You aren't planning to get in an accident when you put your seatbelt on, but it sure is good to be buckled in if something does happen. Think of life insurance as a seatbelt that helps protect your family's financial success.
Life insurance is often considered to be both complicated and boring, but it doesn't have to be! Understanding the different types of insurance can help you decide what is the best fit for you and your family.
Why do you need life insurance?
It isn't always pleasant thinking about your own mortality, however, having the right protection in place can have a significant impact for those who depend on you financially, like a spouse, a child, or even aging parents.
If you're currently employed, think about how your income is spent today, and what would happen if that it suddenly wasn't available for your family. How would your partner or children manage expenses, debt obligations, and future financial goals? This is the main reason you want to consider life insurance.
There are two main types of life insurance: Term Insurance and Permanent Insurance
Term life insurance is the simplest and most affordable form of life insurance. You pay a premium for a set timeframe, usually 10, 20, or 30 years, and the policy protects you for that same timeframe. For example, if you purchased a 20 year term life insurance policy today with a $500,000 death benefit, and you (unfortunately) were to pass away ten years from now, your beneficiaries would get $500,000 tax-free all at once.
For someone in their 30s, a 20 year term insurance policy with a $500,000 death benefit will cost around $35/month. You would pay $35/month for the 20 year term of the policy and if you don't want coverage anymore, you can simply cancel the policy. You also can rest assured that your premiums won't increase during the term period.
For many individuals, term insurance is sufficient coverage to keep their families protected.
If the term policy is convertible, you can convert the policy to a permanent policy without having to provide proof of insurability at the time of conversion.
If the term policy is renewable, you can renew coverage at the end of the term without having to provide proof of insurability at the time of renewal. When you renew at the end of the original term, your premiums will probably increase based on your age.
According to this MoneySense article, term insurance is critical in these scenarios:
- Newlyweds with debt
- Buying your first home
- Starting a family
The other main type of insurance is permanent insurance, which provides lifelong coverage as long as you pay the premiums, and the ability to accumulate a cash-value, commonly referred to as a cash surrender value (CSV).
Since permanent life insurance is much more expensive than term insurance, the cost should be considered and factored into your entire financial plan.
Permanent insurance policies may make sense if you have investments that will generate a large tax liability on death. A common example here is a family cottage that has significantly increased in value.
If you find that you are maxing out your RRSP and TFSA contributions, certain permanent policies can also provide additional tax-deferred investment options.
The two main types are whole life and universal life.
Whole Life Insurance
Whole life insurance provides coverage for the lifetime of the insured as long as the premiums are paid. The policy builds up a cash surrender value over time, and if the policy holder (owner of the life insurance contract) surrenders the policy prior to the death of the life insured, the policy holder will be able to collect the cash surrender value.
To add another layer of complexity, there are participating and non-participating policies. Essentially, a participating policy allows the policyholder to benefit if the insurance company generates higher than expected revenues.
You might come across permanent insurance called Term to 100. This is essentially whole life insurance with lower premiums and without the concept of a cash surrender value.
Universal Life Insurance
Like whole life, universal life insurance provides coverage for the lifetime of the insured as long as premiums are paid, but it also includes a separate savings and investment component. Essentially, if you deposit more than is required to pay the minimum premium, the additional amount stays in the the policy and can be invested.
Upon your death, your beneficiaries receive the death benefit and the investment proceeds.
Life insurance tips
- Paying your premiums annually instead of monthly can often reduce the premium expense.
- It's best to work with an insurance expert who incorporates financial planning into the discussion.
- Concealing smoking or health issues can lead to a policy being canceled, or even worse, not paying out the death benefit. It's best to be honest about any lifestyle and health questions upfront.
- If you are applying for a mortgage, the banks will likely suggest creditor life insurance for you. This is often more expensive than term insurance and the death benefit is paid to the financial institution to cover the remaining loan balance; it isn't paid to your beneficiaries or estate like with normal life insurance. Note that mortgage creditor insurance is different than mortgage default insurance (CMHC insurance), which is sometimes mandatory
- With permanent policies that build up a cash value, you can use the savings as collateral to take out a policy loan.
What's the best policy for you?
When deciding how you will financially protect yourself and your family when you pass-away, there are a lot of variables to consider. If you want protection up to a certain life milestone, like your children starting university or your own retirement, term insurance is very cost effective and it's likely the best solution for you. In fact, for the majority of young Canadians, term insurance is the most suitable option.
If you want a policy that lasts your entire life and you are looking for an additional investment vehicle to maximize your estate, permanent insurance could be the right solution.
If you have built up a very substantial nest-egg, or if you are single with no dependents (no one relies on you financially), life insurance might not make sense for you at all.
As with any large financial decisions, it helps to talk to an expert who can guide you in the right direction and source the best options for your specific needs. It's best to start the process by doing a financial plan so you and your advisor can assess how life insurance fits into your overall financial picture. With Frame you can easily create a free custom financial plan in minutes!