Shopping for life insurance is unfortunately not as exciting as shopping for a new wardrobe. In fact, many find it downright daunting and confusing. However, this is not a reason to avoid, as it is important to keep your loved ones covered financially in case of death. Here we try to make the process a bit simpler for you by breaking down the two major types of life insurance: Term insurance and Permanent (Whole Life and/or Universal Life) insurance.
Term insurance, as the name suggests, only protects you for a limited number of years. Whether its five years, 10 years, 20 years, then after that the policy renews at a significantly higher rate. However, policies have a term exchange option that allows you to extend the length.
Term Exchange Option – means that you can “exchange” your Term 10 policy for a longer duration term within the first 5 policy years without any medical underwriting, essentially providing you with 25 years of coverage (if you switched for a Term 20 at the end of 5 years). There is a bit of risk however, you don’t want to miss the window for the exchange, otherwise if health issues arise, one will need to pay the high renewal rate at the end of 10 years.
Term insurance makes sense if you are looking to cover any debt and replace a portion of your income for your family in case of death.
- Term policies tend to be the most affordable and simplest to understand.
- Individual Rates are guaranteed not to change for the duration of the term.
- Provides your family with protection in case of death.
- It renews after a limited number of years; thus protection may become unaffordable after the term of the policy.
- Term policies cannot be used to build wealth or save on taxes.
Whole Life and Universal Life (Permanent) Insurance
Permanent insurance provides lifelong protection. It differs from term insurance as it never expires (as long as you can keep up with the payments) and it could be designed to provide some cash value in addition to death benefit, which can be a source of funds for future. Keep in mind, whole life premiums can cost five to 15 times more than term policies with the same death benefit.
- Designed to cover capital gains or transfer wealth to the next generation in the most tax-efficient manner.
- You can borrow funds against the policy.
- Individual premiums can be locked in for life.
- Permanent insurance is much more expensive than term insurance, therefore it may prevent you from putting dollars towards proper insurance and/or investing for your own retirement.
- A much more complex form of insurance.
- Unlike term insurance, you cannot just stop paying, as with this insurance you could face a surrender charge.
In simplest terms:
Term insurance is for “IF” you die. Permanent Insurance (Whole Life) is for “WHEN” you die.
So which type of insurance is best for you and your family?
Are you simply looking to cover any debt and replace a portion of your income for your family? If so, term would likely make the most sense. It would be a similar scenario if you are unable to afford whole life insurance. Basic protection is always better than no protection!
Term Insurance is something you purchase and hope you never need, like an alarm system for your home. It offers you peace of mind that your family is protected in case something was to happen replacing a portion of your income to allow them to sustain the same quality of life as they are currently accustomed to. It’s inexpensive and can be converted to a permanent policy in the future.
Whole Life and Universal Life are good products, however it’s not for everyone. Are you maxing out your RRSP/TFSA and investing in non-registered investments? Do you have corporate surplus? If so, this type of coverage can be a great tool to reduce taxation and enhance the overall value of your estate for your loved ones or favourite charity.
As you age, your needs/wants will evolve and you will look at insurance as an overall part of your estate plan. Many permanent plans are designed to cover capital gains or transfer wealth to the next generation in the most tax-efficient manner. Hopefully by this point, your mortgage is paid off and you no longer depend on your income meaning the need for both Term Insurance and Disability Insurance are likely no longer needed. In addition, your kids may now be done school, married and financially independent. This will free up the cash flow allowing you to invest towards a permanent plan.
Some permanent insurance has cash values that grow inside the policy. In most cases, you should maximize your RRSP and TFSA’s before investing into an Insurance Policy. In addition, you should have a need/want for the insurance itself as you will also be paying for the actual cost of insurance. Life insurance can be used as an investment, but the real benefit is when those investment dollars are intended to go to a beneficiary as those proceeds are paid out tax-free upon your death. However, if you need access to additional capital, you do have options in which you can access the cash value of your policy.
Thus, whole life does offer more financial flexibility with its cash value component. However, these policies are complex and expensive, so you need to ensure it is the correct fit for your scenario.
Bottom line is that it is always best to work with an insurance broker that takes the time to explain your options. Here at SecurePlan™, we take pride in the fact that we help our clients make an informed decision on what type of coverage, and how much coverage, makes the most sense for their situation. We know some brokers only prefer term insurance while other brokers only prefer permanent life insurance. We understand that one policy isn’t better than the other, and the right policy is dependent on what you are trying to accomplish.
Here is a good article, that really hits home with me (More Canadians consider life insurance during pandemic, survey suggests | CTV News). Too often, I meet someone who has purchased an expensive permanent policy where a term insurance policy would likely have been the better fit. If the purpose of insurance is to financially provide for your family if you are no longer able, make sure you have an adequate amount of coverage to do so.