Let’s face it, life insurance, the various types, terms, products and durations available to the Canadian consumer is downright confusing and overwhelming. I’ve struggled to figure this stuff out and I write about personal finance, saving, debt and investing every week. So, for today’s post thanks to some help from my friends at LSM Insurance I thought I’d post a life insurance primer, and then some. The guidelines below are just that, there is no one-size-fits-all when it comes to risk. That’s what insurance means to me anyhow, transferring risk.
Life insurance is generally grouped into two (2) major buckets:
Let’s take a look at each.
- Temporary Insurance (Term Insurance)
- Insured for short-term; coverage ends with term.
- Terms can be 5, 10, 20, or even 30 years.
- In terms of premiums paid, usually provides the largest “bang for your buck”.
- No cash value.
Term insurance is popular and rightly so, for people with mortgages, small business owners with debts or entrepreneurs experiencing major start-up costs. If these costs (or risks) will not last forever, term is usually a good choice.
- Permanent Insurance
- Insured until the policy matures – refer to sub-categories below.
- Policy guaranteed not to change although some products are adjustable – refer to sub-categories below.
- In terms of premiums paid, premiums can be higher than term insurance (when you’re younger) and can be lower than tern insurance (when you’re older). As such, if you’re going to renew term insurance a few over during your lifetime then obtaining permanent insurance is generally a better way to go.
- There is a cash value, see below folks.
Some permanent insurance plans allow you to pay for a limited number of years, then never again.
There are three (3) major types of permanent insurance, let’s take a quick tour…
2a. Whole Life
This is lifetime coverage for most plans, as long as you pay the premiums! Premiums for some plans “level out” over time, premiums tend to be front-loaded early-on (you pay more when younger) but you under-pay for your coverage over time (you pay less as you get older). For other plans, you have a guaranteed payment-period and once your premiums are paid, that’s it, you’re done and you can keep the coverage.
- Policies are structured to last your entire life. Policies remain in force regardless of your age or health status.
- All whole life plans build up a cash value over time.
- Some whole life policies pay a dividend (participating life insurance). Policyholders are usually encouraged to reinvest the dividends paid into the cash value (CV) of the policy, and use the dollars to purchase additional, paid-up insurance.
- Once whole life coverage has been issued, it cannot be revoked or reduced or cancelled unless there is a non-payment of fraud involved.
- If you cancel your whole life policy – you’ll likely get what is called the cash surrender value (CSV) – which is really a refund in premium overpayments.
Why Whole Life?
Whole Life Plans are popular for some Canadians because of the certainty they provide and the CSV available to policyholders. These plans provide more guarantees but this certainty sometimes comes at a cost (more than term insurance).
2b. Universal Life
- This combines two quality elements of financial planning: insurance protection and investment options.
- You can choose a guaranteed death benefit amount, pay premiums into a “policy fund” and any money over and above what is required for your death benefit can be placed into an investment account to grow a) tax-deferred or b) used to increase the value of your death benefit. So, you have lifelong coverage with flexible premiums and adjustable benefits.
Why Universal Life?
Universal life can be good for businesses, a tax-efficient way to provide coverage to yourself as an owner or your employees and it can be good for investors. Individual investor who have maxed out their Registered Retirement Savings Plans (RRSPs) and want to maximize their estate, for one example, can choose to own universal life.
- The insured pays a premium over a period of time that is shorter than the duration of the coverage. For example, the insured is covered for life but the policy premiums only last 20 years.
- Limited-pay policies are fully guaranteed – the payment period will not vary. The payment window can be anywhere from 10 to 20 years or more depending upon policy terms and conditions.
- Limited-pay policies can be participating or non-participating. (You already know from above participating policies pay a dividend; the dividend can be used to increase the death benefit of the policy).
Limited-Pay policies can be an effective way to hedge any inflation or underlying investment risk. For example, a universal life policy with an underlying equity investment might project a payment period of 15 years, but if the markets tank, the insured may have to pay up for more years than that.
This post didn’t even tackle the balancing act of using life insurance, disability insurance and critical illness insurance to protect you and your family, so I’ll leave those details for another day.
In the end, just reminder from me about two key things: life insurance is about transferring risk away from you to someone else and it’s designed to protect the financial security of those you love should a catastrophic event unfortunately occur.
Thanks to the team at LSM Insurance (affiliate) for sharing some finer details about life insurance, and then some.