess who pays for it? There’s more: as Steve pointed out, the management fees on perm life insurance are high too, so again guess who pays for those high fees?

    Insurance sales people get a lot less commission on term insurance because it sells for much less. Perm life policies tend to cost 4x+ more. If you’re a sales person, would you prefer to get 60% to 80% on $4000 or on $1,000?

    Hence why insurance sales people are so keen to push perm life coverage.

    For some it is the right choice, but for most, term insurance is the best choice.

  16. 16. Paul

    Had a typo:

    Term insurance, life perm life insurance, typically operates on a level premium basis, so your premium is the SAME for the term of that policy.

    Should have been:

    Term insurance, like perm life insurance, typically operates on a level premium basis, so your premium is the SAME for the term of that policy.

  17. Paul,

    “For some it is the right choice, but for most, term insurance is the best choice.”

    If cash flow is tight then term maybe the only choice.

    If you get older (unless you are dead) insurance costs more every year.
    Yes you can buy a level term policy the rate is fixed for that period of time, but what happens after that period of time and you want coverage? It goes up.

  18. Paul, your comments about commissions are wrong. I’m guessing you read those numbers on the internet somewhere and didn’t get them from a primary source? Until you care to share where the numbers came from, I’ll simply suggest that your information is long out of date.

    You’re also incorrect on trying to convince readers that the life insurance industry is bent on selling permanent. Everything I hear says that the overwhelming majority of sales these days (like 70%+) are 10 year term, followed by 20 year term.

    The industry overall has long moved past all this nonsense about flogging permanent insurance. I remember when your criticism would have been fair, but that’s not the industry I see today (or for the last decade). There may be isolated examples otherwise but overall they’ve moved on.

  19. 19. Paul

    LifeInsuranceCanada.com

    I completely disagree with you. Firstly, my main complaint was that the article was very biased toward perm life insurance. Hell it was plain misleading for the reasons I have previously stated.

    Every life insurance salesperson I have spoken to (5 so far) was VERY keen for me to buy perm life insurance.

    The commission figures I gave are correct, you know well that you get hugely more commission for selling perm life than term insurance.

    You are well aware Advocis and the industry’s big players have received a lot of bad press for the lack of transparency regarding compensation paid to brokers / insurance sales people. There should be commission transparency but there’s still very little.

    It is ridiculous that customers can be sold an insurance product without being told exactly what compensation the broker / salesperson will receive. If they knew, I’m sure the sales of perm life insurance products would drop significantly. Hence why you and others are keen to keep the status quo.

    But the status quo’s unfair and unjust. With much higher commissions on one product (perm life) compared to the other (term life), there’s a huge risk that a client will not receive the best product for them. They’ll receive the best product for the broker / salesperson. With such generous commissions on perm life, I’m sure such things happen a lot.

    And misleading articles like this, only make things worst. Particularly, when it’s on a financial blog that I typically hold in high opinion.

    You can argue as much as you want that I am incorrect but you know good well that what I say is correct.

    For others reading this, have a look at the ‘The Globe and Mail’ Dec 2010 (updated Dec 2012) article titled ‘What your insurance broker doesn’t want you to know’… Do a google on it.

  20. 20. Brian So

    Maybe they were keen to sell you permanent because that was the most suitable product for you? Just a thought.

    Like someone else mentioned before, there are situations for which permanent insurance is simply the better fit. eg leaving a legacy, insured annuity, etc.

    Surely you agree that term insurance isn’t necessarily the most suitable product for every single person.

  21. Paul,

    The fact that five insurance people were keen to offer you term maybe good in your situation. You maybe married have children who depend on you and your cash flow may be limited.

    Everyone is different. Some own a business which is based on good will. Insurance guarantees the value of that business. Some have pensions worth over $1,000,000 at retirement and want to have options at retirement.

    Where permanent insurance generally gets bad press is Universal Insurance where money is also invested in the stock market with higher fees and has done poorly for years. That being said this is not someone’s only choice.

    Paul as one example as a strategy is to read the story on annuites. See link below. This requires long range planning.

    http://www.milliondollarjourney.com/how-annuities-work.htm

  22. Paul,

    Here is a great example of buy term and invest the difference does not work in some cases.

    A new client who has a great pension had two policies one was Primerica the other was Transamerica Life.

    His situation was his health was poor and he was not insurable. Also his wife who had heart problems also had a Policy with Primerica and also is now not insurable.

    In that situation (we applied to other insurance companies but were turned down). The best we could do was convert the Transamerica policy into a permanent one. With Primerica (buy term and invest the difference) there is no option to convert to a permanent policy to protect the family.

    The problem is people’s health it changes over time and sometimes rates of return do not pan out the way we want it to.

    The media and others make a big deal out of one size fits all. We can all be self-insured. If that was the case why not drop insurance on the house? The odds of it burning down is very slim and if you have money in bank you can build a new one.

    Insurance is transfering Risk to an insurance company for a small amount of money. Life insurance does this. Permanent coverage is more expensive because the insurance must pay out at death which is 100% vs term coverage which becomes more expensive over time and many people drop coverage. Since some people have limited cash flow, they should be educated on where best to get the best coverage for a limited time frame.

  23. From what I’ve been reading online, it appears accurate that insurance commissions are about 60%-70% of the first year premiums. Is this accurate? I believe that insurance agents should be paid for their work, but it is good to know what the compensation is.

  24. 24. Paul

    “From what I’ve been reading online, it appears accurate that insurance commissions are about 60%-70% of the first year premiums. ”

    It is accurate FrugalTrader, There is also trail commission every year with many policies too.

    But as a buyer, you’re not told any of this. You should be.

