August 27, 2020
“I’m so excited to shop for life insurance!” Said no one, ever.
Aside from opening a rather grim conversation (you are discussing what happens when you die, after all), life insurance can be confusing.
However, life insurance is very important. The right insurance can mean the difference between your family living in financial peace while they adjust to your passing and having to put their grief on the back burner as they struggle to make ends meet.
Despite this, millennials in particular are more likely to be under insured. Those that do have insurance often only have a policy through their employer, which is typically inadequate on its own and by default doesn’t move with you if you change jobs.
But, how do you know which type of life insurance to buy? Let’s compare term vs. whole vs. universal life insurance to see which might be the best fit for you.
Term life insurance is the simplest type of life insurance to understand. You take out a policy for a set term, for example, 10 or 20 years. You pay monthly premiums during this term. If you die before the term ends, your beneficiaries will receive a death benefit.
Term life insurance may include accidental death and dismemberment coverage as well. Under these policies, you can collect a benefit if you lose a limb or your sight or some other body part.
At the end of the term, you can renew your policy. However, you will typically pay a higher premium because now you are older and the risk of you dying has gone up. The premium will typically go up a fixed amount.
However, if you’re very healthy, you may be able to get a lower premium by taking a medical exam. Another benefit is that you can also renew due to guaranteed renewal without an exam, even if you have developed a medical condition that would prohibit you from qualifying now.
If you never use the benefits and decide not to renew your policy, it simply lapses. A term life insurance policy has no value outside of benefits that can only be collected if you die before the term ends.
This type of policy is popular among young people with children or young homeowners with a high mortgage. Since the risk of death in your 20s or 30s is relatively low (barring a medical condition or other risk factors) premiums are very affordable. However, for this small monthly price, you have the peace of mind that your dependents will have what they need in the event of your death.
There are two main differences when comparing term vs whole life insurance. First, whole life insurance is a type of permanent life insurance that never expires. Second, it accumulates an actual cash value outside of the death benefit.
What’s the downside? It is quite a bit more expensive than term life insurance in the beginning. Let’s look at how it works.
Permanent life insurance is kind of like marriage. As long as you keep paying your premiums, it will be with you as long as you live — however long that may be. Rather than rising with renewal, as would happen with a term life insurance policy, your premiums stay the same throughout.
For this reason, starting a whole life insurance policy when you’re young can also make sense. You’ll pay a higher premium in the beginning, but it won’t keep going up as you age. In a sense, your premiums are averaged out over the span of your life.
However, this means that the premiums you’re paying at the beginning are higher than the actual cost of your insurance. The excess accumulates into what is called the Cash Surplus Value (CSV) of your policy.
The CSV can provide financial benefits over the course of your life. For example, you can use your CSV as collateral when taking out a loan.
Additionally, if you stop paying your premiums, your policy won’t lapse immediately. Instead, automatic loans will be triggered against your CSV until the funds run out, then your policy will lapse and the CSV is surrendered to pay your loans. To keep your policy going, you’ll have to pay the loans back with interest and continue paying your premiums.
The CSV doesn’t earn interest, but if you choose to participate in your company’s investment strategy, it can earn dividends. If you don’t participate, the insurance company gets the interest earned from your CSV, and you enjoy paying lower premiums in return. There are variations on the individual policies so it is always recommended to check the individual policies you might be signing up for.
Universal life insurance, another type of permanent life insurance, is similar to whole life insurance — with a few key differences, of course. You can think of universal life insurance as a more flexible permanent life insurance option.
For example, like whole life, you’ll pay a higher premium than your actual insurance cost, but instead of merely accumulating cash value, the excess goes into a savings account. The interest earned on this savings account is tax-deferred and if it ends up being paid out as part of your death benefit, it may not be taxed at all! While the tax advantages of universal life insurance are attractive, they may only make sense for high net-worth individuals who have already maxed out their TFSAs and RRSPs.
Like whole life CSVs, you can use your savings account as collateral for taking out a loan. You can also make withdrawals, although you may have to pay taxes on the amount you withdraw. Depending on your situation, it may be cheaper to take out a loan instead.
Another benefit of universal life compared to whole life are the flexible premiums. While whole life premiums stay the same over the life of your policy, you can adjust your universal life payments.
It works like this, instead of directly paying your insurance costs, your monthly payment goes into your savings account. The insurance company deducts the cost of your insurance and associated fees from your savings account. To that end, you can set your monthly payments at virtually whatever amount you want, as long as there is enough in your savings account to cover the cost of insurance.
Now you have a basic idea of term vs. permanent life insurances like whole and universal life insurance. But here’s the big question — what makes sense for you?
For most young people, i.e. folks in their 20s and 30s, term life is the way to go. You’re at a period in your life with a lot of financial responsibilities. You may have student loans, car payments, a mortgage, young children to care for, perhaps even elderly parents who need care, and more. With so many demands on your paycheck, it doesn’t always make sense to put the extra cash into permanent life insurance.
However, if the idea of permanent life insurance appeals to you and you have the extra cash, there is an advantage to taking out the policy when you’re young. A young person in good health will pay a lower premium than someone in their 50s or 60s. And remember, your premiums are fixed with a whole life insurance policy.
This can be a good move, particularly if you are a high net-worth individual. Permanent life insurance will probably make more sense for you anyway, regardless of your age. Your policy will cover funeral costs and estate taxes and generally facilitate the passing along of your estate.
Plus, if you’ve already maxed out your TFSA and RRSP contributions, a universal life insurance policy gives you another account for tax-deferred savings. Keep in mind, however, that you shouldn’t take out a universal life insurance policy solely for the tax advantages. Other tax-sheltered accounts could be more cost-effective. You should consider your life insurance savings account as an addition to regular TFSAs and the like rather than a replacement.
Regardless of which type of insurance you choose, you’ll need to figure out how much coverage you need. Remember, even among Canadians that have insurance, most are underinsured. Figuring out how much you need can also help you decide on which type of policy to get.
To determine how much you need, look at your expenses and your goals. For example, if you have young children, you may want to take out a term policy that will last until they’re out of the house and be enough to replace your lost income. You may want enough to pay their college expenses as well.
Or perhaps you have a hefty mortgage payment or other debts to worry about. Your coverage should be enough to pay off those debts and remove that responsibility from your family’s shoulders as well as replace your lost income.
No matter how you look at it, some type of life insurance policy is better than no life insurance. If you are the breadwinner for your family, losing you will not merely be an emotional loss, but also put a heavy financial burden on your family. A life insurance policy is an excellent way to remove financial worries from a difficult time in your family’s lives.
Signing up for life insurance in Canada is easier than you think! You can typically sign up for a simple term life policy online. If you’re young and healthy, a medical exam may not even be necessary.
If you still have questions or are wondering which type of policy is best for you, don’t hesitate to reach out. We can help you compare life insurance policies and choose the right type of policy for you as well as figure out how much coverage you need.