While life insurance is not the most exciting topic to discuss, I promise it is more relevant to you and your family’s financial health than you think. In this article, you will learn the basic terminology about life insurance, the different types of insurance you can get in Canada, how they work and how to choose the one that best suits you.
Do I need life insurance?
Spoiler: the answer is yes. Life insurance plays a huge role in the risk management side and you can think of it as a gift for your loved ones in case you pass away sooner than expected. It helps cover the costs such as your funeral, any leftover debt or tax bills and potentially save your parents, friends or siblings from financial burden.
Think of it this way: in a life insurance, you are making regular payments during your life, and in exchange the insurance company will guarantee a predetermined sum of money to your loved ones after your passing, formally called a death benefit.
Basic terminology you need to learn about life insurance
Policy – A policy is your agreement with the insurance company. You can also buy policies on behalf of your loved ones.
Policyholder – If you have a policy with the insurance company, you are the policyholder as you are the person who owns the insurance.
Premiums – This is the payments you make regularly to the insurance company to maintain your policy. Premiums are generally paid monthly, quarterly, semi-annually or annually
Beneficiary – This is the person who will receive your death benefit. It doesn’t have to be one person and you can choose to divide the payment up amongst several beneficiaries, or it can also be a charity, a company, to your pets too! In 2010, a person in Miami left her Chihuahua named Conchita with an estimated worth of $11.3 million and in 2011, an Italian woman left a stray cat a sum of $13 million!
In case you are an accountant and you are thinking about taxes all the time in Canada, your beneficiary does not have to report life insurance as taxable income.
What are the different types of life insurance?
There are two major types: term and permanent life insurance.
Term, as the term suggests, covers you for a specific period of time, usually ranging from 10 to 30 years. For example, when you get a policy with a 20 year term, the insurance will pay your beneficiaries if you die within the next 20 years. With most policies, your premiums won’t increase during that time.
How much does Term life insurance cost?
The cost of a life insurance largely depends on your health conditions and age, but if you are young and healthy, a $100,000 life insurance policy is only about the price of a large pizza each month. If you sign up later in life though, your premium would be much more costly because you are at a higher risk. This is why if you can afford it, I would suggest you sign up as early in life.
Term is a great option if you feel you only need coverage for a set period of time, say until your home mortgage is paid off or until your kids move out. Many term policies can be converted to permanent ones later in life, and there is no need to take another medical exam to renew your policy. Insurance providers have to renew the policy no matter what.
If you’re interested in getting a short term life insurance policy, Canada Life which is one of the biggest insurance companies is doing an exclusive promotion. If you’re accepted, your first four months of premium is free!
What happens if I still need insurance coverage when my term insurance expires?
Well, this is where our next type of life insurance comes in: Permanent Life Insurance.
It provides lifelong coverage instead of only a specific period of time and premiums are typically locked in. Most of the time, it’s a lot higher at the beginning and using the pizza analogy, it might be the cost of 10 large pizzas per month instead of one.
In a term life insurance, if you still live beyond the term that you are covered for,
then obviously your beneficiary won’t get paid. Whereas in a permanent one, your beneficiary is bound to have a payout, unless you are a vampire.
Permanent insurance is mainly in two forms in Canada: whole life insurance and universal life insurance. For whole life insurance, your premium pays for your insurance coverage plus an investment portfolio that can grow your money over time. The insurance company manages that portfolio for you, aiming for low risk and moderate growth. And in case you were wondering, yes this investment is sheltered from taxation.
Whole life insurance can be either participating or non-participating. In a participating policy, you’ll share in the company’s profits in the form of dividends
which you can have extra cash flow reducing your premiums or boost your death benefit. The key advantage is once they give out the dividends, the insurance company cannot collect it back. So, unlike the stock market, the cash value inside a whole life insurance policy cannot go down. Now, there is tons of controversy about whole life insurance. One of them will be that you can only get either the cash value or the death benefits. This is not true! For a lot of properly constructed whole life plans, you can get both the cash value and payout, and each year they are indexed.
The other type of permanent insurance you can get in Canada is universal life insurance which gives you the highest degree of freedom. It acts more like investment accounts with a life insurance component. Instead of paying regular premiums, you can invest as much as a yacht or as little as a cup of coffee you want into your account, with the freedom to manage it as you like. Another difference is that instead of being locked in, you have the ability to increase or decrease your premiums as you wish, according to your budget. Why? Mainly utilize the tax shelter room inside the policy.
As you can see, because of the high degree of flexibility and freedom, many wealthy Canadians often use this type of policy to invest once they’ve maxed out their TFSAs and RRSPs.
I know that was a lot of information on the different types of life insurance, so you might be wondering how much coverage is enough for you or which product to choose.
As a financial consultant in Vancouver for over 10 years, usually I will suggest a coverage worth 7 to 10 times your annual salary. For example, if Tom is making $100,000 then a $1 million life insurance coverage amount is an ideal amount. From there depending on your budget and the features you want, you can choose a whole life insurance, a term insurance or even a hybrid one.
I also recommend that all of your insurance premiums combined should be no more than 10% of your income. Using 10% of your assets to cover the remaining 90%! If you’d like a complimentary consult for your specific needs, please book an appointment with me and I’d be happy to discuss your options. Subscribe to my YouTube channel if you find information like this useful – I share tips on how to grow your wealth in Canada.