Why is life insurance intimidating? You see the ads for life insurance companies promoting this product or that, under a panoply of names that tell the consumer very little about what they are actually selling. Why do they make life insurance so complicated? Is it an attempt to avoid the word – sshhh, now – “death”? They can call it what they want, but when it comes down to it, that’s what life insurance companies offer. Here’s a look at the basics.
Whether they want to avoid the word or not, what they are selling is insurance against the financial impact of death. At its core, life insurance does two things:
1. Lump sum payment.Typically, in a situation of two spouses, it provides a lump sum of money which would be invested by one spouse if the spouse dies. The returns from that lump sum are intended to replace income that the deceased spouse would have earned during the remainder of his or her working life had he or she not died.
2. Estate settlement.In this case, life insurance pays taxes due at death and provides an inheritance to the beneficiaries named in the policy. This can facilitate property transfer, such as a cottage, from a parent to a child.
Life insurance premiums transfer the risk of death, and its financial impacts, from the person to the insurance company. They are used to transfer that risk for a period of time through term insurance or for the entirety of life, through permanent insurance.
It is essential to understand which is which when you are buying a policy, because they are very fundamentally different. How do you know what you need is what you’re getting? Here’s a highly simplified explanation to help you get at the basics. Try these questions out when you’re buying:
How long does the insurance coverage last?
First, a policy can stay in force until the end of its term. This is term insurance and is issued commonly for 5 or 10 years, but it can be as short as one year, and as long as 30 years. If the person on whose life the policy is based dies during the term, the face amount of the policy is paid to the beneficiary. If the person does not die during the term, and the policy ends, that’s it. There is no repayment of premiums.
Secondly, a policy can last a lifetime. It ends with the death of the individual whenever that might be. This is permanent insurance. It is available in three forms: whole life insurance; universal life insurance; and Term-to-100 insurance.
Why would a person choose one or the other?
Term insurance.You would choose term insurance for its lower premiums. You would choose permanent insurance because you want the certainty of insurance being in place whenever death occurs.
Permanent insurance.No frills permanent insurance is provided by Term-to-100. Its premiums are lower than other forms of permanent insurance because it is pure life insurance coverage until age 100, at which point it pays out. If you want life insurance for the duration of your life that is straightforward and nothing more than life insurance, choose a Term-to-100 policy. You’ll know you have this policy if the agent tells you the policy has no cash value.
Whole life permanent insurance is more expensive because it builds a cash value over time that the policyowner can access in the form of loans, and allows the policyowner to convert the policy to term insurance. On death, the policyowner does not receive the cash value plus the death benefit. He or she receives the death benefit – which will be reduced if some of the cash value has been used for one reason or another.
The final form of permanent life insurance is universal life insurance. It offers a somewhat complicated combination of investment with insurance, which requires constant management by the policyowner. It has options that allow the death benefit to increase as a result of investment performance. Many individuals are not prepared for the monitoring and decision-making required to make their universal life policy successful.
What are the risks?
The risk of term insurance is that the policyowner pays premiums for 20 years and dies the day after the policy expires. Another risk of term insurance is its increasing cost over time. In addition, eventually the policy will not be available. That age varies between insurers. So, insurance coverage will be lost and perhaps due to health issues at such a point in life, a permanent policy will not be available.
Permanent insurance is a lot more costly than term, and it is not unusual for a policyowner to start a policy, and either tire of the premium expense or find his or her circumstances change to make the premium unaffordable. An agent will say that provisions are available within whole life and universal life to pay premiums and give the policyowner a premium holiday, but the agent might not talk about what happens when the holiday ends. The fact is, if premium payments don’t resume, the policy ends and so does life insurance coverage. A lot of money may have been spent – for nothing.
Can a terminated policy be reinstated?
Yes, but there are conditions that must be satisfied and limitations on the policy for two years after it is reinstated.
Can I receive an income from my life insurance policy?
Regular withdrawals can be taken from the investment account within a universal life policy. However, advertising that mentions income and insurance in the same breath are actually based on a segregated mutual fund contract with a guaranteed income benefit rider on the policy. The segregated fund contract is an investment contract, not a life insurance policy. You must understand very thoroughly what these contracts with the rider will pay and when, and the penalties that apply.
How can I save money on my policy?
Shop around when you are buying. Make sure you meet with an insurance broker and not just an agent from a company that only offers only products from one insurance provider. Make sure you compare apples with apples. Start with a quote for a non-renewable 10-term life policy just to see who charges what. Then develop the conversation with the agent to find the policy that suits your needs best. Don’t be intimidated by the jargon. If you don’t fully understand what you are buying, keep looking.
Courtesy Fundata Canada Inc. © 2015.Susan Yates is president of the Centre for Life Insurance and Financial Education (CLIFE).This article is not intended as personalized advice.