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An honest guide to life insurance

by Mark Cluett
18 min read

For a lot of us, how life insurance works is not exactly an area of expertise. When the topic comes up, we just smile and nod and hope we don’t get asked any direct questions.

In fact, about one-third of Canadians are currently without life insurance and 1 in 4 millennials in the country admit they are unlikely to purchase any kind of insurance in the near future.

It’s just not on our radars. So if you thought ‘Term to 100’  was the title of a Drake song, don’t be embarrassed, you’re not alone.

The ins and outs of life insurance aren’t common knowledge in our country, which is exactly why it’s a subject worth exploring, especially if you’ve increasingly found yourself in the company of real estate agents, in-laws or babies.

Just because we don’t want to think about something… doesn’t mean we don’t need to.

But where to begin? Is a death benefit a charity concert? Does “participating insurance” come with a ribbon? Is “return-of-the-premium” a new Star Wars flick?

Let’s just start with the basics…

OK… so what is life insurance?

Boiled down, the concept of life insurance is simple. It’s an agreement between you and an insurance company, where if you die, they will pay a lump-sum of tax-free money to someone you choose. In exchange, you agree to periodically pay them a small amount of money over time.

You both decide on the amounts of cash coming in and out and the timeframes involved, but in a super, simplified form, that’s really it.

Got it. Can the lump-sum payment from a life insurance benefit be used to pay for anything? Are there any restrictions on life insurance benefits?

Yes and no; your beneficiary (the person you select to receive the payment) is free to use that tax-free money in any way they wish. Most people plan for their death benefit (the lump-sum of cash paid out by the insurer) to be used to cover their family’s ongoing financial needs (like cost of living, tuition, bills etc.), pay off their debts (mortgages, lines of credit, business loans, etc.) and handle their funeral costs. If you don’t have a family, you could arrange for your death benefit to be given as a tax free gift to an institution (like your college or a charity.) If you fail to name a beneficiary, the benefit will be paid to your estate and heavily taxed.

Is life insurance expensive?

It doesn’t have to be, and for most young, healthy adults, it’s not. 80 percent of millennials overestimate the cost of life insurance by up to five times the actual price. Rates can be as low as the cost of an extra large pizza. For instance, a 30-year old, non-smoking Ontario woman of average health, would only pay $24 per month for a $500,000 payout on a 20-year policy. Less if she lowered her death benefit. If you’re personalizing your insurance policy so that it suits your specific needs and budget, life insurance can and should be affordable.

OK, but do I really need life insurance?

Perhaps a better question is, do the people in your life need it?

After all, life insurance isn’t something you buy for yourself. It’s for the people that depend on you.

It’s for clearing out debts (personal or business-related) and supplying an income replacement to someone who relies on you, because you’re no longer around.

Think of it this way, buying life insurance is a financially responsible move that lets you secure assets for your family’s future by investing in an alternate income source. Without life insurance, you’re putting all your family’s financial eggs in one basket: you, being alive and able to earn an income. Things you want for your family, like a mortgage-free home or college tuition, plus their current needs like food, clothes and maybe even a Netflix subscription, could become compromised if you and your salary disappear. By diversifying your income-generating investments to include life insurance, those great things (education, financial freedom, on-demand entertainment) are still promised for your family.

So while we won’t tell anyone they absolutely need life insurance; unless they’re some combination of young, wealthy, debt-free, single and childless (and planning on staying that way,) we can advise that you might really want it.

Alright, let’s say I want it. How much life insurance coverage should I get?

Everybody would love to be able to leave a multi-million dollar fortune to their family when they die. But for most of us that’s not realistic. Before you figure out how much coverage you want to buy, you should consider how much you can afford. You’ll be required to pay a regular coverage fee for the length of your term which can cover decades or even the rest of your life. A million dollar policy is worthless if you miss your payments and it’s cancelled.

The best way to determine what affordable means to you is to build a budget to assess your family’s current financial needs, their future needs, your current liabilities and debts, and any costs associated with your death. That’ll reveal what kind of coverage amount you should aim for and the costs associated with it. We highly recommend using our life insurance coverage calculator to get a quick but comprehensive recommendation.

Thanks. So, what types of life insurance are there?

There are a lot. But for the average person, you only really need to know two types: term and permanent. Both have their pros and cons, but most Canadians (76 per cent in fact) wind up with term insurance, either through individual plans or through their employer as a group plan.

What is term life insurance?

Term life insurance is a straightforward insurance product that makes the promise stated above: if you die, we’ll pay, but only if that were to happen within a specified length of time, or ‘term’. It’s typically purchased in decade-long chunks, 10, 20, 30 years, but you can choose smaller term lengths or if you prefer you can set your coverage to last until you hit specific age milestones like senior-citizen status at 65.

