A common question about life insurance in Canada is whether or not you should go for term life insurance. After all, they seem to be the cheapest form of life insurance and anything other than that feels unnecessary, as if you are giving extra to the insurance company. Or, if you take a quick search, you’ll see all the different opinions between term and permanent insurance but most of the comments are not even correct as they don’t have the whole picture.
In this blog post, I’ll share the good, the bad and the ulgy about term life insurance in Canada. What you’ll learn:
- The pros & cons of term life insurance
- The average price of term life insurance from the big four insurance companies in Canada
- An action plan to see if a term insurance can cover your needs
Read on to see if a term insurance is for you! Or if you’d like a complimentary consult and review of your specific needs by a professional, please feel free to reach out and book an appointment with me.
The Pros of Term Life Insurance
Term insurance is the simplest and cheapest form of life insurance. You paid and you get covered. You die and your family will get the money. Straightforward and simple. Term insurance is best at diverting risk during a critical phase which means it’s most ideal for people who know exactly what they need OR for those who are on a tight budget.
For example, you have a mortgage for a new home with a newborn child that you plan to have leave your house when they reach 18 years old. Term insurance in this case is to cover the immediate risk and that risk has an expiry date. To get a coverage of $500,000 for the next 20 years, I ran quotes with the big four insurance companies in Canada. The average cost for a 30 year old male who is non-smoker comes to $33 per month. For women, it was $24 per month. The difference is because females tend to live longer.
In Canada, both the coverage and the payment are fixed so life insurance companies cannot increase the price or adjust the coverage amount of an old policy.
The Cons of Term Life Insurance
Your term insurance ends but you still need coverage
In the above example, what happens if your mortgage goes from 20 years amortization to 30 years? Or if your child does not move out at 18 years old? At this point, if you want to renew your life insurance policy, you can expect the $33 per month to now jump to $350 per month to cover your age from 50 to 70. Yes, that’s 10 times more! And if you need coverage after the age of 70, you can expect it to jump to $2000 per month.
As term life insurance coverage is usually fixed, if you pass away tomorrow or 30 years later, you will still get the same coverage. However, inflation will affect this and can take away most of the money. With an inflation rate of 2% per year, $500,000 in the next 30 years will only be worth $280,000. In comparison, permanent insurance coverage can be indexed so the coverage increases as time goes by.
A lot of people will say the best strategy is to buy term and invest the difference. By the time you retire, you assume your debt will be paid off therefore you wouldn’t need insurance anymore. Is this true? If you take a look back to 2008 where the oil prices hit rock bottom. In theory, people were paying less in gas so they had more money to save. However, most were getting more expensive gas to compensate because in their mind, that money was meant to be spent, whether on gas or at a restaurant instead of saving it. According to Statistics Canada, 34% of retired people over the age of 55 are still carrying debt and this number will increase due to the pandemic.
Life insurance for long term risk
Term insurance is best to cover immediate risk but what about long term risk? For example, someone passes away and there are two final tax bills left to pay. In Canada, there is no death tax but we do have the probate fee where you will need to pay 1-2% fees of your overall asset depending on which province you are in. You will also still need to pay a final income tax bill when you pass away – this includes all the RRSP, investments growth, if you have a 2nd property and more. Your family will likely have to write a 6-figure cheque. If the person lives beyond 80-85 years old, term insurance will not be able to cover the bill, and the more investments they have, the heavier the tax bill will be.
The ugly truth about term life insurance
If set up for the wrong purpose, term life insurance can hide a nasty surprise. As a financial consultant for over 10 years in Vancouver, many clients have shared their insurance policies purchased 20 years ago. The sole reason they purchased it was because of the low upfront cost but 20 years passes and they still want to keep their coverage. In order to do so means they must pay 10 times more than before which is a heavy burden and they are stuck. This is why the initial set up of your life insurance plan is critical.
Your action plan
Whether you’re considering a term life insurance only or not, the cost of a term insurance plan is very low at the beginning but it gets very steep when you renew the policy. Consider how long it will take to repay the debts, possibilities of your debts to be extended and what budget you can allocate. The ideal budget for all insurance should be no more than 10% of your income.
Another consideration is what is your shopping mode? Example, if you are purchasing a car, do you look for the basic features due to cost or do you like add-ons to make the car more valuable?
What about your saving habits? Do you always spend before you save or the opposite?
You may think you can force yourself to save in permanent insurance where it can boost additional retirement savings vs term insurance where there is nothing you can get back in the end. From these points, you can see term life insurance cannot be the perfect solution to the questions above.
Every plan has a purpose and instead of seeing what is better, take a look at your situation and see which one makes more sense. During your prime, life insurance is a risk protection tool but later in life, it becomes a wealth transfer tool. Personally, I have both a term and permanent life insurance to cover both immediate and long term risks. Regardless of which insurance plan you choose, remember that the insurance is meant to divert risk. How you want to set it up depends on your risk factors and that should be your primary discussion with your insurance professional.