Life insurance isn’t a fun topic, but it’s a critical part of your financial strategy. People don’t often talk about it. Most don’t understand it. Few want to buy it. Even those people who buy it don’t necessarily understand it or appreciate its importance in building and preserving wealth. As a result, a lot of people don’t have any life insurance protection. If they do, most don’t have enough.
Today, people have all types of protection. They insure their house, cars, phones, and appliances.
They even buy travel insurance for their vacations. But when it comes to life insurance, people remain sceptical. The most important insurance that protects their family and their children is not taken seriously.
Life insurance doesn’t insure your life. It insures your family’s ability to continue on without being financial devastated. A good number of people believe they won’t die anytime soon. Why would they need insurance.
Some take it easy by just signing up with their employer’s group life insurance. There’s no need for a medical check up. Others get it free from their company. However, the company may not provide enough coverage, and if their employment terminates, they won’t have protection. They may also have difficulties buying individual life insurance if they have medical problems and need more coverage
Are You Insurable?
Most life insurance requires medical exams, blood tests, and/or health records before a policy is issued. If you have health problems, life insurance companies may deny your application, or they may charge a higher rate. This is similar to how car insurance treats drivers with bad driving records.
A lot of people are not insurable and may not know it. 1 out of 2 men and 1 out of 3 women have the risk developing cancer in their life time. 90% of Canadians having at least 1 risk factor of heart disease or stroke.
Thus, if you have the need, buy life insurance as soon as you can while your healthy and insurable. Buying early is also wise because you may qualify for better rates.
Don’t wait too long, because when you have a health issue it may be too late. You might find out that you are no longer insurable.
Some policies can be issued without medical exam or with limited medical questions. These forms of ” guaranteed” policies typically charge higher premiums and are only available on lower coverage amounts.
How Much Life Insurance?
Buying car insurance is simple. If you car is worth $35,000, you need $35,000 of coverage to cover the car in the event of a total loss.
Same with your house, if the value of your house is $300,000 you will need $300,000 coverage in case of disaster.
Most people can’t apply the same valuation with life insurance. Simply because they don’t know how to calculate how much they need.
The Dime Method
Many people buy policies worth $100,000, $200,000 or $300,000, but that may not be enough. The DIME method offers a easy formula to calculate your life protection need:
How to calculate your protection need:
Example of a hypothetical case
Debt $50,000 ( Combined credit cards, loans and other debts)
Income $360,000 ( $3k/mo. ( $36K/yr) income replacement for 10 years)
Mortgage $200,000 (Mortgage balances)
Education $120,000 (Assuming $15k/yr for a 4-year college for 2 kids)
TOTAL $730,000 Protection Needed
Most people have good protection on their houses and cars, but few have enough coverage for their loves ones.
With $730,000 of insurance protection, it this person dies too soon, the surviving spouse will have enough money to pay off the $50,000 debt, continue to have $3,000 income per month for 10 years or more, pay off the remaining $200,000 of their mortgage, keep the house, and still have $120,000 saved up for 2 kids when they are ready for college.
The DIME method will allow to you calculate exactly how much your insurance need is.
People say, ” I already have life insurance!” They may, but the real question is do they have enough?
How would you feel if your $300,000 home burned to the ground and when you file a claim, your insurer tells you have $50,000 worth of coverage? That normally won’t happen as the bank will make sure you have $300,000 of protection.
What your life and if you pass away? How would your spouse and kids feel when they receive a check for $100,000? After expenses, they may be left with very little and face a bleak future.
Do Stay at home parents need life Insurance?
Yes, they do. They need a lot more then they think.
A lot of people think life insurance is for the breadwinner only. But stay at home parents should have protection to replace their value services to their family. Without them, these services can cost a lot.
They are the driver, the cook, the cleaner, the teacher, and the accountant for the family.
Without them, it could cost a lot of money to hire people to do the job. In most cases , the monetary value of their services is as high as if they had a full-time job. According to Salary.com, a stay at home parent is worth $112,929 per year.
Do Single people need Life Insurance?
Most people buy life insurance to take care of their spouse and children. However, single people buy life insurance for different reasons.
They have loves ones to take care of , such as their parents r less fortunate siblings
They may have a friend or relative who co-signed a student loan or mortgage. The co-signers will be on the hook if they’re gone.
They may start a family soon and want to buy when the cost is lower or while they are still healthy and insurable.
They are in a business partnership and want to protect the business
They want to take advantage of the tax benefits of savings in the policy and have the coverage at the same time
They want to leave a legacy to the cause they are passionate about.
How to buy Life Insurance?
Many people find it complicated and confusing to buy life insurance. It is not complicated to understand.
Buying life insurance is no different than the many other things you buy daily. You buy it by its unit costs.
Sugar 60 cents/$1.32 pound/kilogram
Eggs $2 dozen
Gold $1,100/$39 ounce/gram
Life Insurance COI $1,000 Insurance
Cost per $1,000
The cost of insurance (COI) per $1,000 coverage (or death benefit) for 1 year is the unit cost.
For example: The COI per $1,000 for a 35 year old male non-smoker is $1. This means that this man can pay $1 to get $1,000 insurance coverage for 1 year, or $1 per unit.
So if he buys a $100,000 insurance policy, he would buy 100 units, which is $1 X 100= $100 for one year.
If he needs $250,000, then he needs to buy 250 units. Thus, $1 X 250= $250 for one year.
