Life Insurance: Keeping Pace with Your Needs
Life insurance is a financial product whereby you make periodic payments (insurance premiums) in exchange for a preset benefit (insured amount) after you die. Benefits are non-taxable, since premiums are non-deductible (with some exceptions). Before issuing a policy, insurers usually require proof of the applicant's health and proof of an insurable interest justifying the relevance of the policy.
Young singles can easily do without life insurance or take out only enough to cover their debts or their funeral expenses should they die young. From a strictly financial standpoint, their death would have little impact on their families.
Add a spouse and young children, and the situation may change. Death could now have serious financial repercussions on the people under your care. At this early stage in your career, your total assets are often limited and your debts may be high—and the cost of raising your children until they're self-sufficient can be enormous. You should probably maximize your life insurance to replace the loss of income to your family should you pass away.
In mid-career, your debts are partially repaid and your children will soon be setting out on their own. If one parent has stayed at home to take care of the kids, this is when he or she will think about going back to work. As a couple, you may also have a fair amount of savings. A death at this point could still cause financial problems, but the amount of life insurance you need will begin to drop.
Last comes retirement. With good financial planning, you've paid off your debts and accumulated enough savings to support you and your spouse. Your children have most likely moved out and are probably supporting themselves. In the event of death, the surviving spouse often inherits the assets left behind and may become the beneficiary of certain pension plans (e.g., the survivor's pension under the Québec Pension Plan or a supplemental pension plan's joint and survivor pension). The drop in income is often offset by the drop in expenses due to the spouse's death. At this stage, you may not need to take out a life insurance policy.
Types of Products
This type of insurance covers a set period (5 years, 10 years, or 20 years), but the policy may contain a conversion clause, so you can convert it into permanent insurance. Since the risk of dying during the term is often minimal, premiums are very affordable. At the end of the term, you can usually renew the policy for an equal amount of time, but with a higher premium since the chance of death is higher. This is a great way to protect yourself from temporary financial risk by, for example, covering your loans (by choosing a term that ends when your loan matures) or replacing your salary (by choosing a term that ends when you retire). As you get older, the risk rises faster, and so do your premiums. That's why term insurance usually ends at age 80. This graph illustrates risk of death according to age, sex, and whether or not you smoke.
If you don't die during the term, no benefits will be paid in your name, and your premiums will have funded claims by other clients. One-hundred-year term insurance (age 100) is virtually the same thing as permanent coverage.
Permanent (Whole-Life) Insurance
Because this insurance is permanent, the insurer knows it will have to pay out the insured amount. Instead of taking out term after term with ever-rising premiums, you pay a level premium. Compared to term insurance, the premium is higher in the early years but lower in the later years. It's also higher depending on how old you are when you take out the policy. The insurer puts aside the extra premiums in the early years to offset the lower premiums in later years. Because of this reserve, there may be "surrender value" in case you decide to terminate the policy (not available with 100-year term insurance).
Permanent life insurance provides an enormous return if you die young, but less if you live longer. It's used for situations of permanent financial risk. If much of your estate is in fixed, non-liquid assets when you die and you don't have life insurance, your assets may need to be sold quickly (at a loss).
Universal Life Insurance (UL)
This type of insurance is more flexible, but the policyholder shares some of the risks, including the rate of return. With UL, you deposit premiums into an account and select investment vehicles. The account is credited with the returns on your investments and debited for administration fees (e.g., $10/month) and the cost of the insurance. The policy may have premiums that are level or that rise over time.
Investment returns are non-taxable for the insured, which may seem to be a tax shelter. But returns are usually less than they would be for the identical investment outside the policy. The difference in returns, which varies due to bonus clauses, occurs largely because your insurer pays taxes on the returns and bills them to you, the policyholder. As an investment vehicle, UL is less effective than unregistered savings and much less profitable than a tax-free savings account (TFSA) or a registered retirement savings plan (RRSP). Remember, universal life is first and foremost an insurance product, not an investment strategy. Be careful when you see sales materials illustrating returns. The minimum guaranteed performance is closest to reality.
Other Insurance (payable during your lifetime)
- Disability insurance replaces a portion of the income lost in the event of disability. With this type of policy, pay particular attention to how disability is defined (sometimes very restrictively), the wait period (time before benefits begin), and any benefit indexing (adjustment for inflation).
- Health insurance covers a portion of the cost of medical, dental, and hospital care. Find out about the deductible (amount you'll have to pay before coverage starts) and the coinsurance rate (percentage reimbursed after you pay your deductible).
- Critical illness insurance can free up large amounts of money in certain situations to cover the cost of healthcare at a private clinic or adapting one's environment to accommodate a new physical condition. Only the situations listed in the policy are covered (cancer, etc.). Make sure you know what's excluded.
With all the variety of products available, you can adjust your coverage as your needs change. Your insurance needs are usually at their highest when the likelihood of death is lowest, so you can get good coverage at a low cost. When needs are truly temporary, a frequent error is to limit protection because of the high premium for permanent products. In fact, it may be possible to ask for temporary coverage and get the full coverage you need at a lower premium.
Taking out insurance to cover the taxes on your RRSPs after you die is not usually financially effective, especially if you have to make early withdrawals from your RRSP to cover your premiums.
A financial security advisor (authorized to distribute the product) and financial planner can provide further information. For permanent insurance, financial service advisors can explain the differences between participating and non-participating policies. They can also help you combine personal insurance with group insurance programs and credit insurance offered by lending institutions.
To consult the Guide to Life Insurance published by the Canadian Life and Health Insurance Association (CLHIA), go to www.clhia.ca under the heading "Consumer Assistance".