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What is Life Insurance and why do you need it?

What is Life insurance? What are the different types of life insurance? It is a product that pays a lump sum (Tax Free) death benefit to a beneficiary of your choosing and ensures that your family will still have a financial future even when you pass away.

As a homeowner, would it be wise for you to have no insurance on your property? How about the car- as a driver/owner of a vehicle, would it be advisable for you to have no car insurance? Heck, even if we have valuable jewelry, art or other possessions, we make sure that those are insured. So, how about your most valuable asset?

This table represents your potential earnings by the age of 65

Annual Income Age 25 Age 35 Age 45
$35,000 $2.36M $1.54M $894K
$50,000 $3.37M $2.2M $1.28M
$65,000 $4.38M $2.85M $1.66M
$90,000 $6.07M $3.92M $2.3M
$120,000 $8.09M $5.27M $3.07M
$150,000 $10.11M $6.59M $3.83M

***Based on a 2.5{a03822e28c5c906589e58caafc71b922ff7b2692d58bfeefe8f12d55f85871c7} annual increase in income to match inflation***M = Million K = Thousand

Yes, of course, you are your most valuable asset, and the table above proves it regarding the financial area of our lives. What it proves is that our ability to earn money is our most valuable skill. It is potentially worth millions of dollars to us and to our societies. The three biggest risks to your income are to do with your health.

Putting an income protection plan in place is the most affordable and efficient way of protecting you and your family. Insurance can’t replace you, but it can replace the financial burden.

What prompts most of our clients to get Life Insurance is the realization that when we die the bills don’t die with us. In the case of the main breadwinner of the family, getting life insurance becomes a necessity. How would the other spouse support the household? Kids, their education, their health?

How much Life Insurance do you need?

You can use our quick and easy Insurance Needs Analysis Tool in addition to reading below to get a better understanding.

In general, when calculating the amount of insurance, take into account four main things

  • How much capital would be needed to replace your income?
  • How much capital would be needed to pay off debts (mortgage, credit cards, car loans)
  • How much capital would be needed for extra expenses (e.g. funeral, children’s education)
  • What assets already exist that will offset the total insurance need

The simplest way to calculate the replacement value of your income is to take your annual income after taxes (life insurance is paid out tax free) and multiply that number by 10. We are effectively giving your family 10 years to adjust to the loss of your income.

To determine how much is needed for other capital needs, take all liabilities/debts, expected funeral expenses, any other expenses that need to be paid off upon death, and then, if you have children, include another $50,000 per child to pay for their college education.

See Example

Keep in mind, this is a good baseline but by no means takes into account all possibilities that an individual might want to cover using a Life Insurance Policy. There are other ways to come up with a number like this, but in our experience, the formula that makes sense and is simple is usually the best.

What is the best type of life insurance for you?

The best type of life insurance for you will depend on your situation, and that can change over time, so, most of our clients go for a combination of different types of life insurance policies to cover all their basis.

There are generally three types of life insurance policies.

Term Life Insurance

The purpose of term insurance is to cover a certain amount of liability for a specified amount of time (hence “term”). This type of insurance gives you the ability to buy the largest amount of insurance for the cheapest price. Term Insurance is the best option when you are a young family and have a lot of liabilities such as mortgage, car loans, student debts, credit cards, children’s education. The downside to Term Insurance is that premiums will increase at the time of renewal (e.g. 20 years), and that the coverage will eventually cease at some point (example age 85).

Permanent Life Insurance

This policy provides a set amount of insurance that is paid out upon death. Usually this type of insurance is chosen when you know that you will have a specific set of liabilities that will need to be paid upon death (e.g. a big tax bill due to the sale of a business). It differs from Term Insurance in that the premium is level, and it is guaranteed to never increase. The coverage will never expire as long as you pay the premiums. It is more expensive than Term but more affordable than Whole Life.

*You have the ability to shelter investment assets in a Permanent/Universal Life Policy as well

Whole Life Insurance

Akin to owning an asset, and just like the Universal Life, Whole Life insurance is a permanent insurance, the coverage never expires and remains in force as long as the premiums are paid. Whole Life has an investment component built right into the policy, in fact with policy dividends among other things, the coverage amount actually increases over time. It generates a cash value that can be drawn upon or borrowed against. Whole life can make a lot of sense when you know that your insurance needs will increase over time or if you want to diversify your investment portfolio with another asset class. Indeed it is the most robust policy for retirement and estate planning purposes.

Keep in mind, the above descriptions are just to give you a general overview of the different types of insurance. Although Term Insurance is pretty straight forward, Permanent Life and Whole Life can be used by individuals in a variety of ways both simple and complex. It is important that you seek professional advice, especially if you plan on moving forward with the latter two options.

The first step to putting a plan like this in place is to book a free no-obligation consultation. An advisor can help you to come up with a plan that is suitable for your needs by completing a Health and Lifestyle Evaluation and providing a free quote.

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