August 2023 LifeSpring Insights

Figuring out how much life insurance you need is no easy task. Do you use a multiple of your wages – five or 10 times, say? Or do you buy just enough to pay off your family’s debts if the unexpected were to happen? 

Your age is a factor when it comes to buying insurance, too, as it affects how you plan to use your coverage. Are you mainly focused on looking out for your family’s needs if you pass away, for example, or do you want to use life insurance as part of your estate planning – such as to pay final expenses like funeral costs and estate taxes?

This article will look at some things to consider when tackling questions like these. Before we do, though, let’s examine the two main types of life insurance: term and permanent, and to whom each is best suited.

One thing term and permanent insurance have in common is that they pay a one-time benefit to your named beneficiary (or beneficiaries) upon your death. The payout avoids probate fees and is not part of your estate. This payout is also tax-free, so your beneficiaries know exactly what they will receive – and won’t have to report it on their tax return.

Term life insurance: A lower-cost option that’s great for younger people 

When most people think about life insurance, they’re really thinking about term insurance, for a couple of reasons: 1) it’s simple and 2) it’s more affordable than permanent insurance.

A good way to think about term insurance is as if you’re “renting” coverage for a certain period of time (the policy’s term). When the term expires, you’ll have the option to renew, likely at a higher premium (because you’ll be older at the time of renewal). Your other options are to simply cancel your policy or convert it to permanent coverage. Term policies also terminate at a certain age, potentially as early as 65 or 70.

Term insurance’s relative affordability makes it a great choice for when you’re starting a family or have children at home, as this is when you tend to have the most debt. 

If you were to die unexpectedly, your spouse or partner could use the tax-free benefit as they see fit – to repay obligations such as the mortgage and car loans, for example. Or they may choose to treat it almost as an annuity, holding the benefit in a non-registered account and annually withdrawing a sum roughly equal to the annual income you would have provided. 

Permanent insurance: a good option for empty-nesters and soon-to-be retirees

When you buy permanent insurance, you basically “own” your coverage, in a couple of different ways. 

For one, part of your premium builds up within the policy and is invested, so it nets you a yearly return. This money – known as the policy’s cash value – grows tax-free, and you can withdraw it while you’re still alive, though there may be tax consequences of doing so (your insurance company can give you this information). One way to get around that is to borrow against the policy, something you can only do with permanent insurance. 

For these reasons, permanent policies’ premiums are higher than those on a term policy, so they may not fit into a young family’s budget. 

Second, unlike term policies, permanent policies cover you until your death, so you can count on them paying out (both the death benefit and the cash value). This makes them a good estate-planning tool because you’re assured that these funds will be available for final expenses, such as your estate’s tax payable and funeral costs. 

Within permanent insurance are two “sub-types”: whole life (where the cash value is guaranteed and invested in a conservatively managed portfolio) and universal life (where you choose how to invest the cash value, usually from different accounts holding investments that vary in risk level). 

How to judge your insurance needs in your working years

Once you’ve settled on the kind of insurance that’s right for you, how do you know how much to purchase? One thing you don’t want to do is use a “back-of-the-napkin” number like a multiple of your income, for example.

One figure Derek Sabourin, a wealth-protection specialist at BlueShore Wealth, hears regularly is that you should have coverage equal to 10 times your yearly wages if you live in Vancouver. 

“Trouble is, that’s far too simplistic for most people,” he says. “For example, is that pre-tax or post-tax income? What if there are multiple earners in the home, or young children, a large mortgage or other obligations? A simple ‘rule’ like this can’t accurately account for any of these.”

Instead, Sabourin recommends sitting down with your advisor and doing a complete overview of your income, assets and liabilities to arrive at the right figure. It sounds time-consuming, but it really isn’t: “At BlueShore Wealth, we can give you an accurate insurance estimate in about 10 minutes,” says Sabourin.

Permanent insurance can give your child a head start

Your advisor can also help you come up with creative approaches to insurance. For example, if you’re younger and have room in your budget, a modest amount of permanent insurance can make sense, as the cash value will have more time to grow. 

Another move you might consider is to take out permanent insurance on a child, as the investment component will have a long time to grow and will be available to them in adulthood. Or they may choose to name their own children as beneficiaries when they start a family. 

Single with no kids? You still need coverage. Here are two smart options.

Finally, Sabourin sometimes hears from single clients with no children who wonder if they need life insurance at all. 

In a case like this, you might consider putting a bit less emphasis on life insurance and more on critical-illness insurance – which pays you a one-time, tax-free lump sum you can use however you like if you’re diagnosed with an illness. Another option is disability insurance, which gives you an ongoing monthly payout if you’re sick or injured and can’t work. 

Your advisor can help direct you to develop a plan that fits your needs

When it comes to insurance, the bottom line is that trying to calculate the amount and type you need on your own can lead to being under (or even over-) insured. Insurance can be a vital and helpful part of your financial future. A visit to an advisor – who can give you a valuable outside perspective on your situation and help direct you to an insurance and wealth protection advisor – can help to make sure you and your loved ones’ needs are met at minimal cost. Reach out today or as part of your regular financial planning discussions.