How Does Life Insurance Work in Canada? (Updated for 2022)

Tobin Tuff, Certified Life Insurance Advisor

Life insurance is a financial tool used to ensure your family's stability if you pass away. When you get a life insurance policy, it works as a contract between you and the life insurance company.

In this article, we break down how life insurance works in Canada, from the monthly costs, naming your beneficiaries, making a claim, etc.

How does life insurance work?

Life insurance works by giving the people who rely on your income a one-time, tax-free payout after your passing. Usually this payment is directed to your immediate family members to help provide them with financial stability.

You buy coverage based on the amount you'd like for a payout and you make monthly payments (called premiums) to keep your policy active.

Affordable protection is a click away with PolicyMe. Start with getting an instant quote below (it might be more affordable than you think!).

Applying for life insurance is one thing, but how does it work for your loved ones that would benefit from your policy?

How does life insurance work for your beneficiaries?

When you buy your plan, you select the individuals who will receive the payout if you pass away. Like your partner or your kids.

Some people balk at the cost of life insurance; after all, your family will only get a payout if you die within your policy term. But insurance is meant for peace of mind, providing you with a plan to protect your family should the worst-case scenario happen. Jump to section: “How does my beneficiary make a claim for a death benefit?” below!

Having this kind of security comes at a cost. But the good news is, it can be an affordable one.

Thinking about getting life insurance? It's easier than you might think – here’s a breakdown of the process of getting life insurance. Your life insurance decision is either an approval or denial.

how does life insurance work

Let’s be real: no one enjoys applying for life insurance. That’s why we’ve simplified the process. Still have questions? Learn more about getting a life insurance quote.

TL;DR: Three things to know about how life insurance works

The basics of life insurance are actually quite simple.

1. You buy life insurance to protect your family in case you pass away.

Select a life insurance policy based on your family's financial needs. Consider how long you'll need the coverage and how much coverage you need before deciding.

2. Your family will receive a tax-free death benefit.

In the event that you pass away during the term, your named beneficiaries can make a claim on your life insurance policy. They'll receive funds equal to the coverage you've purchased on your policy within a few weeks.

Recommended reading: Is Life Insurance Taxable?

3. Your family can use the death benefit for their needs.

They can use this money to cover their daily expenses, pay off any remaining debts (like the mortgage or a car loan), cover your medical or funeral costs, or even save it for their future financial goals. Jump to section: “What can a life insurance claim be used for?" below!

Find out how much your life insurance policy would cost by getting a no-commitment, no-strings-attached quote below.

Glossary: life insurance terms to know

If you're a life insurance novice, here's a list of frequently used terms on the topic to help you make sense of the explainers you find online – like this one.

  • Policyholder: The owner of the life insurance policy (that would be you!).
  • Beneficiary: The person or people who will receive the death benefit if/when you pass away.
  • Premium: The monthly payment you make towards your life insurance policy to keep it active.
  • Death benefit: The payout the beneficiary will receive if/when you pass away. How much the death benefit is depends on the coverage you’ve chosen for your plan.
  • Underwriting: The process your insurance company goes through to determine how risky it is to insure you. They do this to calculate the price you'll pay for your coverage. More risk = higher premiums.
  • Coverage: The amount of money the plan will pay the beneficiary if you pass. One way to figure out how much coverage you need is by adding up your debts, mortgage and an estimate of your beneficiaries' daily expenses. You may want additional coverage for other costs, such as your burial expenses or post-secondary savings for your beneficiary.
  • Policy term: How long your insurance policy will cover you. This can vary from 10 to 30 years for term life insurance plans. Permanent insurance plans provide lifelong protection.
  • Riders: Optional coverage options you can add to your life insurance policy, allowing you to customize the plan to your needs.
  • Whole life insurance: A type of life insurance that covers you for your entire life (assuming you’ve kept up with your premium payments). Can also be referred to as permanent life insurance.
  • Term life insurance: A type of life insurance that covers you for a set period of time, usually 10, 20 or 30 years.

What kind of life insurance do I need?

There are two main categories of life insurance: term life or permanent life. Here's what they are and why you might choose one over the other.

When should I choose a term life insurance policy?

  • Term life insurance protects your family financially in the event you pass away. Money from a term life policy can help your family manage mortgage payments or outstanding debts when they can no longer rely on your income.
  • For most Canadians, especially if you're a young and healthy adult, term life insurance is the most affordable option.
  • With lower premiums (compared to whole life policies), you can budget less for life insurance coverage and put the extra money towards your other needs.

When should I choose a permanent life insurance policy?