However, next year the COI per $1,000 will go up. As he gets older, the risk increases, and so does the price.
Age COI/1,000 100K Policy
35 $1 $1 x 100 =$100/year
36 $1.10 $1.10 x 100=$110/year
37 $1.20 $1.20 x 100=$120/year
38 $1.30 $1.30 x 100=$135/year
39 $1.50 $1.50 x 100=$150/year
As he ages into his later years, the cost escalates greatly.
All insurance policies are based on cost of insurance ( COI).
The cost goes up every year because your risk of dying is higher as you get older.
It is also based on your health. For Example, whether you smoke or not affects your rate.
And if you are a female, your rate is lower due to having better life expectancy.
Some refer to it as temporary insurance because it has a term or set period of coverage.
And you have different kinds of terms. Generally, there are 3 kinds of Term Insurance.
Annual Renewal Term (ART)
Coverage is for a one -year term, renewable every year with higher price. It costs much less you are young but will be very expensive when you are old.
Decreasing term or Mortgage Insurance
The premium cost will not increase during the entire life of the mortgage. The death benefit will pay off the balance of the mortgage. Thus, if something happens to you, the house will be paid off for the surviving spouse. Sounds good right?
Mortgage life insurance is still Term life. However, since the balance of the loan will decrease every year, the benefit decreases accordingly. Thus, you’re buying a decreasing term.
Make sure you look at the cost. Quiet often, you can get better rates with Level Term, and the benefits will remain constant- and not decrease during the term.
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CBC Market Watch- Mortgage insurance Denial.
Permanent Life : Term + Cash
Also called cash value life insurance, there are different types of permanent life insurance.
It is the original and oldest form of cash value life insurance. Instead of playing just the cost of insurance, you pay higher premiums.
The difference between the cost of insurance and the premiums goes into your cash value. Whole Life policies give you a guaranteed rate of interest. Some insurance companies may provide dividends, but dividends are not guaranteed.
The cash value compounded with interest built up in the early years will pay for the higher COI in the later years, so the policy can last a whole lifetime.
Whole life policy is not very flexible. The premium is fixed, the interests guaranteed, and the death benefit fixed. Since insurance companies have to guarantee the interests for the whole life , they tend to give conservative rate. As a result, the cash build up can be slow.
It should be noted that these types of policies may have surrender charges ( fees associated with selling the policy in the early years).
Buy term , Invest the Difference
Many people say, “Why bother with cash value life?” , especially Whole Life, when you can use a strategy such as “Buy Term and Invest the difference”.
It questions why you should pay, for example, $1,000 a year for Whole Life when you can just pay $200 for Term Insurance for the same coverage? You can invest the difference ($800) into another investment ( such as mutual funds) to get a better potential return. And you can use the investment to pay the higher cost of insurance in the later years, or you can use it for retirement.
There are a lot of believers in this logic, and quite a few of them converted their Whole Life policies to buy Term.
However, in order to have this theory work, 2 conditions must be met.
You must have the discipline and consistency to invest the difference. If not, you may end up buying Term but spending the difference. With uncertainty about the economy and the changing job market, consistency can be a challenge.
You must know how to invest the difference. Other investments may be able to give you better returns but they may also sink your nest egg.
In either case, if your investments haven’t performed well at the end of the term, and the cost of insurance substantially increases, you may have lost your surplus money , or even worse, you may no longer be able to afford to continue your insurance coverage.
Thus, consider all options to find a suitable solution for your financial foundation.
The difference between Universal life and Whole Life is its flexible. You can change your premium. You can pay more one month or less the next. Sometimes when you face money problems, you can even skip a few payments as long as the cash value inside the policy is enough to pay for the COI.
You can adjust the your death benefit to fit with the life-changing conditions. The interests on the cash value may also be sensitive to the market conditions. That allows insurance companies to adjust the interest rate to give higher or lower rates if necessary.
Additionally, Uls maybe a useful tool in implementing some tax and or estate strategies, may allow for changes to the death benefit, and may allow some flexibility in the timing of premium payments.
ULs also tend to be more transparent, in that the different fees are the COI are broken out.
No matter what you call it, all insurance has one thing in common. You have to pay for the COI inside the policy, which is the cost of term insurance.
We can sum it up as follows:
All insurance is term insurance ( COI)
The costs of term insurance always goes up
There is no free lunch. You have to pay for it
In other words, all insurance is either term or term plus cash. The COI always goes up as you get older.
You must pay for the term insurance directly, or you must have enough money in the cash value to pay for it.
Tax advantages of Life Insurance
Under the current Canada Revenue Agency (CRA) guidelines, insurance policies receive many favourable tax advantages.
Tax – Free Death Benefit
Should the insured die, the entire death benefit including the cash value is income-tax free to the beneficiary.
Tax- Deferred Earnings
You do not pay taxes on the gains in the policy. Tax is deferred until you decide to surrender the policy, the policy has lapsed, or when certain distributions occur.
Tax- Free withdrawls
When cash value in the policy is sufficient, premiums paid into the a policy can be taken as tax-free withdrawls up to the your costs basis in the policy. The is the premium you paid with after-tax dollars.
Besides the withdrawls, you can take more money out of the policy in excess of your basis ( your paid premiums) through tax-free loans with a very low net effective rate.
Quit smoking. Smokers pay 40% more than non- smokers
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