What Is Life Insurance And How Does It Work? [2022] - PolicyAdvisor
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A guide to how life insurance works in Canada – Updated 2022

SUMMARY

The meanings of term life insurance, permanent life insurance, premiums, and death benefit are not general knowledge. We know how tricky life insurance can seem, so we’re here to demystify how life insurance works in Canada, what the cost of life insurance is, and help you figure out if you need a life insurance policy.

By Jiten Puri
CEO & Founder, Insurance Advisor, LLQP
19 min read
IN THIS ARTICLE

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.

The basics of life insurance are 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.

Life insurance 101 isn’t common knowledge in Canada, 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.

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…

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What is life insurance?

Life insurance is an agreement between you and a life insurance company. The agreement is if you die, they will pay a death benefit( a lump sum of tax-free money) to someone you choose. In exchange, you agree to periodically pay them an insurance premium: (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.

Read more: What is life insurance.

What can a life insurance claim payment be used for?

Your beneficiary (the person you select to receive the payment) is free to use the life insurance death benefit in any way they wish. The death benefit is tax-free. They can use the money to:

  • Cover everyday expenses so their family can maintain the same standard of living (groceries, bills, rent, etc.)
  • Pay off outstanding debt (mortgages, lines of credit, credit card bills, business loans, etc.)
  • Provide for their children’s education
  • Make a large donation to their preferred charity
  • Pay for their funeral arrangements
  • Protect their business

If you fail to name a beneficiary, the death benefit will be paid to your estate and the money may get taxed.

Learn more about life insurance claims.

What are the different types of life insurance in Canada?

There are two main types of life insurance: term life insurance and permanent life insurance (or whole life insurance).  Both whole life insurance and permanent life insurance have their pros and cons, but most Canadians (76 percent in fact) wind up with term insurance, either through individual plans or through their employer as a group plan.

Learn more about the different types of life insurance:

Term life insurance

Term life insurance makes the promise if you die, we’ll pay, but only if that were to happen within a specified period of time, or ‘term’. These terms are generally 10, 20, or 30 years, but you can choose smaller or larger term lengths or coverage that last until a specific age.

Learn more about how term life insurance works.

Whole life insurance

Whole life insurance covers you for your entire life and there is a cash value associated with your policy. Sometimes, whole life policies will also pay dividends based on the insurance company’s profits. This is known as participating insurance.

Learn more about how whole life insurance works.

Limited-pay whole life insurance

Limited-pay insurance is similar to whole life, except the payment plan is condensed. For example, the term could be 20 years: once you’ve paid your premiums over that 20-year period, your insurance is guaranteed for life and you’re off the hook for premiums. This type of coverage is typically the most expensive policy option. This is because premiums are front-loaded to offset the years where you will no longer be paying.

Learn more about how limited-pay whole life insurance works.

Universal life insurance

Universal life insurance is the same as whole life insurance, except you have more choice of where your cash value is invested. If you’re a savvy investor, this gives you the opportunity to generate a larger return than what is guaranteed from a traditional whole life policy. That said, it requires you to actively monitor the investment choices you’ve made with the cash value. Alternative investment solutions may help you achieve your financial goals faster.

Learn more about how universal life insurance works.

Term to 100 life insurance

Even though the word term is in the name, term to 100 is a whole life insurance policy that covers you until your death. The difference is with this policy there is no cash value or investment component, making the premiums a little cheaper. As a bonus, if you do live beyond age 100, you are no longer required to pay premiums and retain your coverage. Term to 100 life insurance policies are unique to Canada.

Learn more about how term to 100 life insurance works.

Annual renewable term life insurance (ART)

A less popular life insurance option, annual renewable term life insurance (ART) is designed for those looking for short-term life insurance coverage. ART is available on an annual basis with the possibility of renewal and can protect people who are between jobs, who want to improve their health before locking in a longer-term policy, or those with short-term debt.

Learn more about annual renewable term life insurance.

Is life insurance worth it?

If you have dependents, life insurance premiums are worth the cost. Life insurance provides peace of mind knowing that your family will be taken care of financially when you pass away.

If you don’t have dependents, there could be other circumstances where the benefits of life insurance is worth the price of premiums. These can include:

  • Taking advantage of your youth and health to ensure a lower premium and future insurability
  • Providing a charitable gift to your favourite cause or organization
  • Leaving a financial gift or legacy to children or grandchildren, regardless if they are dependents or not

Learn more about if life insurance is worth it.

Does life insurance have cash value?

Permanent life insurance policies accumulate a cash value as the insurance companies invest your premiums. Policies such as whole life and universal life insurance have this investment feature. You can either cash it out, save it, loan against it, or apply the value to your existing policy.

Learn more about the cash value of life insurance.

Read more about:

How much is life insurance?

The cost of life insurance depends on several individual factors. For most young, healthy adults life insurance costs are quite reasonable on a 20-year term policy.

For instance, a 30-year old, non-smoking Ontario woman of average health, would only pay $21 per month for a $500,000 death benefit on a 20-year policy. If you’re personalizing your insurance policy so that it suits your specific needs and budget, life insurance can and should be affordable.

