Almost half of Canadian adults have no life insurance, while almost a third of Canadians believe that they need more life insurance coverage. Yet, for most people, life insurance is crucial for helping to keep your loved ones financially secure, should you die unexpectedly.
One in three Canadians with no life insurance believes it to be too expensive, while a fifth of Canadians believe insurers only pay out around half of life insurance claims (when the actual figure is around 99%). Clearly, there is a disconnect between the need for a crucial form of insurance and Canadians’ understanding of it. Let’s take a deep dive into how life insurance works, who should have it, how much it costs and how much coverage you need.
What is life insurance?
Fundamentally, life insurance is a contract; in exchange for regular premium payments, the insurer agrees to pay a specified sum of money — known as the death benefit — to one or more designated beneficiaries when the insured person passes away. Designated beneficiaries are the people you want the money to go to after your death; this would typically be your spouse or other family member, but could also be a friend, a charity or a trust.
The money from life insurance is designed to help pay for many things, such as funerals, a mortgage, children's post-secondary education and daily expenses. Life insurance helps ensure that your loved ones are not left with overwhelming financial burdens after you’re gone.
Life insurance is not an investment in the traditional sense, although certain types do build cash value over time, and some people use life insurance as part of their estate plan. Mostly, it’s a risk management tool, a way to transfer the financial risk of premature death from your family to an insurance company.
How does life insurance work?
Now that we've answered the question, "What is life insurance?" let's delve into how it works, both in general and specifically within Canada.
When you seek out a life insurance policy, your insurer will make you an offer, basing the premiums (the amount you have to pay to keep the insurance active) on several aspects of your personal life, such as your age, health, lifestyle, etc. (more on that subject later). You then make regular premium payments (usually monthly, quarterly or annually) to maintain the policy's validity.
If you pass away while the policy is active, the insurer will pay the tax-free death benefit to your beneficiaries. This process is typically completed within a few weeks, after the insurer has received the death certificate and the completed claim form.
The payout is not considered income, so your beneficiaries won’t pay income tax on the amount received. This is in part why life insurance is often used to transfer wealth and support dependents.
For example, if you had a $500,000 term life insurance policy and passed away during the coverage period, your beneficiaries would receive $500,000 to help maintain their standard of living, pay off debts or fund future goals.
Who should have life insurance?
You may be wondering: do I need life insurance? The short answer is: if anyone depends on your income or would face financial hardship due to your death, then yes, you probably need life insurance.
People who should have life insurance include:
- Parents with dependent children: life insurance can replace lost income, ensuring your children’s care and education are funded.
- Spouses or partners: your income needs to be replaced, and even if you’re not the primary earner, your contributions to household management, child care, etc. have huge financial value.
- Homeowners: if you have a mortgage, life insurance can help ensure your family doesn’t lose the home if you die prematurely.
- Business owners: life insurance can help protect the business, maintain it as a going concern and cover key expenses.
- Retirees with dependents or estate tax considerations: even in retirement, you may need coverage to support a spouse, cover final expenses or help heirs pay for estate taxes.
Find out more about whether you might need life insurance in this article, Five key milestones that call for life insurance.
Life insurance beneficiaries
One of the most important aspects of life insurance is being able to stipulate who will receive the money when you die. You can designate one or several beneficiaries and you can determine how much is paid to each one. You could name any of the following as a beneficiary:
- Spouse or common-law partner.
- Children or grandchildren.
- Friends or relatives.
- Business partners.
- Trusts.
- Charities.
When establishing your policy, you have the option to name primary and secondary beneficiaries. If the primary beneficiary were to pass away before you, the secondary beneficiary would receive the death benefit.
Life insurance proceeds are typically paid out more quickly and privately than assets from your estate, which typically need to go through probate. This means your beneficiaries can access the funds faster and with less legal involvement.
To claim the benefit, beneficiaries must submit a death certificate and a claim form to the insurance company. Once verified, the payment is issued, usually within 30 days.
It’s crucial to keep your beneficiary designations up to date. Significant life changes, such as marriage, divorce, the arrival of a child or the death of a beneficiary, should prompt you to review your policy’s beneficiaries.
For example, if you named someone as your beneficiary who then becomes your ex-spouse and forgot to update your policy after the divorce, they could still receive the payout, even if your intention was for your children to get it.