Why would I want life insurance that is only temporary?

Term insurance provides temporary coverage because it’s designed for temporary needs.

Life insurance is at its most valuable when your family is at its most vulnerable.

Financially speaking, of course. For most people, that’s either when their kids are young, their mortgage is new or they’re at the height of their earning power. This state of vulnerability typically only lasts a couple of decades though. After that, your kids are self-sufficient, your mortgage is almost paid off, and you’re planning for retirement. Having the option to buy term life coverage for a specific period of time, allows for flexibility in financial planning and lets you buy only the financial security you need to address specific life risks, at a manageable cost. Term insurance policies build no value over time and can’t be invested or surrendered for cash; because of this simplicity, they are offered for much lower premiums.

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Sorry, what are life insurance premiums?

Apologies, premiums are the amount of money you agree to pay the insurance company, usually monthly (though you can choose different payment frequencies), in order to receive coverage. The higher your age, the longer your term, or the larger your death benefit, the higher your premiums will be.

Conversely, if you’re a young, healthy female who’s never smoked a cigarette (or at least not in the past year), the lower the cost of your premiums. Why? Because statistically each of the preceding traits suggests you’re less likely to die within the term and more likely to outlive your policy.  Insurers want customers with good health because then they are taking on less risk, so they offer you lower rates as an incentive.

So my youth and health are finally saving me money?

Yes. If you’re committed to getting term life insurance, we’d encourage you to lock into a policy at a young age, when you’re in good health and will fly through your medical exam. Most term policies also offer level premiums, which means you’ll pay the same fees throughout the life of the term, even if you develop poorer health as you age. Over several decades, this can save you thousands of dollars and avoid a scenario where you could be considered uninsurable. If you wait until you’re older to be insured, or choose a shorter term that requires regular renewals, you will undoubtedly face higher premiums for the same coverage.

TL;DR: Premiums can be substantially less expensive when you’re younger – don’t sleep on this!

I can renew my term life insurance policy?

Yes, many term life insurance plans come with a renewability clause, that lets you extend your coverage without having to medically requalify. The downside of renewing your coverage is the cost: your premiums are reassessed (read: increased) to match your older age. Most renewable term life insurance policies are upfront about this though; they will guarantee the renewal premium amounts at the time of the policy purchase. Many also offer a convertibility clause, which gives you the option to convert your term insurance to coverage that lasts through your life, instead of requiring periodic renewals. While these clauses must be locked in when first buying a policy, they offer significant flexibility in allowing you to start with a shorter coverage term and increase it as your insurance needs and financial resources evolve, without worrying about your health deteriorating.

So why not skip the renewals and just pick the longest term life insurance available?

You absolutely could, but the premiums will be expensive and more importantly, you might not need it.

Let’s look at an example.

Meet, Neil Patrick.  He’s a 45-year old man, with two kids, Harold and Kumar. Harold is 10 and Kumar is 8. Life expectancy for a Canadian male is around 80 years so chances are he’ll die in the next 40 years. So, he should get a 40-year term policy to guarantee a payout, right? Well, not so fast.

Neil Patrick’s kids will be financially independent adults in the next 20 years. His partner is only 30 and could still be working at 50. With the kids out of the house, living costs will drop and making ends meet will become more manageable.

If Neil Patrick instead opted for 20 years of coverage through a renewable term policy with the same payout to cover his family’s financial needs, his premium would be considerably lower than a 40-year policy. If he dies at 48, his family will receive the same death benefit with either policy but he’ll save thousands of dollars while living and still meet his coverage needs. On the flip side, if he is still alive and kicking at 65, he could choose to extend his coverage for another 20 years, albeit at a higher premium, or reduce his coverage altogether to match his new financial situation.

This is a bit complicated, what if I want life insurance coverage for my entire life, no questions asked?

That’s where permanent insurance comes into play. This kind of policy will pay a lump sum to your beneficiary when you die, full stop, regardless of your age when you pass away. Premiums for permanent life insurance are usually level throughout your life and you don’t need to worry about renewing or converting your policy at any point.

This seems like a good bet. What’s the catch?

It’s expensive. Very. Premiums are often five to ten times higher than what you’d pay for a term insurance policy with the same coverage amount. Permanent policies are priced in this manner because there’s a lot more to them. They hold value in ways that make them appealing as investment and tax sheltering products. Unfortunately though, for a lot of people, a lifetime of expensive premiums can be too much of a draw on their bank account.

What if I’m good for the money?

Well, then you’ve got some options.

What types of permanent life insurance policies are there?

Whole Life: You’re covered until you’re cremated (or buried, or cryogenically frozen, etc.) and there is a cash value associated with your policy.

