Life insurance is the cornerstone of a solid financial foundation. However, there are many different reasons for life insurance and many different life insurance products in the marketplace. It can be confusing trying to figure out how much life insurance you should have and how it should be structured. That’s where we come in!
Once we have helped you figure out how much and what type of life insurance you need, we have contracts with 17 of the largest insurance companies in Canada to ensure that we can provide you with the most cost effective insurance solution.
Different types of insurance available
After your life insurance needs are addressed, the next risk management tool, in order of importance, is disability insurance. Many people are lucky enough to have disability coverage through their group benefits plan at work. However, if you are one of those individuals who do not have a group benefits plan or have one that is limited in scope, individual disability insurance provides you with income protection if you become sick or disabled.
The financial impact of a serious injury or illness can be devastating. At risk could be your house, car and family’s future (all those things that you would have insured against other perils). Disability insurance, unlike life insurance, is something you buy for yourself to protect your cash flow.
Disability insurance covers a portion of your income in the event of illness or injury until your return to work. The maximum benefit is 2/3 of your earned income, which then would be reduced by any other payments or income that continues even after the disability (the insurance company’s rationale being that it shouldn’t be more beneficial for you to be receiving the disability benefit than to be working).
Your earned income is the starting point in determining the amount of coverage you may receive. For self-employed individuals, that is your gross earnings minus expenses before income taxes. Most insurance companies will require at least two years of financial information from self-employed individuals to establish a reasonable gross income.
The chances of being disabled (illness or injury) are far greater than the risk of death and therefore, the cost of this type of insurance is usually higher than for life insurance.
Proceeds from a disability claim are received tax free if you are paying the premium. If your disability coverage is through your employer and they pay the premium, the claim will be taxable to you.
Besides the amount of the coverage, there are three other features of disability insurance you need to understand when you are shopping for this product:
- Insurers ‘define’ disability to determine when benefits will be paid.
- Own Occupation is where the insured is considered disabled if unable to perform the regular duties of his or her occupation. While receiving benefits, the insured can work at another occupation.
- Regular Occupation is similar to ‘own occupation’ except that the insured cannot work at another occupation while receiving benefits.
- Any Occupation is the most restrictive, where the insured is considered disabled if unable to perform the regular duties of the occupation, or any other for which they are qualified by education, training, or experience. While receiving benefits, the insured cannot be employed in any other occupation for remuneration or profit.
- The elimination period is the waiting period from the date the disability occurred until benefits start. The most common are 30 days, 60 days, 90 days and 120 days. The longer the elimination period, the lower the cost of the insurance.
- The benefit period states how long the benefits will be paid. Ultimately, benefits cease when the insured reaches age 65.
The cost of the coverage is dependent upon these factors and the amount of coverage you would qualify for. It’s always wise to obtain the advice of an insurance professional to determine what’s right for you.
The most basic form of insurance is term insurance. It is designed to cover the risk of death to the insured. Term insurance covers the risk in return for a level annual premium over a prescribed period of time. Terms can range from 5, 10, 20 and even 30 years. At the end of the term, the policy renews and the annual premium increases to reflect the current age of the insured.
Term insurance will usually expire when the insured reaches age 75 or 80. Most term insurance policies never last that long, as they become more costly at each renewal and very expensive in the latter years. An exception to that rule is Term to 100. This product provides coverage as long as you live and premiums stay unchanged. As it usually represents straight insurance costs with no bells and whistles, it can be a cost-effective way of obtaining permanent insurance.
It is important that term coverage is both renewable and convertible. Renewable means that at the end of every term, the insurance is guaranteed to be renewed no matter the health of the insured. The convertible option allows the term insurance, in whole and in part, to be converted over to a permanent insurance policy. In both scenarios, the premium will be based on the age attained by the insured at that point in time but does not require any additional medical underwriting, regardless of the health of the insured. Conversion options often expire prior to the expiration date of the policy, for example, when the insured reaches age 60.
Term insurance is relatively cheap coverage when the insured is younger and therefore, ideal to provide income replacement or for short term liabilities. We are often asked, “How much is enough insurance?” In order to compute the amount of insurance needed to replace the income generated by a wage earner, several factors have to be considered:
- Determine the cash needs at death to retire any outstanding debts (mortgage, car loan, etc.), to fund post-secondary education for any children and to cover funeral expenses.