The cost of life insurance in Canada
Many Canadians who don’t have life insurance believe that it’s too expensive for them to afford. Yet over a third of Canadian adults believe the cost of life insurance to be three times more than it actually is. Not surprisingly, a common question is: how much does life insurance cost?
There are several key factors that influence the cost of life insurance in Canada, including:
- Age: typically, the older you are, the higher life insurance premiums become. For this reason, it’s often wise to sign up for life insurance at a young age, to benefit from lower premiums.
- Health and medical history: your current health, family medical history and any pre-existing conditions (such as diabetes and heart disease) will impact the cost. You may have to take a medical exam to qualify for some life insurance policies.
- Lifestyle habits: smokers and those who use tobacco products will pay significantly higher premiums. Other factors, like excessive alcohol consumption or dangerous hobbies (such as skydiving, rock climbing, scuba diving and hang gliding), can also increase costs.
- Coverage amount: the amount of coverage you select will influence your premium. A policy with a $1 million death benefit will have a higher premium than one with a $500,000 benefit.
- Policy type: term life insurance is generally less expensive than permanent life insurance (more on these insurance types follows).
- Gender: women typically have a longer life expectancy than men, which can result in lower premium rates for the same coverage.
- Job and travel: if you work in a dangerous field (like construction or mining) or travel often, you may pay more.
Determining the right amount of life insurance
The amount of life insurance you need would depend on your income, financial obligations, lifestyle and future aspirations. To calculate your actual need, consider:
- Final expenses: funeral and burial costs can range from $10,000 to $20,000 or more.
- Debts: include any outstanding mortgage, car loans, credit card debt and other liabilities.
- Income replacement: consider how many years of income your family would need. For instance, if your annual income is $80,000 and you want to replace 70% of it for 15 years (remember, life insurance payouts are tax-free), this would add up to $840,000.
- Children’s education: estimate future tuition costs for your children.
- Spousal retirement needs: if your spouse depends on your income, you may want to ensure they have sufficient resources for a comfortable retirement.
Add all these costs up, then subtract any savings or company life insurance coverage you may already have to reach the final figure.
The two types of life insurance: term and permanent
Life insurance in Canada is mainly divided into two categories: term life insurance and permanent life insurance. While they are similar, they do serve different needs, come with different costs and offer distinct benefits.
How does term life insurance work?
As its name suggests, term life insurance provides protection for a specific term (or length of time), typically 10, 20 or 30 years. If you were to pass away during the term, your beneficiaries would receive the death benefit. If you outlived the term, you’d need to renew the policy for a new term in order to maintain your life insurance coverage.
Term life insurance is typically more affordable than permanent life insurance, as it doesn’t accumulate cash value. However, it’s important to note that term policies are not permanent. Once the term expires, you may need to requalify for coverage, and the new premiums could increase due to factors such as age or health.
Term life insurance is often most suitable for people who:
- Need temporary coverage.
- Want the maximum death benefit with the lowest costs.
- Are on a tight budget but still want financial protection.
How does permanent life insurance work?
Permanent life insurance lasts your entire life, for as long as you keep making your premium payments. It may also include a cash value component, which acts like a savings element that grows over time in a tax-deferred way.
In Canada, there are two key types of permanent life insurance: whole life and universal life. Let’s take a look at the differences between the two of them.
Whole life insurance
Whole life insurance provides lifelong coverage with fixed premiums and guaranteed cash value growth. Premiums typically remain the same for life (or policy investments can eventually be used to pay the premiums), and the policy includes both a death benefit and a savings element that grows consistently. Some policies are guaranteed to be paid up after a certain timeframe, after which the coverage remains (for example, 20 pay life insurance, where you pay premiums for 20 years, but coverage lasts until you die).
Whole life insurance provides stability; the insurer guarantees the cash value and death benefit, which is why it’s considered low risk. The growth rate is modest (similar to a conservative investment fund), but the stability makes it appealing to the risk-averse.
Whole life insurance is often used as a tool for:
- Estate planning.
- Passing on a legacy.
- Funeral costs and final expenses.
Universal life insurance
Universal life insurance provides lifelong coverage with investment-like features. Part of your premiums is allocated to covering the cost of insurance, and the rest is invested in a tax-sheltered investment account.
