Life insurance is a financial product that helps ensure the financial security of your loved ones. In the event of the death of the insured person, the amount of life insurance is paid to the persons designated as beneficiaries, like a spouse, your children, etc. This enables your relatives to cover the costs associated with your death such as funeral costs, legal fees, debts of the insured and an inheritance.
Before using a life insurance policy comparison tool, however, you should determine what goals you want to achieve when insuring yourself. Some of the goals that a life insurance policy can help achieve may include ensuring that your children and life partner do not have to move out of the family home. In this case, you could take out a life insurance policy for at least the amount of the mortgage value.
Another goal might be to make sure your kids go to college, to pass on an inheritance to the next generation, or to secure the future of your business. In fact, in the case of a company, life insurance can be taken out in order to give the partners the possibility of buying back the deceased's shares in order to return the sum to their family, who are normally the heirs of the assets.
There are several types of life insurance that would best suit your needs. The three most popular types of life insurance are term life insurance, permanent life insurance, and universal life insurance.
Term Life Insurance
Term life insurance is coverage that comes with an expiration date. It is the cheapest insurance, especially if you are young, because it has a term. If the insured person does not die during the term of the contract, the insurer will not have to pay the amount. The risks for the insurer are therefore much less and that is why the premiums (monthly payments) are less expensive than with permanent life insurance. The duration can vary between 1 and 30 years.
The premium remains constant throughout the duration of the contract. It is based on the age of the insured when they sign the contract, as well as on their state of health. At the end of the contract, you no longer have life insurance. However, if you want to keep your insurance, it is possible to either renew your term insurance or convert it to permanent insurance. The insured can choose to renew their term life insurance in the form of another term life insurance policy or permanent, and the premium will then be adjusted for the new period.
When renewing, the new policy will therefore cost you more than the one that has just ended, because you will have aged during the term and it is possible that you will have new health problems. However, it is possible to lower the cost with proof of good health. You don't need to prove that you're still healthy when you renew term insurance, but doing so usually lowers the premium.
You may want to renew your insurance if you have developed health problems during the term and think you are no longer insurable. Otherwise, if you have no reason to believe that you are no longer insurable, it would be wise to start the insurance purchasing process again as it’s quite possible that the insurer with the best price for your situation is no longer the same one.
If the insured dies while term life insurance is in effect, the insurer will pay the insurance amount to the beneficiaries. They can therefore use this sum to cover the many costs related to the death, as well as any of the insured’s debts. As a general rule, it’s no longer possible (nor advantageous) to take out any type of life insurance policy from the age of 80.
Why choose a term life insurance policy?
A term life insurance policy protects you for a predefined period. It addresses needs that are not “forever”, such as protection while your children are growing up, or mortgage repayment coverage. If your needs are not permanent, then this life insurance is perfect for you.
Let’s consider an example of a couple that just had a child. They believe that if one of them had an accident, the surviving spouse would be unable to support the child with only their salary. They then decide to each take out term life insurance for 20 years, as they estimate that they will have to support the child for another 20 years. They opt for $300,000 in coverage because they estimate that the child will incur costs of $15,000 per year for 20 years (15,000 x 20 = 300,000).
Let's continue the analysis with another couple that just bought a house. They have $350,000 in mortgage debt. They then decide to take out joint term life insurance for $350,000 over a period of 25 years (amortization of their mortgage). Thus, in the event that one of them dies, the other spouse can use this insurance to pay off the mortgage in full and get rid of the financial burden that they would be unable to manage on their own.
The two most typical cases for taking out term life insurance are those mentioned above. However, term life insurance can meet other needs, such as ensuring the sustainability of a business in the event of death. If two partners own a company and one of them dies, the surviving partner can use the insurance amount to pay the value of the deceased's shares to their family. You can also take out insurance to cover car payments, spousal support, student loan debt, etc.
With a mortgage, if you’re in good health, it is better to take out term life insurance rather than the mortgage insurance policy offered by the bank. The price of term life insurance is generally lower, you own your contract (for mortgage insurance, it is the bank even if you are the one paying), you can make changes to your contract at any time and you can name the beneficiaries you want.
What's more, with mortgage insurance, even though the amount of coverage required decreases each year since you are paying down your mortgage, the premium you pay each month for mortgage insurance does not change. With term life insurance, even if you die 20 years later and have only $50,000 left to pay on your mortgage, your beneficiaries will receive the full amount of coverage.
When should you choose a term life insurance policy?
Term life insurance is useful when you have financial obligations that you don't want to leave with loved ones after your death. That said, there is no specific age when you should take out term life insurance, but rather specific times. Keep in mind, however, that the premium increases with age. In addition, it’s a good idea to choose the term of insurance according to your needs, such as the age at which your children will no longer be dependent on you financially, or the term of your mortgage.
Permanent life insurance
Permanent life insurance is financial protection for the duration of your life. The price of this type of policy is higher than that of term life insurance, since the insurer is sure that sooner or later it will have to pay the amount of your insurance to your estate. Since this type of insurance lasts your entire life, you don't need to renew it. Costs can be fixed, change with your age, or be payable over a number of years.
Why choose permanent life insurance?
It’s a good idea to take out permanent life insurance if you think you will die one day…No joke, permanent life insurance will cover your funeral costs and leave an inheritance for your estate. In any case, permanent life insurance will always be well received by your loved ones. In slightly more specific cases, permanent life insurance could be part of an investment strategy or to optimize taxes when transferring wealth.
