#FinancialFridays: Understanding Insurance – Part 4: Life Insurance
What is life insurance? Why would I want to buy life insurance? What are some of the “insurance words” that I need to know to have a conversation? How much insurance should I have? How much is it going to cost me? What isn’t covered? All of these are important questions. This post will try answering these questions and to give you some additional links to find more detailed information.
Terms you should know
“What is Life Insurance?” – According to the Financial Consumer Agency of Canada (Life Insurance), life insurance can help your loved ones deal with the financial impact of your death. The death benefit (payout) is a tax-free, lump sum amount that can be used to:
– Pay for funeral expenses
– Pay off your debts
– Replace your income so your family can maintain their standard of living
– Provide for your children and partner
Term Insurance – If you are on a budget, ask about term life insurance. This type of insurance refers to a policy that ONLY provides coverage for a fixed period. The coverage might be five, 10, 20 or more years. If you are young and healthy, your premiums could be lower than when you are older. Term life insurance typically costs less upfront. It is important to remember that your rate is not locked in for life. Instead, it increases during every renewal period. Many term policies come with a feature that lets you convert your policy to permanent life insurance.
Permanent, or “Whole Life” Insurance – There are a group of policies that will provide life insurance coverage for your entire life. One is a “whole life policy” and you would make regular payments for the remainder of your life. The premiums (payment) can vary, as the policy will earn a return that can be used to pay some portion of the premiums or to increase the amount of benefit. This “cash value” accumulates over the life of the policy as an investment. Other types of permanent insurance include Universal Life and Term to 100. Universal Life is similar to “whole” life but it has a self-directed investment component that is beyond the scope of this post; and Term to 100, is a “whole” life policy that does not have a “cash” value and the premiums end at age 100, although the coverage does not. Permanent insurance is generally more expensive than “term” insurance.
Medical Exam – Depending on your age, physical condition, and your insurance company, you may be required to undergo a medical exam. This exam would be to determine whether the company would insure you and to discover any medical conditions that you might have. If you have pre-existing medical conditions like diabetes or cancer, the insurer may not provide coverage to you.
Exclusions – Something your life insurance policy does not cover. Exclusions can include death by suicide within a certain period after purchasing your life insurance policy, death from high-risk activities such as skydiving and death from pre-existing medical conditions.
Your needs change – The amount of Life Insurance coverage that you require will change as you experience each stage of life. Young families with large mortgages will have different needs than someone who is older and may be paying tuition. Senior citizens will have different requirements as well. You should review your coverage and your insurance needs regularly as your circumstances and financial needs change. “How much insurance” you require will depend on your personal circumstances and your goals.
Your estate and your beneficiary – When you die, all of your assets (things you own) and your liabilities (things you owe) are part of your estate. Your executor (someone you have selected to look after your estate) needs to resolve your debts and then distribute what is left. If you name family members specifically rather than your estate, your death benefit, the value of your life insurance policy, goes directly to your beneficiary. If you do not name some one specifically the policy payout MUST be used to pay debts. If you want the benefit to go to multiple people, you need to name them in the policy, not your will.
What is not covered? – The answer varies from policy to policy, which is why it is important to ask your insurance provider BEFORE you agree to anything. There are some circumstances under which policy benefits are not payable, and some things they do not cover. Unless you have specific “mortgage insurance”, your mortgage will not be automatically paid. Your beneficiary could use some or all of the life insurance payout (called a death benefit) to pay against your mortgage. Disability and critical illness coverage are available as separate insurances and are not covered by your life insurance policy. Some life insurance policies do allow for the payment of benefits in the event of a suicide if the policy is over two years old, while others do not cover suicide at any time while the policy is in force. Your policy will list all of the exclusions, but they may include pre-existing medical conditions, reckless endangerment (e.g. if you die racing a car), or if you die while committing a crime. In situations like this, your beneficiary may not receive benefits.
Life insurance vs mortgage insurance: Mortgage insurance loses value each time you make a mortgage payment, as all that is covered is the outstanding amount of your mortgage. Buying life insurance can have the same affect, enabling family members to pay off the mortgage if that is what they wish, and does not lose value the same way.
Legacy insurance: There is a way to support your favourite charity with a life insurance policy. You may be able to support your favourite charity with large donations, as you need your income for your day-to-day costs. However, you can purchase a policy that provides the benefit to your charity of choice at the time of your passing. The insurance payments are tax deductible when you make them, helping you out at income tax time.
Myths and Misconceptions about Life Insurance
Myth: Your employer’s life insurance coverage is enough. Having insurance through work is a great benefit; however, you do not own the plan and your employer can change the coverage at any time. Some plans have options to convert to a private plan if you leave your job; however, there may be limited features and benefits. Also, note the amount of the pay out is usually much lower than for a private insurance policy.
Myth: Life insurance is too expensive. All costs are relative but there are a few points to consider; first, if something happened to you, how would your family meet their obligations now and into the future? Consider the contributions that you make to the family income. Mortgages, loans, tuition are all major expenses; second, what costs would be incurred if you suddenly died? Even for a simple funeral, the costs can be enormous. Remember life insurance is not something that you buy for yourself.
Life insurance being too expensive is a common myth, particularly among younger adults. It is possible to get on-line quotes, which will give you estimates based on the coverage you are looking for.
Myth: You need the same amount of life insurance coverage as your partner. Your needs depend on your individual debts and income levels. Unless you and your partner have the same income, you likely need different plans. A pair of personalized policies ensure both you and your partner have the right coverage level.
Myth: If you are young and healthy, you do not need it. Your life insurance needs depend on many factors, but if possible, it is better to buy a policy when you are young and healthy and it costs the least. Most people are more likely to develop health problems as they age and the price for insurance coverage will increase. There are many examples of people buying an insurance policy and then several years later developing a terminal illness. Had they not purchased when they did, they would have been unable to purchase insurance after they were diagnosed.
Myth: If you have health issues, you cannot get it. Unless you have severe health conditions, you generally can buy term life insurance. Conditions such as diabetes, high cholesterol and arthritis will mean higher life insurance quotes, but it is still available.
Myth: Life insurance is not available for older people. Even people over 60 can usually buy term life insurance unless you have a terminal illness. The cost of coverage, of course, is much higher for older people.
Myth: If you are a stay-at-home parent, you do not need it. If you die, who is going to take care of your children, elderly parents and even your pets? Your surviving spouse may need to hire help, and insurance benefits could help pay for these costs. Stay-at-home parents provide a tremendous benefit to the family, and that void is expensive to fill.
Myth: I do not Need Coverage Because I am Single and Don’t Have Dependents. Even single people should have enough life insurance to cover the costs of personal debts and medical and funeral bills. If you are uninsured, you may leave a legacy of unpaid expenses for your family to deal with.
I am Better Off Investing My Money Than Buying Life Insurance. Anyone is taking a big chance when you depend solely on your investments in the early years of your life, especially if you have a family. If you die without insurance coverage for them, there may be no other means of supporting them after the depletion of your current assets.
Having a life insurance policy can fit almost any budget. The purposes of having this insurance is to provide those people you care about with a tax-free lump-sum amount of money. The insurance payout can be used to settle your outstanding debts, perhaps pay off your mortgage and give them the financial security to continue to live comfortably with out you.