What Kind Of Life Insurance Is Right For You?
Insurance companies already get a bad rap. Many view insurance as something you pay for but never reap the benefits. Car insurance is typically the first exposure for individuals in the world of insurance and directly affects their view on life insurance.
For example, car insurance is mandatory and, if you never submit a claim, that’s ‘money in the bank’ for the insurance company. But when you are ready to submit a claim, insurance companies tend to give you a runaround!
It’s important to remember that life insurance and car insurance are very different. How? Read on! This post will break down the different types of life insurance and empower you to choose if you require term insurance, whole life insurance, or both.
The one guarantee in life is death
When many families and individuals start getting insurance, they will get insurance on things like their vehicles, cell phones, homes, and jewellery, just in case something happens. This grants them peace of mind and security, knowing they will be fully reimbursed for the insured item’s value. There has been an increase over the years with respect to Canadian households owning a life insurance policy, however, many Canadian consumers have a difficult time making the decision when purchasing life insurance, according to a LIMRA life insurance article in 2019.
Think about it. A 30-year-old may have 35 working years left to retirement. Assuming they are earning $75,000 annually for the next 35 years, they have an earning potential of $2,625,000 for themselves and their family—this is where life insurance comes in.
There are two types of life insurance
Life insurance falls into two categories:
term life insurance, also known as:
- Term insurance; and,
- Permanent life insurance, typically referred to as whole life insurance.
Over the years, I’ve found that some advisors only offer term insurance, and others only offer permanent insurance. What’s important is that you have the right insurance coverage in place for the right need. Let’s break them down.
Term life insurance
Term insurance covers you for a temporary amount of time. Terms typically range from 10 years – 40 years.
The advantage of term insurance is that it’s relatively affordable. The disadvantage of term insurance is that, once it reaches the end of the term, should you decide to keep your policy, your renewal rates will increase.
I’ve seen renewal rate increases of seven times the initial amount. Term insurance is best to cover temporary needs that have a definitive time horizon. To determine if you require term insurance, we must first distinguish what a term insurance need is.
Examples of term life insurance needs
- You purchase a home and take out a mortgage for 25 – 30 years. After you pay off the mortgage, you no longer need insurance to cover this risk.
- You co-sign on a loan, mortgage, vehicle, etc. Once you pay off the loan, you no longer need insurance to cover this risk.
- You want to save for your children’s education. Typically, children go to post-secondary school in their late teens, and if you are saving for their education, this is a time-bound goal. You can purchase life insurance to ensure their education funding is in place if you happen to predecease them and haven’t yet saved the whole amount. Once they are in post-secondary school or completed their studies, you no longer need to insure this risk.
- Future earnings. You have a newborn child, and you want to ensure that you can financially provide for them until they are independent, which may be in about 20 – 30 years. You can purchase term insurance to ensure that you have financially provided for their wellbeing if you predecease them.
- You are recently married and have big goals and dreams of building a life together. You can purchase term insurance for 20 – 30 years to provide your partner’s financial means to ensure a life fulfilled. After all, those are the vows you signed.
How much term insurance do I need?
There are multiple ways to calculate how much term life insurance you need.
For the loans and saving for your children’s education those are relatively simple. The remaining balance or amount required for school would be the insurance coverage amount required.
The calculation for future earning can look like your annual income multiplied by the number of years you want to provide for, or the annual cost to raise a child multiplied by the number of years until the child is independent.
Permanent insurance or whole life insurance or will never expire or increase in price. However, it’s at least twice as expensive as term insurance from the start.
Whole life insurance can also fall into two categories:
With a Participating policy, you agree to participate in the growth and performance of the company, enabling you to earn dividends as a policy owner. Dividends are not guaranteed and typically paid out annually. Once the dividend is declared, it cannot be taken back.
With a Non-Participating policy, you do not agree to participate in the growth and performance of the company.
To keep things simple, we will talk about non-participating insurance and all of its advantages.
While term insurance is excellent for temporary needs, using it for permanent needs is like putting Band-Aids on bullet wounds. Pretty graphic, I know, but I think you get the picture. That’s where permanent insurance comes in handy.
Examples of permanent insurance needs
- Death: There is nothing more permanent than death. As I alluded to earlier, it’s guaranteed to happen but when, no one knows. As an advisor myself, if I knew when my last day on earth would be, I would purchase a term insurance policy 30 days prior. But the reality is, I do not know so I purchased a permanent insurance policy on myself to ensure that when I pass, my family is guaranteed to receive a financial windfall.
- Taxes: When you die, there will still be taxes to be paid. Your estate needs to pay tax on any income earned in the final year of your life. Also, in Canada, there is a “deemed disposition” on death. To put it simply, if you own certain types of assets and they have appreciated in value during your life, your estate may need to pay tax on that increase in value. Life insurance can help cover the cost of the tax bill.
- Supporting a cause, or charity: If there’s a cause or charity that you’re passionate about, permanent life insurance is a great gift to ensure your charity of choice receives a financial windfall to advance its mission. This is done by naming the charity as the beneficiary on your life insurance policy.
- Gift for grandchildren. Similarly like the charity example above, another permanent need can be to ensure grandparents leave something behind for their grandchildren.
Life insurance is a selfless act
Life insurance is for everyone and let’s also get one thing clear: Life insurance isn’t a need, it’s a want. It’s a selfless act.
If you want to ensure the financial wellbeing, peace of mind, and security of your family, you want to own a life insurance policy. It doesn’t matter the stage of life or how wealthy one may be.
There are many advantages of owning a life insurance policy if you have the right one for the stage of life you are in.
Also, when making a Will, it would be wise to consult a life insurance professional to determine how much permanent life insurance coverage is required. When it comes to permanent life insurance, there is no ‘quick formula’ like term insurance.
So, remember, distinguish the need (temporary or permanent) and then get the appropriate policy to match.