It accumulates cash value, with the amount dependent on how well the investments perform (you can choose higher-risk investments if you prefer).
Due to its flexibility, universal life insurance is often strategically used in wealth planning. For example, you can:
- Overfund the policy by paying more than the minimum premium to accelerate the growth of cash value.
- Help with future premium payments by using the cash value.
- Take out loans on the policy or withdraw investments (subject to potential tax consequences).
Understanding life insurance cash value
One of the key benefits of permanent life insurance is cash value. It functions as a tax-advantaged savings account within your policy. Here is how it works:
- The cash value grows tax-free (similar as with an RRSP) and remains a separate entity.
- Borrowing against the cash value is typically tax-free (while collateral loans are tax-free, policy loans may be subject to tax).
- If loans associated with the policy are not repaid, they reduce the final death benefit amount.
Given that it accumulates cash value over time, permanent insurance is ideal for long-term financial planning, but not ideal for those seeking short-term protection.
Workplace life insurance
Workplace or group life insurance is typically offered at little or no cost to employees and is a valuable perk. The death benefit is often a multiple of your annual salary, and some employers offer additional coverage that you can purchase at discounted group rates. However, workplace life insurance has important limitations:
- The policy remains active only while you’re employed; coverage typically ends when you leave your job.
- It’s rarely enough to cover all of your life insurance needs, so relying on it could leave your family struggling, especially if you have a mortgage, debts or young children.
- It usually has no savings component.
- Some plans may allow you to “port” the coverage after you leave, but premiums may increase.
Read more about how workplace life insurance may not be enough.
Life insurance and estate planning
Few people realize that you can use life insurance in Canada as a powerful estate planning tool. As your wealth grows, so do the complexities of passing it on to the next generation. Life insurance can help simplify this process, make your estate distribution fairer and protect your heirs from financial stress.
Covering taxes and final expenses
After you die, the executor of your will has to arrange for your final tax filing on behalf of your estate. This could be a considerable amount, especially if you had significant earnings or you have assets such as an RRSP.
Your life insurance death benefit can help cover these taxes, preventing your family from having to sell assets to pay them. For example, if you own a vacation property or a business, your heirs might want to keep it in the family, but without life insurance proceeds they might be forced to sell it to pay the capital gains tax (which can be substantial for second homes).
Avoiding probate
Probate is the legal process of validating a will and distributing assets. It can be time-consuming and expensive, and the details are made available to the public. In some provinces, probate fees can be substantial.
Because the death benefit is paid directly to your named beneficiaries, your life insurance payout doesn’t become part of your estate and isn’t subject to probate.
Making inheritances equal
Life insurance can help ensure your estate distribution is fair for all of your beneficiaries. For example, if you want to leave your family business to one child and your investment portfolio to another, the values might not be equal.
Using life insurance can help balance the estate, making sure that each child receives an equal value, even if the value of assets differs. Find out more about how to use permanent life insurance to protect your estate’s wealth.
Supporting charitable giving
By designating a charity as a beneficiary, you can ensure that your legacy lives on through the causes you care about, in a tax-efficient way. When you die, your chosen charity will receive the tax-free lump sum, and your estate will receive a considerable tax receipt, which can help lower your estate’s final tax bill.
Find out more about using life insurance as part of estate planning. And, if you’re a business owner, find out how life insurance can help with business succession.
Finding the right insurance strategy for you
Your IG Advisor can look at your life insurance needs through the lens of your overall financial plan. They’ll help work out how much life insurance coverage you should take out, with premiums that fit both your income and your financial goals. They’ll also review your insurance needs on a regular basis, to make sure you’ve always got sufficient coverage in place.
If you’re concerned that you might not have enough life insurance coverage, talk to your IG Advisor today to arrange an insurance strategy meeting. If you don’t have an IG Advisor, you can find one here.
Written and published by IG Wealth Management as a general source of information only. Not intended as a solicitation to buy or sell specific investments, or to provide tax, legal or investment advice. Seek advice on your specific circumstances from an IG Advisor. Trademarks, including IG Wealth Management and IG Private Wealth Management, are owned by IGM Financial Inc. and licensed to subsidiary corporations.
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