  • You'll need to make your monthly payments for as long as you're alive or risk losing your coverage with whole life insurance. Before committing to a policy, make sure you'll be able to afford the premiums as you age into different stages of your life.
  • Because whole life policies never expire, your beneficiaries are guaranteed a payout after your passing, which can help secure their financial futures.
  • Whole life insurance can be used to set up a trust for someone in your family who will need financial support for their lifetimes, such as a disabled child or older family member. Consult with a lawyer before going this route - there may be better ways to protect them financially.
how does life insurance work

When should I choose a universal life insurance policy?

  • Universal policies are a type of permanent life insurance plan. A percentage of your premiums goes towards a savings and investment component.
  • The monthly premium can fluctuate, either at your request or based on how well the investment portion is doing. Poor performance = additional funds needed to cover the life insurance portion of the plan.
  • In order to take full advantage of the plan's flexibility, you'll need to be highly knowledgeable and interested in self-directing your insurance plan to balance your coverage while maximizing your investment growth. Many people may prefer a more hands-off approach.
  • A universal life policy could be an option if you're a high-earning Canadian who's already maxed out their TFSA and RESPs - otherwise, you'd be better off purchasing a cheaper insurance plan and investing the difference.

Do I really need life insurance?

If you're not sure whether you need life insurance, you're not alone!

Here are some real-life scenarios to help you determine whether it's a good idea for you to purchase coverage to protect your family.

Example 1: Calvin

  • In his mid-30's
  • Married to Marie, who works part-time at a library
  • Just welcomed his first daughter with Marie (congrats!)
  • He works full time at an office
how does life insurance work

Should Calvin get life insurance?

Yes.  With a new baby and a wife who works part-time, his family relies on his income to cover their daily expenses.

Example 2: Ana

  • In her early 40's
  • In a relationship with Jon, a teacher
  • Is a stay-at-home mom caring for their 4 kids, ages 2-9

Should Ana get life insurance?

Maybe. Ana provides child care for the couple's young children. If Ana were to pass away, Jon would need to pay for daycare and before and after school care for the kids – potentially a major expense. But if Jon can cover these costs comfortably or have family members that can step in to help, life insurance may not be necessary for Ana.

Example 3: Ming

  • In her late 20's
  • Owns a townhome with her boyfriend Tanvir
  • Both climbing the ladder in their respective careers in finance

Should Ming get life insurance?

Yes. Both Ming and Tanvir's salaries are required to pay the mortgage and other housing costs. Life insurance would help Tanvir pay the bills if Ming were to pass away.

Example 4: Mateo

  • In his late 50s
  • Is a widower with grown children
  • His home is paid off, with no other outstanding debts
  • Is set to retire within the next 5 years

Should Mateo get life insurance?

Probably not. His kids have moved out, so he no longer has financial dependents, and he doesn't have any significant debts.

Example 5: Dean

  • In his late 30's
  • In a relationship with Ben, an accountant, and they have no children
  • Owns a successful salon downtown

Should Dean get life insurance?

Yes. Dean has taken out a few business loans to start up his salon. Life insurance can help Ben cover these debts if he passes away.

Recommended reading: Life Insurance for Couples: Best Options for Canadians.

Maybe life insurance is worth it for you, maybe it’s not. But if you fall into one of the categories below, it’s worth taking a look at your finances and obligations to consider whether it’d be best to purchase coverage.

how does life insurance work

Where does the money come from for a life insurance payout?

The money for life insurance payouts come from clients’ monthly premium payments. A life insurance company will pool these funds and invest them to have enough money for claim payouts.

Funds can also be drawn from any expired, cancelled or unclaimed plans the company holds. Since most people outlive their life insurance plans, there's generally a healthy pool of money to pay any beneficiaries that end up making a claim.

How do life insurance companies make a profit?

Life insurance companies make a profit from premium payments and surrendered plans from former clients. This money is then invested, allowing the company to grow profits over a period of time.

The money from these inactive policies pay for administration and overhead costs of operation. This is standard for all insurance providers, including PolicyMe.

How does life insurance work if I don't pass away?

If you’ve wondered how life insurance works if you don’t pass away, it depends on the type of policy you’ve chosen. You're likely to outlive your coverage with term insurance. If you do so, the life insurance provider will keep the money you've paid into your plan.

But if you have a permanent policy, these don’t expire, so your family will receive a payout when you eventually pass away.

This may make it seem like a permanent policy is the way to go. After all, you won't "lose" any of the money you've paid. But their premiums can be very high (10-15x more than term) and you have to commit to paying them for your lifetime.

So for most Canadians, it makes more sense to opt for the affordability of a term plan. It’s like paying for a roadside assistance plan. Most months you won’t need it at all. But you’ll be glad to have it if your car breaks down.  