Wait a minute – cash value?

Yes, whole life insurances policies build value over time with guaranteed rates similar to a high-interest savings account or GIC. In order to pay these guaranteed rates, your insurer will invest your premiums in a low-risk portfolio that you have no say in directing. Sometimes, whole life policies will also pay dividends based on the insurance company’s profits. This is known as participating insurance. If you opt for a non-participating policy, it means you won’t receive these dividends.

If you wish to surrender your whole life policy for cash at some point or borrow a loan against it, that’s also an option. However, doing so will incur taxes or interest charges or both.

Whole Life Limited-pay:
This is similar to whole life, except a payment term is specified, say 20 years. Once you’ve paid your premiums over that period of time, your insurance is guaranteed for life and you’re off the hook for fees. This is typically the most expensive policy option because the premiums are front-loaded to offset the years where you will no longer be paying.

Universal Life: This is the same as whole life insurance, except there is a self-directed investment component. Your insurer will give you options to invest the cash value of your policy however you wish. If you’re a savvy investor, like a certain Mr. Buffett, this gives you the opportunity to generate a larger return than what is guaranteed from a traditional whole life policy. The trade-off is: it requires you to actively monitor those investment choices. It’s kind of like opting to build your own investment portfolio vs. paying into a mutual fund.

Term to 100: Even though it’s got the word term in the title, this is still a whole life policy that will cover you until your death. The difference is with this policy there is no cash value or investment component which makes the premiums a little cheaper. Also as a bonus, if you manage to crack the century mark and join the other 6,000 centenarians living in the country, you’ll no longer be required to pay premiums and you’ll still be covered. It’s a nice extra, which is why it’s no surprise that this kind of policy is uniquely Canadian.

Because permanent insurance policies offer the opportunity for tax-free investing and payout, it can be very useful for wealthy people who want to shelter their savings until dropping into a lower tax bracket or to be able to transfer more of their wealth to their families when they die by offsetting estate liabilities. They’re handy for regular income earners too though as they can be used to cover the universal costs associated with death that can’t be avoided such as funeral expenses. This is why people often convert from term life insurance to a permanent policy when they’ve gotten older and their term is up for renewal.

While these permanent life insurance options might sound great (and they can be!) it’s worth noting that 40 percent of permanent life insurance policies lapse within the first ten years as policyholders are unable to afford the high annual premiums. That’s how life insurance works in favour of the carriers at times.

Give us a call at 1-888-601-9980 or book some time with our licensed experts.

That’s why it’s important to do your due diligence and only purchase life insurance you can comfortably afford.

How can I get lower life insurance premiums?

The most effective way to cut the cost of premiums on a life insurance policy is to lower the size of your death benefit. It’s worth noting too that comparable term insurance will always be cheaper than permanent insurance and shorter terms will also offer lower rates.

From there you can sometimes get further savings by sharing more personal information with your insurer that shows proof of good health.

What kind of personal information do I need to share with my insurer?

Insurance companies have a mandatory set of questions they ask for most policies. This includes divulging your gender, your age, where you live and whether you smoke. You’ll be asked details about your health, your family’s medical history, how much you drink, your history with drugs, your passion for extreme sports (seriously) and how dangerous your job is (like if you’re a logger for instance.) Based on your answers to these questions, you’ll be placed into a risk category and offered premiums accordingly.

Insurance companies are hoping you don’t die while you’re covered (how sweet!) so they want to make sure you’re healthy before insuring you. If you prove you’re in good health, they in turn offer you lower rates. In-person medical exams are commonplace, especially for larger coverage amounts, and some insurance companies even offer free fitness wearables to track your activity levels in the short term, while you apply for coverage.

There are also some basic coverage plans available that don’t require any deep probing and guarantee acceptance regardless of your health. They are called guaranteed issue policies. However, they are, you guessed it, much more expensive and therefore not recommended for most people, especially if you’re currently in good health.

Which life insurance policy should I pick?

Unfortunately, the answer isn’t in the back of the book for this question. Life insurance is a deeply personal purchase and there are a lot of factors to consider. Not only should you factor in your family’s current financial needs, but you should also account for future costs like tuition fees, funeral arrangements, estate taxes, and any other debts or obligations you would want settled should you die.  There a lot of options to choose from and myriad combinations of coverage, but you should only purchase a policy you can afford and that you’re confident makes the most sense for you and your family.

Luckily, we’ve built a pretty great tool that can help you figure that out now that you know how life insurance works in Canada.

We’ve only scratched the surface here, so if you’re still curious about life insurance, and want to dive deeper on some of these terms and concepts check out the rest of PolicyAdvisor magazine for honest, insurance advice and in-depth articles.

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