Take the example of the owner of a growing business. If that person wants to bequeath this business to their children after their death, they will have to pay tax on the capital gain. That is to say on the company’s increasing value. Often, this amount is close to the actual value of the company. The cost can therefore be quite steep and this could mean that the estate will not be able to take over the company. Permanent life insurance would therefore meet this need.
You could also buy permanent life insurance to take advantage of its cash value in the future. The cash value of a permanent life insurance policy is the amount that the insured can receive in the event of a withdrawal or surrender from their life insurance. This amount changes over the years and is based on the premiums paid. It can be used as last resort money. For example, a retired person who is starting to run out of money might want to cancel their life insurance to collect that amount so they can continue to support themselves. Parents may also be able to cancel their life insurance to pay for their child's post-secondary education. Obviously, permanent life insurance is not an investment vehicle and it will always be better to save than to rely on this cash value for future needs. However, the cash value represents a certain advantage from which the policyholder can benefit from at any time. What's more, like an RRSP, a permanent life insurance policy is an unseizable asset in bankruptcy, a feature that makes it attractive to entrepreneurs who have guaranteed loans to their business in their own name.
When to choose permanent life insurance
Permanent life insurance is useful regardless of the stages of life. There is no ideal age for choosing life insurance. Again, take into consideration that the sooner you buy life insurance, the cheaper it will be. Also, the sooner you take out your insurance, the less chance you will have of having health problems that could dramatically increase the cost of your insurance premiums.
Universal life insurance
A universal life insurance policy offers greater flexibility compared to the other types of policies mentioned previously. This insurance offers you the same financial security as other types of life insurance, but it also helps you grow your savings at the same time. You have a minimum monthly amount to pay to cover the insurance part, then you can add whatever amount you want for the savings part. Just like other types of life insurance, the amount of premiums is based on your age, health and, of course, the amount of coverage. The insured can choose to invest their money in several types of investments offered within the universal life insurance policy.
Why choose universal life insurance?
Universal life insurance provides more flexibility if your income is variable and you have enough money set aside to build a reserve for more difficult times. The major advantage of universal life insurance is that the death benefits are tax-free for the beneficiary of the policy. The beneficiaries will therefore have a larger after-tax amount than if the policyholder had saved in a non-registered account, in an RRSP or TFSA. If you want to leave a large amount for your loved ones, universal life insurance is a good solution.
Who should choose universal life insurance?
This type of insurance is perfect if you want to leave a substantial legacy for your loved ones. If you want to leverage the amounts saved during your lifetime, it’s better to make the maximum contributions for your RRSP and/or TFSA, or to repay all your debts before investing in a universal policy. The reason is that you will be taxed less on withdrawals from these registered accounts, and you can modify or withdraw the amounts saved at any time. You can modify your coverage (amount of insurance, options) throughout the period according to your needs.
How much are you willing to pay for your insurance policy?
The price of each life insurance policy varies depending on each person and the coverage chosen. There are a few factors that can play a role in the premium, such as the policyholder’s age, gender and health status.
Here is a table to illustrate the premium differences for each customer profile. For this example, the coverage amount is assumed to be $100,000 over 10 years.
|Age||Gender||Term life monthly premium||Permanent life monthly premium|
As can be seen in this table, a person’s gender has a huge influence on life insurance premiums. Men pay on average 30% more in premiums than women. This difference is due to the fact that men’s life expectancies are lower than that of women. Age is an important factor for the premium, because the older the insured taking out insurance, the higher the risk of death. The consumption of tobacco also has a direct impact on the insured’s health. It decreases their life expectancy and, therefore, a smoker will have to expect to pay higher insurance premiums than a non-smoker of the same age.
When should you change coverage?
It is recommended that you review your insurance coverage, i.e. the amount of coverage and options, every 5 years, or during a family change (arrival of a child, purchase of a home, starting or buying a business). In the event of a birth, it is recommended to increase your insurance amount to be able to maintain your family’s level of comfort in the event of your death. When buying a new home, increasing your term life insurance is recommended to cover all of the debts accumulated with the mortgage.
How do you access the cash value of a life insurance policy?
If you need money, but don't want to borrow, it's possible to dip into your permanent or universal life insurance. Rather than going to a bank, you can arrange with your insurance company either a partial surrender or a policy loan. Financial terms can be more attractive and the formalities quicker. The difference between a partial surrender and a policy loan is in the taxation. A surrender may, in part, be subject to income tax, while a policy loan is not taxed.
Let's look at an example. An insured wishes to retire. He contributed $2000 a year to his life insurance over 40 years. The sum of the premiums paid to the contract is $80,000: this amount corresponds to what is called the adjusted cost base (ACB) in the industry. He wants to buy back all of his life insurance for a value of $75,000, which is called the proceeds of disposition (PD) in the industry. This withdrawal will not be taxable because the adjusted cost base (ACB) is greater than the proceeds of disposition (PD). In fact, the proceeds of disposition (PD) are $75,000, which is $5000 less than the adjusted cost base (ACB).
If our insured wanted to buy the same policy for $100,000 (we are talking about the PD here), he would have to pay tax on $20,000, which is the difference between the ACB ($80,000) and the PD ($100,000). In fact, $100,000 minus $80,000 equals $20,000.
In summary, if the amount of your withdrawal is less than the adjusted cost base, which is calculated at the time of your withdrawal, you will not have to pay tax. If your withdrawal is more than the adjusted cost base, you will have to pay tax on the portion in excess of the ACB.
Choosing the right life insurance is to be taken seriously. It is important to understand all the terms of your contract to avoid any unpleasant surprises in the future. Lastly, regularly review your coverage to ensure your loved ones are well taken care of in the event of your death.