Updated: Jan 29, 2021
What are the different kinds of Life Insurance available in Canada?
Life insurance is kinda sorta boring and confusing but very important so bear with me. I tried to make this as short and painless as possible!
Term Life Insurance:
-covers you for a shorter length of time, usually anywhere between 5-30 years
-the cost of the premiums stays the same throughout that period of time
-you only get the pay out if you die within that designated period of time
-when the term expires, you have the option to continue your coverage usually for a higher premium over an extended period of time.
-you choose the set dollar amount of coverage that you will receive, whether that's $100,000 or 1 million dollars.
Whole Life Insurance:
-covers you for your entire life as long as you continue to pay the premiums, even up until age 120.
-premiums are usually 10 to 12 times the cost of Term Life Insurance Premiums
-beneficiaries are NOT taxed on the money paid out after you die
-premiums stay the same dollar amount throughout your lifetime
-You can borrow money against the insured amount but have to repay that amount with interest or you reduce the amount or forfeit coverage
-Some whole life policies can also earn annual dividends, which pay you back with a bit of the insurer’s profit. You can take the dividends in cash, leave them in your account to earn interest or use them to decrease your premium payments, repay policy loans or buy additional coverage. Dividends are NOT guaranteed
-More expensive, again 10-12 times the cost of Term Life Insurance
-Can you afford to be paying that amount for the rest of your life?
-When you no longer have any form of debt including your mortgage and your children are independent, do you still need insurance to take care of them? Do you need to be paying $3,000 per year at age 80?
-A type of Permanent/Whole life insurance
-You get to choose from an array of investments. Earnings are dependent on the market.
-Any income earned on investments held can accumulate and compound tax-free unless they are withdrawn.
-Can customize investment mix.
-Doesn’t have steady premiums, can invest as much or as little as they want, as long as the regular deductions are covered
-Death benefit - there is a lot of flexibility around the death benefit of a universal life insurance policy, and it can be negotiated with the insurance company
-Can use after you've already maxed out your contribution limits on your TFSA and RRSP accounts. Mostly useful for high net worth individuals for the tax advantages upon death
Disadvantages of Universal life insurance
-More complex and expensive product
-Premiums are more expensive than term or whole life insurance, mostly due to higher administration fees.
-Requires regular attention from policy holders, to make sure the investment mix still meets their needs.
-Risk: investments may drop in value over time.
-Mostly useful for Wealthy Individuals who don't plan on withdrawing the money in their lifetime (their beneficiaries will benefit from the tax-free payout).
Participating Whole Life
-Provides the opportunity to participate in policyholder dividends.
-Dividends are derived from the fact that the policy owner is overpaying for the cost of the insurance.
-The overpayments are placed in an investment pool and each year the company decides how much of that pool they will refund in dividends AFTER meeting its obligations and claims.(https://www.coveadvisors.com/wp-content/uploads/2017/07/Great-Canadian-Whole-Life-Face-Plant)
Factors to Consider before purchasing Life Insurance
What is your individual or family situation? Does it follow the acronym DIME?
Do you have Debts that need to be repaid?
What is your current Income?
Do you still have a Mortgage?
Do you still have Educational student loans that need to be repaid?
Keep in mind, the more coverage you want or need, the higher the monthly or annual premiums!
-Premiums are based on several factors including your health status, pre-existing conditions, lifestyle factors, age, gender, occupation and amount that you want to be insured for
-Smokers pay 60% more than non-smokers
I would suggest that Term Life Insurance is the most sufficient type of insurance that majority of people need. It's simple to understand. It's fairly low cost to pay and do-able as a monthly payment. Just remember, that you decide the time limit on the monthly premiums.
I would recommend Dave Ramsey's approach of not mixing insurance with investments.
Keep investments, investments and insurance, insurance. They cannot multitask and here's 8 reasons why:
1. It's Undiversified
You have no control over which specific stocks or bonds are purchased. Your Investments are controlled by one insurance company and what IF this company goes bankrupt? When you diversify in the stock market, then you place that risk over hundreds of different companies not just one. You also get to decide which stocks and bonds, when and how.
2. Returns are not without Steep Fees.
If the insurance company is only guaranteeing 4% returns. Is that before or after fees? With whole life insurance, cash value accounts often see around 5-6% interest before fees. What are the Management Expense Ratios? Ask yourself, would you be better off investing on your own in the long run?
3. What if S*#% (or 2020) happens and I miss a payment?
What if you need that extra $250-500 during that month? You can’t stop paying or you may end up forfeiting your policy with a missed payment. Whereas, if you were contributing to your own investing plan, you could just skip putting extra money into your investments that month and your present invested money would still keep accruing compound interest. Also, if you forfeit your policy, you could lose all the money that you had been setting aside in this policy.
4. It’s Illiquid
You can’t liquidate your cash anytime you want. Unlike a TFSA, if you need to withdraw the money for a good reason, you can, no problem. You can regain your contribution room the next year. Now, this can be a con as well, because sometimes people consider retail Therapy emergencies a reason to withdraw money from their investments. Which is why some people prefer to have their money locked away, to remove this temptation.
5. Takes longer to accumulate the Compound Interest Benefit
Sometimes with the way that polices are written, it takes a lot longer for a whole life policy to accumulate significant cash value (often 12-15 years) versus if you invested on your own. There are many hidden fees. You are paying the company upfront first, because that's their insurance that they get paid first.
6. Claims of Tax Free can be Misleading.
If you borrow against your claim, you still have to pay interest back to the insurance company, unlike if you borrowed money from yourself. I say this because the sales pitch seems to imply that it is similar to borrowing from yourself.
If you borrow from your policy, it is still-taxable income. I say this because they advertise that you can borrow against your claim but you still have to pay the taxes just like if you had taken out an RRSP investment.
7. Lack of transparency
It seems very complicated to understand the policy and whether it will actually carry you for the next 40 years or more or if you will have to pay more in the later years due to inflation? It seems so complicated, that you have to be a lawyer to read it.
8. There are better Methods to Earn Wealth and have Peace of Mind
There are no hard and fast rules about buying life insurance; every person has different considerations. I think you really need to lay out the numbers and research to ensure that you are satisfied and at peace with what you decide in the end.
Let's break down the cost:
But overall it appears that for majority of Canadian families, Term insurance provides enough coverage without the added cost. And it seems that only the wealthy few would benefit from whole life insurance as an estate planning tool so that your beneficiaries don't pay taxes on your death benefit.
Now, don't take my word as gospel. Go and do the research for yourself. It's worth an investment of your time to do the research because you could potentially be locked into this Life Insurance policy for over 40 years.
And don't put it off until you are older because you will end up paying higher premiums and you might discover more pre-existing health conditions in your family as you age.
Now Go and Be Intentional!