Coverage 10-Year Term 20-Year Term
$250,000 $11/month $14/month
$500,000 $15/month $21/month
$1,000,000 $23/month $36/month

Premiums for female, non-smoker, 30-years old

Personal factors affect your life insurance cost. Factors include:

  • Age: Insurance premiums rise in cost as you age.
  • Smoking Status: Smokers pay more for life insurance.
  • Gender: Generally, men have higher life insurance premiums than women.
  • Health: Insurance providers see health problems as adding to the risk of insuring you.
  • Family Medical History: Insurance providers also calculate the risk of known hereditary illnesses.

Details of your life insurance policy will also affect the price of your monthly premium. These aspects include:

  • Term Length: The longer your coverage period, the higher the premiums.
  • Coverage Amount: A larger death benefit will also dictate higher insurance premiums.
  • Type of Insurance: Term life insurance is less expensive than whole life insurance.

What are life insurance premiums?

Life insurance premiums are the amount of money you agree to pay the insurance company, usually monthly or annually, 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.

Learn more about life insurance premiums.

How much does term life insurance cost?

The main factors that affect the cost of term life insurance are the length of the coverage term and the size of the death benefit. This is in addition to personal factors like your health and family medical history.

Learn more about the cost of term life insurance.

How much does whole life insurance cost?

Whole life insurance generally costs much more than term life insurance because the death benefit lasts an entire lifetime. This means the payout from the life insurance is guaranteed as long as the policy owner is up to date on their premiums.

Learn more about the cost of whole life insurance.

More about the cost of life insurance

There are so many scenarios for Canadians of all ages seeking financial protection. Read more on how much life insurance costs at certain ages.

Different size death benefits also have starkly different premium payments. Learn more about the cost of life insurance policies with specific death benefit amounts.

Do I need life insurance?

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

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

Buying life insurance lets you secure assets for your family’s future by investing in an alternate income source. Without life insurance and the security of this death benefit, you’re putting all your family’s financial eggs in one basket: you, being alive and able to earn an income.

You may assume you have life insurance through your work’s group benefits, but such policies require a close look to ensure it covers everything you need.

Learn more about life insurance policies and workplace benefits.

How much life insurance do I need?

You should get as much life insurance as you can afford. Most wish to leave a multi-million dollar fortune to their family and loved ones when they die. But that’s not financially realistic for most.

Determine what “affordable premium” means to you. 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.

Some use the 10x your annual income rule, but we highly recommend using our life insurance coverage calculator to get a quick but comprehensive recommendation.

Read more about how much life insurance you need.

When should I buy life insurance?

Life events create the need for life insurance. Buying a home, having children, and getting married are good indicators that there are those in your life who depend on your income to maintain their quality of life. Premiums rise as you age, so purchasing insurance earlier in life can save you money.

Read more about when to buy life insurance.

What happens to a term life insurance when it expires?

When your insurance policy expires you have several options. Typically you

  • can convert a policy to whole life coverage
  • renew the policy at a higher premium
  • apply for a brand new life insurance policy
  • let the coverage expire if you no longer need it

Learn more about what to do if you outlive your term life insurance policy.

Can I renew a term insurance policy?

Most term life plans come with a renewability clause, that lets you extend your coverage upon expiry without having to redo your medical exam.

The downside of renewing your coverage is the cost: your premiums are reassessed (increased) to match your older age. Thus, some Canadians prefer to apply for a new insurance policy at the end of the term.

Learn more about renewing life insurance.

What personal information do I need to share with my insurance company?

Life insurance companies have a mandatory set of questions they ask during the underwriting process. They include:

Your insurance provider is hoping you don’t die while you’re covered 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 life insurance rates. They’ll ask about:

Based on your answers to these questions, you’ll be placed into a risk category and offered premiums accordingly.

Additional in-person medical exams will be required from time to time, especially when applying for larger coverage amounts.

Learn more about how to prepare for a life insurance medical exam.

What is an attending physicians statement?

The provider may also ask for a health report (called an attending physicians statement or APS) from your family doctor or any specialists you see about ongoing health conditions.

Learn more about attending physician statements.

Who should you name as your life insurance beneficiaries?

Your beneficiaries are those you name in your policy that receive the death benefit when you die. It’s important to list the right people so that your policy’s payout is used as you intended. If you do not name a beneficiary or there is ambiguity at the time of your death then probate can affect your life insurance benefit.

Learn more about how to choose a beneficiary.

Are there different types of beneficiaries?

Yes, there are revocable and irrevocable beneficiaries.

  • Revocable Beneficiary: a beneficiary that can be changed without their consent.
  • Irrevocable Beneficiary: a beneficiary that has to sign off on any changes to the policy, including coverage and beneficiary changes.

Learn more about revocable versus irrevocable beneficiaries.

Should you name your children as beneficiaries?

In Canada, minor children cannot legally receive the funds from a life insurance policy until they reach the age of majority. Thus, many people create a trust to manage the funds of life insurance death benefits meant for their children.