    The advisor / salesperson should indeed be compensated but with perm life policies being 400%+ the cost of term insurance, you can see why many would be very keen to sell you perm life, not term.

    And this article was very badly slanted/biased towards perm life, that’s what pressed my buttons. Particularly when 100+, 1000+ people are reading it. And like many, I come to this site for informative and (hopefully) unbiased advice.

    Brian. You raise a good point, for me, term insurance was by far the best option. For some people indeed, perm life is the better option – see Peter’s points etc.

  25. 25. Sampson

    I wonder if the salesman will ever be removed from this equation.

    Just as discount brokers have increased accessibility and reduced the cost of investing, if sales commissions are this high in the insurance industry, how low would premiums be if that was reduced or out of the picture?

  26. 26. Stu

    I am shocked as to how high first-year commissions are in comparison to trail commissions. There is so much incentive for sales agents to churn customers from one policy to another.

    I also received much pressure to purchase permanent insurance from my agent when I specifically sought out term insurance. Permanent insurance is absolutely not appropriate for my situation.

  27. Sampson,

    That’s a great question. CIBC tried this years ago and failed. The big thing they would advertise is “no commission” the price was a little less but not a lot.

    Who would be interested in getting insurance? A number of people who’s health was not the greatest. So a nurse would go over get the blood work etc. This cost CIBC and insurance companies hundreds of dollars to this.
    The underwriters would look at the results and rate the client. The client would say “that’s too much” and would not take it. This went on for a few years and CIBC got out of the market.

    Investments are easy. Everyone is an expert. Insurance is a topic no one likes and generally males dislike it the most.

    The average age for an insurance agent I believe now is 56. I see people in their 40′s and 50′s who have never discussed or being approached to get insurance. Since most people get a little bit of information on the internet insurance is not a hot topic.

    Since we are getting into tax season, here is tip for self-employed from CRA:

    Subsection 148(9) of the Act defines a disposition in relation to an interest in a life insurance policy. This definition specifically excludes “a payment under a life insurance policy that… is an exempt policy in consequence of the death of any person whose life was insured under the policy”. Consequently, a death benefit from an exempt life insurance policy is not considered a disposition and is therefore received tax-free by both individuals and
    corporations. Virtually all life insurance contracts currently available in Canada are structured to be exempt life insurance policies.

  28. >>>It is accurate FrugalTrader, There is also trail commission every year with many policies too.

    Wrong on all counts. Wildly innacurate. False and misleading. I speak from experience as a life insurance broker. Where’d you get your numbers from – the internet? And if I had to guess, the internet of 1985?

    How much I make specifically is none of your business frankly. It doesn’t affect the premiums a consumer pays, and my income isn’t open for your titillation, which is all this boils down to.

    The argument boils down to “agents are motivated to sell permanent’, and that’s speculation at best on your part (and demonstratibly false, as I’ve already indicated that probably 95%+ of my clients have term insurance), and this idea that because premiums heaped up front instead of levelized that’s another strike. That’s absolutely bizarre, because if any companies could get a finger pointed at them about permanent insurance sales, it’s the ones with levelized commissions. In direct contradiction to what’s being stated here.

    Further, what’s obvious to everyone in the industry is that commissions are based on premiums, not the heebeejeebie math that’s been touted in the comments here. If a consumer has a $1000 budget for life insurance, then they have a $1000 budget for life insurance no matter what product they get with . You don’t just magically sell a consumer $4000 of life insurance because you think permanent insurance is better. Any consumer is going to simply tell you sorry, $1000 is the end of it. If you think you can get a consumer with $1000 term budget to buy a $4000 permanent policy, you really should be selling life insurance for a living, because that’s a pretty unique skill set you’ve got right there.

    What makes this even more complex is that there’s a variety of factors in commission. Volume is a huge one. The wholesaler you use is another one. Company is another one. There are absolutely companies that pay more on their term policies than other companies pay on their permanent policies. Does that somehow sway every insurance agent out there to start selling one companies term plans to every consumer out there? I gotta think, not the case. Again, the inference is simply not true.

    As I’ve stated before, until you have some proof of your claims, all they are is hysterical gibberish intended to elicit an emotional hatred of life insurance agents. And you won’t find that proof, because your numbers are incorrect.

  29. And one thing further before I discard your comments as nuts. Every time I’ve seen a commissionless life insurance product – without exception – it has cost more than a comparable product purchased through a life insurance broker. Unlike MER’s in the fund industry, in the life insurance industry the least expensive products are those that are purchased through a commissioned insurance broker.

  30. 30. Paul

    LifeInsuranceCanada.com, we’re not going to agree. You’re sticking to your opinion, I’m sticking to mine.

    You’re also arguing with ‘The Globe and Mail’ Dec 2010 (updated Dec 2012) article titled ‘What your insurance broker doesn’t want you to know’… Do a google on it.

    The insurance industry should state what commissions (lead and trail) are paid on policies prior to and during any sales. The industry has fought strongly against doing so despite it being obviously in the consumer’s best interests.

    Go ahead and deny it but you rightly know that the commission insurance salespeople make on life policies is hugely more than what they make on term policies. That creates a clear conflict of interest – sell a life policy and make a lot or sell a term policy and make a little…

    Life policies are often 400%+ more than term policies, hence my use of the $1k versus $4k.

    And yes many life policies do pay a trail commission, argue away that they don’t but many do.

    You have a vested interest in ensuring consumers do not understand the commission picture, hence your repeated replies and false/very misleading info.

  31. 31. Vancity

    A little late to the party, but the compensation numbers are incorrect. Both Whole Life & Term-20 offer a 50% First Year Commission.

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