- Determine the income needs of the family and for how many years that income is needed to last. This could be until the children graduate from post-secondary school or for the life of the surviving spouse.
The face value of the policy is paid either to a named beneficiary or to the estate. Proceeds are received tax-free and are usually protected from the creditors of the deceased.
A more complex type of life insurance is a product called Universal Life. Below, we will discuss how it differs from traditional whole life insurance. First, let us outline how they are similar:
- Mortality Cost – Part of the premium that covers the cost of the pure life insurance or death benefit (face value of the policy).
- Administrative Charge – What the insurance company charges to administer the policy and cover the premium tax.
- The Investment – What is left from your premium after the above two charges, the cost of insurance and administrative charge are deducted. This is called the ‘cash value’ or ‘cash surrender value.’
- Return on Investment – The growth/interest credited to your cash value each year.
With a whole life insurance policy, you cannot choose how your money is invested and the companies do not disclose how they calculate the return you are receiving. You will be provided with an illustration showing the cash value, which reflects non-guaranteed, projected returns. Some policies may offer a guaranteed minimum return.
The main difference between a universal life and a whole life policy is the number of investment options available. These include investments that mirror mutual funds and are managed by fund managers. The returns inside an insurance policy may be lower than a similar mutual fund, but there are some other distinct advantages to investing in an insurance policy:
- The funds can grow tax-free like in a registered savings plan and if the policy is properly set up, the entire investment account plus the face value of the insurance policy goes to the beneficiary tax-free on the death of the insured. These proceeds also avoid any probate fees. The same applies to the cash value on a whole life policy depending on the type of policy.
- The funds inside an insurance policy are generally ‘creditor proof’ if set up properly. This can be important for business owners or if you are concerned about lawsuits.
- The funds could be issued within a couple weeks directly to the beneficiaries upon the insurance company receiving the proof of death. An investment outside the insurance policy would be subject to income taxes, probate fees, and funds may not be released until the estate has been settled.
The downside is that, unlike a whole life policy where the insurance company is guaranteeing a minimum return and assuming the investment risk, in a universal life policy, you are making the investment decisions and assuming that risk.
This is a complex subject and should be reviewed with an insurance professional as part of your retirement and estate planning.
Permanent or Whole Life Insurance remains in force for the entire life of the insured and has a savings component, at a single premium. A whole life policy has a level cost, meaning the premium you pay in the first year of the policy is the same as in the last year. Therefore, the initial cost of insurance is considerably higher than a comparative term policy but significantly lower in later years.
There are essentially three types of permanent life insurance:
- Term 100 (T100) – Straight term coverage for life without any cash value.
- Classic Whole Life – Provides a death benefit and has cash value that accumulates. The cash value can be borrowed against or used as collateral and can be partially accessible. It is consequently more expensive than T100.
- Universal Life – A variant on the whole life in which the investment component is clearly separate from the life insurance. This provides for more accountability and flexibility to provide investment options.
Whole life policies, besides requiring level payments for the life of the policy, allow you to make payments for only a certain number of years (e.g. 20) or to a certain age (e.g. 65). The policy is then paid-up for the remaining life of the insured. These policies cost more because the insurance company needs to build up sufficient cash value to fund the pure insurance cost of the policy for the remainder of the insured’s life. This strategy is attractive because the insured can pay the premiums during working years. Once in retirement, coverage continues but no further payments are required.
The savings component of a whole life policy is the interest or investment earnings over and above the actual cost of the life insurance. In other words, in the early years the excess of the premium over and above the actual cost of the pure life insurance is invested by the insurance company and represents the ‘cash value’. The insurance company guarantees a minimum return. You have no control on how this cash value is invested and the insurance companies do not provide any information on how they calculate the return on your savings portion. Therefore, in most cases, a whole life policy doesn’t make a very good choice as purely an investment vehicle.
When insurance is paid out to the named beneficiaries (if there are any) under the policy, it is paid tax-free outside of the estate, usually within days or weeks upon proof of death. This means it is not subject to probate or having to wait to have the estate settled (which could be a lengthy process). Alternatively, the insurance can be paid to the estate to provide needed cash to cover final and other immediate expenses and taxes so other assets don’t have to be liquidated, especially under unfavourable conditions. For estate planning, the advantage of permanent insurance over term insurance is that it will not expire.