A trust is an estate planning tool that allows you to choose another party (the trustee) to manage financial assets for a beneficiary until a pre-determined time or when they reach the age where they can legally manage their own funds.

Learn more about managing life insurance benefits with a trust.

Should couples get life insurance?

Life insurance policies for couples have a number of benefits, including the potential to save money on policy fees and the simplicity of managing a single policy. There are a few life insurance policy options that couples can choose from, such as:

  • joint first-to-die life insurance
  • joint last-to-die insurance
  • combined or multi-life insurance

Learn more about life insurance for couples.

Should you choose individual or joint life insurance policies?

Like all policies, joint life insurance policies have pros and cons.

Pros

  • Save money on policy fees
  • One policy to manage

Cons

  • Less choice than individual coverage
  • Cost savings may be less depending on personal health factors

If you apply for individual coverage together, you can still save on policy fees.

Learn more about joint life insurance policies.

What happens to life insurance after a divorce?

If you’ve set your ex-partner to receive the death benefit from your insurance policy, a divorce won’t automatically change this.

When you separate from your partner, you may want to reassess your life insurance needs. The type of life insurance policy you have, who is named as your beneficiary, and the terms of your divorce will all be factors to consider after a divorce.

Learn more about how divorce affects life insurance.

Do business owners need life insurance?

Life insurance can help ease financial concerns and help sustain the business s after the passing of the owner or essential employee.  Whether it’s to cover a tax liability at death, to ensure adequate funding for a buy-sell agreement, or for use as collateral for a loan, a life insurance policy will often be purchased by a corporation to meet the business’s needs.

Learn more about life insurance for business owners.

Can I buy life insurance coverage through my business?

Life insurance receives unique and specialized tax treatment that makes it an effective tax and estate planning tool for business owners. They can use a corporate-owned policy to protect their families, preserve their personal and business assets, and ensure the continued viability and profitability of their business.

Learn more about the benefits of corporate-owned insurance.

More about life insurance for business owners:

Do seniors need life insurance?

Life insurance is a good consideration for those over 60 who do not have savings and may still have debts or dependents that rely on them. Term life insurance is not usually available for seniors 75 or over.  Permanent coverage (whole life, universal life, term to 100) is a great option and ensures coverage for one’s entire life, and can account for funeral expenses and medical debt.

Learn more about life insurance for seniors.

Is final expenses insurance worth it?

Final expenses insurance is essentially a permanent life insurance policy. This coverage includes a modest death benefit that is meant to cover end-of-life expenses that your loved ones may otherwise have to cover upon your death.

Funeral arrangements, burial costs, medical bills, and tax liabilities can add up quickly. Final expenses insurance is not usually necessary if you have a whole life insurance policy, but it does have the benefit of a fast benefit payout.

Learn more about final expenses insurance.

Should I add life insurance riders to my policy?

A life insurance rider is an optional feature added to your life insurance policy to better address your unique insurance needs. An insurance rider typically requires an additional payment which is added to your monthly premium, though some riders may also be included at no extra cost. There is a wide range of available riders. Common riders include additional term riders, critical illness riders, and guaranteed insurability.

Learn about life insurance for riders or read more about:

Should I get life insurance for my children?

As a parent or grandparent, there are benefits to purchasing a life insurance policy for your child or grandchild. Life insurance for children ensures future insurability for your child, regardless of health issues. The policy also offers an effective way to build wealth and can be an attractive alternative to Registered Education Savings Plans (RESPs).

Learn about how to use life insurance for riders or read more about:

Do you need insurance to travel to Canada?

Certain visas that allow for travel or stays in Canada do require insurance coverage. Super visa insurance is mandatory for those seeking approval for their super visa status. While other visitors to Canada need insurance, it is not mandatory for entrance into the country.

Which is the best life insurance policy?

The life insurance policy you should choose isn’t an answer in the back of the book. 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 a myriad of coverage combinations when you search for life insurance quotes. 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.

Head to our life insurance calculator, learn more about the best term life insurance or best whole life insurance in Canada, or check out the ratings below.

Term Life Insurance Company Rating
Assumption Life ★★★★★
BMO Insurance ★★★★★
Canada Life ★★★★
Canada Protection Plan ★★★★★
CIBC Insurance
Desjardins ★★★★
Empire Life ★★★★★
Equitable Life ★★★★
Foresters Financial ★★★★
Humania ★★★★
Industrial Alliance (iA) ★★★★★
ivari ★★★
La Capitale ★★★★
Manulife ★★★★★
RBC Insurance ★★★★★
SSQ ★★★★
Sun Life ★★★
TD Insurance ★★
Wawanesa ★★★★

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KEY TAKEAWAYS

  • Life insurance is an agreement made between the insured and the insurer. The insured pays a premium to the insurer to keep the policy active.
  • A life insurance death benefit is a tax-free lump sum that is paid by the insurer to the insured’s beneficiaries when they die.
  • Life insurance is a critical financial planning tool, especially if you have sizeable debts and dependents to care for.

By Jiten Puri
CEO & Founder, Insurance Advisor, LLQP
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