What is life insurance?
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.
What is life insurance – for a lot of us – 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 about how does life insurance work, how much life insurance do I need, what is the cost of life insurance, and more. Here’s an overview of the different kinds of life insurance policies in Canada, how much they cost, and who should be purchasing them
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…
What is life insurance?
Life insurance is an agreement between you and a life insurance company, where 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.
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. Most people plan for 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. The death benefit is tax-free.
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) by naming them as a beneficiary on the policy. If you fail to name a beneficiary, the death benefit will be paid to your estate and may get taxed.
What is the average cost of life insurance?
The cost of life insurance depends on several individual factors. In fact, for most young, healthy adults life insurance costs are quite reasonable on a 20-year term policy. 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 death benefit on a 20-year policy. The price for 20-year term life insurance will be even lower if she decreased that 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.
Do I need life insurance?
Perhaps a better question is, do the people in your life need it?
It’s 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 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 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.
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.
How much life insurance do I need?
You should get as much life insurance that you need, that you can afford. Everybody wishes to be able to leave a multi-million dollar fortune to their family and loved ones when they die. But for most of us that’s not realistic. 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. This online life insurance calculator will take into account your individual needs and calculate a personalized insurance coverage amount.
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.
What is term life insurance?
Term life insurance is a straightforward insurance product that makes the promise if you die, we’ll pay, but only if that were to happen within a specified length of time, or ‘term’.
Unlike whole life insurance, permanent life insurance, or universal life insurance, term life insurance is 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 life insurance coverage to last until you hit specific age milestones like senior-citizen status at 65.
Why do I need term life insurance? Is term life insurance worth it?
Term insurance provides temporary coverage because it’s designed for temporary needs.
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 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, the premium payments are lower.
What happens to a term life insurance when it expires? 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 medically re-qualify.
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.
Can I pick the longest term life insurance available?
You absolutely could get lifetime coverage, 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.
Can I get permanent life insurance coverage for my entire life?
Permanent life insurance coverage 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.
What is the average cost of permanent life insurance?
Permanent insurance is very expensive. 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 are the different types of permanent life insurance?
The different types of permanent life insurance in Canada are: Whole Life, Limited-Pay Whole Life, Universal Life, and Term to 100. We explain the types of permanent life insurance in full below.
Whole life insurance and how it works
You’re covered until you’re cremated (or buried, or cryogenically frozen, etc.) and there is a cash value associated with your policy. Whole life insurance policies build cash value over time with guaranteed rates similar to a high-interest savings account or GIC.
In order to pay these guaranteed rates from the accrued cash value, 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 the cash value 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.
Limited-pay whole life insurance and how it works
This is similar to whole life, except a payment term is specified. For example, the term could be 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. The cash value also accrues quicker because of the accelerated payment schedule.
Universal life insurance and how it works
Universal life insurance is the same as whole life insurance, except there is a self-directed investment component. Your insurance provider will give you options to invest the cash value of your universal life 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 with a universal life policy’s cash value than what is guaranteed from a traditional whole life policy.
The trade-off: a universal life insurance policy requires you to actively monitor the investment choices you’ve made with its cash value. It’s kind of like opting to build your own investment portfolio versus paying into a mutual fund.
Term to 100 life insurance and how it works
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 a Term to 100 life insurance policy is uniquely Canadian.
Do I need whole life insurance coverage?
Whole life insurance or permanent life insurance policies offer cash value and the opportunity for tax-free investing and payout. They can be very useful for wealthy people wanting to use the coverage for estate planning and to shelter their savings. They can contribute money into their insurance until they drop into a lower tax bracket amd are 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. Whole life insurance can be used to cover the 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 life insurance when they are older and their term is up for renewal.
While these permanent 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. Unfortunately, some policyholders are unable to afford the high annual premiums; it is important to choose coverage you can afford.
How can I lower the cost of life insurance premiums?
The most effective way to cut the cost of life insurance premiums 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 personal information do I need to share with my insurance company?
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 life insurance coverage plans available that don’t require any deep probing and guarantee acceptance regardless of your health. They are called guaranteed issue policies and are also known as non medical life insurance 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 is the best life insurance policy for me?
The life insurance policy you should choose 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. (If that sounds complicated, there are life insurance calculators). There a lot of options to choose from and myriad combinations of coverage 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 the best life insurance policy for you, 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.
- 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.