Life insurance 101: How much is enough?

A primer on buying life insurance

Photo credit: Ned Ryerson character in Groundhog Day

Life insurance agents get a bad rap. Remember Ned Ryerson (played by Stephen Tobolowsky), the annoying - but hilarious - insurance guy who chases after Bill Murray’s character in Groundhog Day? Or Edward Norton’s character in Fight Club, an insurance agent who joins a club where he can vent his frustrations by beating the crap out of his buddies?

Despite the way its salespeople are portrayed in pop culture, life insurance itself is a very useful and necessary investment. However, it can be complicated to figure out what you need. Here are some basics to help you get started.

Term versus permanent

Life insurance can be broadly divided into two categories: term life insurance and permanent life insurance.

• Term insurance: A policy valid for a short-term period, most term policies are renewable and convertible to a permanent policy. Term insurance has a lower-cost than permanent policies and therefore is often the “starter” choice for people with young children or mortgages.

• Permanent insurance: A policy valid for your entire life that has an insurance and tax-sheltered investment component. Deposits above the minimum premium are invested - giving you equity, compound growth, possibly dividends and tax-free gains. If you cancel the policy, you receive a cash value, or you can make an early withdrawal of some of the funds and still keep the policy in place. The longer you hold the policy, the more the cash value is worth. There are two main types of permanent policies: traditional whole life and universal life, which offer varying levels of flexibility, cash value guarantees, investment risk and fees. (Of note, variable life is only available in the US and off shore.)

According to Great-West Life, “Many people have both short- and long-term insurance needs and require varying amounts of coverage over different periods of time. A combination of permanent and term life insurance features can be available in one policy. Most permanent policies allow for the addition of low-cost term coverage without an additional policy fee. This provides a way to obtain the right amount of coverage at a more economical price, giving you a base of permanent coverage that won’t increase in cost.”

Singleton, no kids

For a single person, the biggest purpose of life insurance is to have a back-up plan for your income while you’re alive and the confidence of enough funds to cover any debts you owe when you die (credit cards, car payments, mortgages, lines of credit and other loans). While leaving an inheritance may not be a priority at this point in your life, the threat of leaving a burden of debt on your nearest and dearest is probably not desirable to you either.

According to Great-West Life: “A life insurance policy can provide an efficient and cost-effective way to take care of any expenses or unpaid bills you might leave behind, such as legal fees and taxes, medical expenses, funeral costs, mortgage debt or car loans. It can also be used to leave a gift to a loved one or a favourite charity or to provide a supplemental income while you are alive.”

Beyond life insurance, you need to consider disability and critical illness insurance. As Great-West Life points out, your ability to earn an income is probably your most valuable asset. But what if disease or an injury suddenly puts you out of work? A safety net of insurance will protect your income in the event that you are unable to do your job.

Furthermore, Great-West Life adds, “If your employer doesn’t offer a group benefits plan, you may want to invest in additional health and dental insurance coverage.”

Married, no kids

When you add a spouse into the picture, you share the concerns of the singleton above, however the importance of not leaving your spouse mired in your debts comes into sharper focus. The death benefits of a life insurance plan are typically used to cover estate taxes as well.

According to The Co-operators, “Life insurance is another step towards building your future together. It can also cover the needs of your partner, such as rent and other lifestyle expenses if something were to happen to you.”

Great-West Life advises, “If you have a mortgage or loan, consider term life insurance. It will cover the debt if you die before your debt is repaid.”

A permanent life insurance plan can be a good addition to your retirement plan and can supplement retirement income. As part of an estate plan, permanent life insurance can help you pass an inheritance tax-free to your loved ones or to a charity.

Married or single with kids

Quite often, people only start to think about life insurance when they have kids. According to Standard Life, “To help ensure your peace of mind, you should take steps to make sure that your family will not want for anything if something happens to you. So make sure you review your life insurance coverage and increase it accordingly when you have a child.”

Basically, you want to make sure that your life insurance is sufficient to cover the additional costs of childcare for the surviving spouse, or to pay for the child’s care under a guardian as long as they need it. You may also consider putting money into trust to pay for the child’s education.

Couples with one partner who stays at home with the kids have special concerns. Great-West Life points out, “If you’re a stay-at-home parent, the role you play also needs to be covered because of the additional expenses associated with childcare if something happens to you.” As a stay-at-home parent, your spouse’s life insurance policy should either provide enough to replace the working parent’s income, ideally until the children become of legal age, or reflect the childcare costs of having the stay-at-home parent return to the workforce.

For a single parent who is fully reliant on only one income to care for her family, critical illness insurance and disability insurance are very important to ensure there is a safety net to help care for her family in the event of a disease or injury.

Another component of insurance that Standard Life suggests is critical illness insurance, for both parents and children. The company advises that “it is distressing when any family member falls critically ill, but this is particularly so when the family member concerned is your child. Knowing that you will have extra money to help if your child becomes seriously ill can be a considerable weight off any parent’s mind.”

Indeed, most insurance providers offers life insurance plans specifically structured for children, to give them a head start in savings programs as well as critical illness policies.

Make it a part of your plan!

According to Rebecca Capri, Investment Advisor at RBC Dominion Securities, whether you have a family, are a professional, or own a business, insurance should be an integral part of your wealth management plan. Insurance helps give you peace of mind and protects that which is important to you. It can also create a way to tax shelter investments that can be passed tax-free to the next generation or used to supplement your retirement income. You should speak with your investment advisor to create a financial plan that can uncover the insurance needs and opportunities that are right for you.

The cocktail policy

Ultimately, choosing the right kind of life insurance is like mixing a great cocktail. There are hundreds of different features and combinations that can make a certain plan the right one for you. Just don’t think that life insurance is for the old, since you can secure better rates when you are younger and faster! Kind of like enjoying a few too many cocktails - the older you get, the more you’re going to pay for it.

 

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