A co-worker recently commented on our benefit renewal at work and mentioned it might be worthwhile to talk life insurance on the blog. At that point, I realized I’ve never actually talked about life insurance and was wondering why the heck not! So here we are.

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Life insurance is kind of this topic that no one really ever brings up. It seems relatively mystical, individuals not really understanding how it works, and the options tend to seem endless, so I’m here to break it down for you!

There are a bunch of different types of insurance, namely whole life, and term life insurance. What you should pick depends on your family’s needs. Before you dive into what type of life insurance you need it’s important to know the following:

  1. How much are your outstanding debts?
  2. How many dependents do you have?
  3. How long would you want your spouse to have an income stream if you passed away?

Then you need to take a total of the above to figure out how much coverage you need. I’ve made up an example based on some numbers that a common Canadian might find themselves in.

Outstanding Debt:

Credit Card: $1,500

Student Loan: $10,000

Mortgage: $250,000

Number of dependents: 1 ( 1 child X $250,000 to raise them to age 18) = $250,000

1 Year of Income: $60,000

I like to put the year of income in my calculation because if my spouse passed away I’d want to be able to take some time off work. I don’t know how long I’d take, and everyone is different on this but I think for our household it would be important to give each other that option.

Total: $571,500

Next, you need to choose what type of policy you would want.

Whole Life Insurance

The biggest thing to note with whole life insurance is that it is for the duration of your life. The monthly payment (premiums) you pay stay constant for the entirety of the plan. A piece of this plan is invested by the insurance company which would mean that you benefit from the investment gains.

Whole life includes a cash surrender value (CSV). This portion of the insurance policy allows you to borrow against the policy (it is taxed upon using it). The problem with Whole Life insurance is how expensive it is. The insurance experts say it’s important to get in while you’re young so that your premiums are lower, which is true… to an extent. Locking into huge financial obligation so early in your life could put a strain on your bank account.

Pros:

  • Payments are constant
  • Investment piece to the policy
  • Get it and forget it

Cons:

  • Payments are much larger
  • If you use the CSV the amount is taxed

I ran the numbers. For $500,000 of whole life insurance, it would cost $300 per month.

Assuming I live till I’m 80 (I’m 25 now) that’s 55 years of payments

55 years * 12 months * 300 =  $198,000 paid for $500,000 in insurance

 

Term Life Insurance 

Term Life Insurance covers you for a specific period of time, anywhere from 5-30 years. Once your term is up you will have the option to renew your policy. However, based on your age and health your monthly premium could increase. Depending on your health you can be denied for term life insurance, as well some policies have a maximum age they are willing to insure.

Once the term runs out there is no amount paid out to you, and there is no investment piece to the insurance policy. Term life insurance is typically a lot less of a financial obligation on a monthly basis which makes it much more affordable to families starting out.

Pros:

  • Payments are lower
  • No amount is taxed

Cons:

  • Uncertainty of payments when you renew
  • No cash value
  • Could be denied based on health

I ran the numbers…. For $500,000 of term life insurance, it would cost the following:

10 years….  34.25 per month …. = $4,110 in payments

20 years….  49.69 per month … = $11,925 in payments

30 years….  76.75 per month … = $27,630 in payments

Many term policies stop insuring once you hit 65 years of age. I’m 25 so I’d need 40 years of insurance, but the last 10 years are very expensive so let’s assume I’d need coverage for the total of 30 years. Renewing the 10 or 20-year term policies would increase my costs tremendously.

10 Year Term

1st 10 Years – $4,110

2nd 10 Year Period – $16,080

3rd  10 Year Period – $32,847.50

Total = $53,038

20 Year Term

1st 20 Years – $11,925

Last 10 Years – $49,189

Total = $61,113

So what should you do?

$300 per month seems like a hefty bill for a 20 or 30 something to foot and while there is more security in whole life insurance the circumstances in our life are not certain. How do you know where you’re going to be in 30 years, or if you will have stayed in the relationship you’re in? In my opinion, it would be a lot better of an idea to pay less now for term life insurance and build up enough savings, and pay down your debt so that you don’t have to renew your term policy when it comes time to renew. As a family, you need to decide if you’re going to be able to do this in 10, 20, or 30 years. As you can see, once you renew the cost of the policy doubles or even triples the original cost.

It’s important to remember that insurance is an expense, not a way to grow wealth. It’s an expense that you have to suck up and pay and hopefully never have to use! I think a lot of people are uncomfortable with the insecurity of the payments and potentially not being approved for their second term. What individuals need to remember when they are picking insurance is that if they keep up with a healthy lifestyle it is likely they will be approved. Taking the difference you would have paid with whole life ($300-$77 = $223) and using it to bolster your savings account and invest in the stock market means you’ll be able to sock away $224,000 by the time your 30-year term life insurance is due (assuming 6% returns). Insurance is a good thing to have especially when you have liabilities and dependents that couldn’t survive on your assets. But if you get to a point where you don’t need an insurance payout to keep your household surviving then you will you’ll be able to get rid of that expense all together!