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Back in November 2015, I blogged about whether or not it was time to buy life insurance for my husband and myself. I went through the different scenarios of “what if I die” and “what if he dies” and concluded that although he and I didn’t need life insurance immediately, it’s something that we’ll need to address within the next few years.
Six months later, and our need for life insurance is becoming more pronounced.
My husband is turning 29 this month, so it’s time to get our life insurance sorted out. I don’t want to spend a lot on a life insurance policy, so I’d like to lock into a low rate sooner rather than later.
Even though we don’t have a mortgage or dependents yet, in all likelihood we’ll have those things within the next two or three years. I’d rather get it sorted out now while we’re both DINKS (dual income, no kids) than post-mortgage or post-baby when we’re both stressed about other things.
As Forrest says, “One less thing”.
So I started researching life insurance. Now, when I begin to research a topic, I try and find as many non-corporate resources as possible, and as luck would have it, the Financial Consumer Agency of Canada put together a pretty swell primer on life insurance. Here’s what I learned about the basics:
Two Types: Term and Permanent Life Insurance
Life insurance is used to protect loved ones in the event of your death, and some types of life insurance can also be used as a source of income while you’re still living. Insurance policies have a beneficiary designated, and in the event of your death, that beneficiary will receive a lump-sum financial payment, tax-free. In our case, we would not be leaving the money to an estate or trust.
There are two primary types of insurance, term and permanent.
Term Life Insurance
Term life insurance provides coverage if you die within a period of time (the term), as long as your pay your premiums. Terms are usually 5, 10, 20, or 25 years.
The premiums (the monthly payment) for a term policy are generally lower (when you are younger) than permanent insurance premiums and do not increase over the length of the term.
Once the original term expires, most companies offer options to maintain the coverage without further underwriting (underwriting is when the company decides if you are insurable/for how much, etc.), convert the policy to something permanent, or let the policy lapse or expire. Most term policies don’t accumulate a cash value and most expire with no further options after age 85.
If you are coming into the life insurance game having only ever purchased car or tenant’s insurance, think of term life insurance as similar to car insurance. When you pay your premiums and have insurance, you are covered. Cancelling your insurance on your vehicle does not give you any payout, and it’s the same for term insurance.
Permanent Life Insurance
Permanent life insurance provides you with coverage throughout your lifetime, as long as you pay your premiums, or as long as there is cash in the policy to support the premiums. There is no “term”, the policy is permanent.
Permanent life insurance premiums are usually more expensive than term. The significant difference between term and permanent life insurance is that some permanent life insurance accumulates a cash value that you can access while you are still living.
There are four main ways to access this cash while you are still alive. You can borrow directly from the company, you can surrender dividends from a participating policy, or you can withdraw cash from a universal life policy. You can also use your policy as collateral with a lender. There are two primary types of permanent life insurance: whole life and universal life.
Whole Life Insurance
Whole life insurance has guaranteed premiums that will not increase, and your policy has a guaranteed minimum cash value.
In addition to the guaranteed cash values, some insurance may be able to provide additional cash from dividends. Once credited to a policy, these dividends are fully vested and can’t go down in value.
Universal Life Insurance
Universal life insurance is life insurance with an investment option and flexible premiums. You can choose to pay into this policy above the cost of insurance (called over funding), and you can choose an investment option from a predefined list. Growth is tax deferred.
You can withdraw this money, but there will be tax consequences. You can also use your policy is collateral. The cash value of a universal life insurance policy fluctuates depending on investment performance.
Choosing Between Term vs Permanent Life Insurance
Whew! That’s a lot of information! I swear I had to go over it a few times before I got everything straight in my head. Once I knew the difference between term and permanent and whole and universal life insurance, I had to figure out the next big thing: what do I need?
Choosing life insurance is pretty straightforward if you just break down what you need, and then choose the type of insurance that is the best fit. The best way for you to figure out what type of insurance you need is to do a needs analysis for your situation. My good friend and financial advisor Calen Outhouse says this is the focal point of his practice when working with new clients. A needs analysis sheds light on every aspect of insurance planning.
Here’s what I need, and what I don’t need: (this refers to my husband and me together):
- I need a life insurance policy that will cover me if I die unexpectedly.
- It needs to cover my (future) mortgage and costs associated with death.
Here’s what I don’t need:
- A life insurance policy that pays out if I die when I’m 70. I will have no need for life insurance at that point. My house will be paid for, my kids will be grown up, and I’ll still have retirement money in the bank.
- A life insurance policy that has a cash value that I can use when I’m alive. That’s what my emergency fund is for.
- A life insurance policy that can be used as collateral (because you all know how I feel about debt).
- I don’t need a life insurance policy with an investment portion. Between my husband and myself, we have more room in our tax-sheltered accounts than we could ever hope to use.
A 25-year term that expires when I’m 51 is almost perfect. It will cover me at my most vulnerable years, and after that, I can self-insure. When I’m 51, my mortgage will be paid off, which means my husband will probably be able to survive on his salary alone. The kid(s) will be grown up and self-supporting, and I’ll have $430,000 in the bank. I literally won’t need insurance anymore.
If you’ve been paying attention, you’ve probably figured out that I’m leaning towards a term life insurance policy. Term life insurance tends to be less expensive because it is so limited, but limited is good, limited is what I need. I only need insurance to cover my husband and me in case it hits the fan. I don’t need the bells and whistles of permanent insurance.
So now that I’ve figured out what type of insurance I need, I need to decide how much to buy, and where to buy it.
The saga continues.
Psst…If you’re located in Atlantic Canada and have questions about insurance, talk to my friend Calen Outhouse, I threw a lot of questions his way while researching life insurance and he was super helpful!
Photo Credit: Cam Adams