How does life insurance work with an employer?

Life insurance works through your employer a little differently. Your work may offer a type of policy through your benefits called “group life insurance”. A group life policy usually provides coverage as a multiple of your annual income.

This means that if you pass away, your beneficiaries will receive an amount equal to 1 to 3 times your yearly pay, depending on the policy terms.

While it's a nice perk to have, this type of insurance is usually not enough to cover your remaining debts, obligations and your family's day-to-day expenses.

For full coverage, you'll likely need to purchase your own life insurance policy, outside of work.

What can a life insurance claim be used for?

Money from a life insurance claim can be used on anything! Your beneficiary can direct the funds from a life insurance claim on whatever they might need the money for.

Some common uses include:

  • Housing costs, like mortgage or rent payments
  • Paying off any outstanding debts, such as car loans or credit card balances
  • Covering their day to day expenses (i.e. gas, groceries, and bills)
  • Covering the policyholder's funeral expenses
  • Childcare or extracurricular activities
  • Funding a child's RESP
  • Income replacement, so the surviving partner can take leave from work

An unexpected passing can be deeply shocking for the remaining family members. A life insurance payout helps ensure they'll have time to grieve and adjust without worrying about money.

How does my beneficiary make a claim for a death benefit?

The steps your beneficiary must take to make a claim for a death benefit is fairly straightforward. During this challenging time, the reps at your life insurance company will be available to help guide them through the process.

For starters, when you purchase a life insurance policy, you'll need to decide who will receive your death benefit if you pass.

If you choose more than one person, your life insurance company will divide the money between them, according to the percentages you’ve requested.

This is how they would make a claim.

1. Submit proof that the policyholder has died.

  • Reach out to the appropriate life insurance company to start a claim.
  • Usually, a death certificate will be enough, but your insurance company will let them know if additional documents are needed.

2. Submit a copy of the policy contract.

  • If your beneficiaries have a copy of the original policy contract, it'll speed up the claim processing.
  • If not, they can either ask the insurer whether a copy is necessary, and, if so, how they can go about getting one.

3. Complete the necessary paperwork.

  • Once the death has been confirmed, the insurance company will send the appropriate claim forms for your beneficiaries to fill out.
  • They'll need to provide the policy number, their relationship to you, the reason for your passing, contact info, etc.

4. Specifying payment details.

  • After reviewing the completed paperwork, the insurance company may provide options on how the death benefit can be paid out (i.e. cheque vs. direct deposit, number of payments, etc.).

5. Wait for the claim to be processed.

  • The insurance company checks out all the details provided in the documentation and completed forms. Once approved, the payment will be issued to the beneficiaries.
  •  For most claims, this usually takes about 30-60 days.

Is life insurance a scam?

Life insurance is not a scam, it's a financial product designed to protect your family in the case of your passing. But when choosing a life insurance provider, make sure it's backed by a reputable company for reliable service and smooth payouts.

For example, PolicyMe is backed by Canadian Premier, a major player in the life insurance industry. Read more: Canadian Premier Life Insurance Review.

An aside: make sure your premiums are not prohibitively high. While it’s not a scam, many life insurance advisors are commissioned. This means it’s in their own best interest to sell you an expensive product that you don’t necessarily need, like permanent or universal life insurance.

Non-commissioned advisors, like the team at PolicyMe, are upfront in terms of finding a plan that works best for you. Generally, term policies offer adequate coverage for your needs at an affordable cost.

Recommended reading: Best Life Insurance Companies in Canada 2022 (Rated + Reviewed).

In summary: Life insurance exists to protect your family

  •  An affordable policy will secure your family’s financial future if you die.
  • Your beneficiaries can use the money however they’d like - pay off the mortgage, cover their daily expenses, everyday bills, or fund your children’s educations, for example.
  • The lump sum payment is tax-free, and can be released to your beneficiaries within a few weeks of your passing.

Find out (in minutes!) how much it’ll cost to protect your family with a term policy.

FAQs: All about how life insurance works

How much money do you get from life insurance?

How much money you get from life insurance depends on the amount of coverage you’ve chosen. Your beneficiary can receive a payout under $100,000 all the way up to $5 million or even more. It’s up to the policy owner to choose the amount of coverage they need (that’s you!).

That being said, according to a recent report published by the Canadian Life and Health Insurance Association (CLHIA), the average Canadian has life insurance coverage of about $440,000.

Who gets the life insurance payout if the beneficiary is also deceased?

If the beneficiary is deceased, then the recipient of the life insurance payout depends on the time of their passing. If your beneficiary dies before you, the payout will go to your estate. But if the beneficiary passes away shortly after you do (before they’ve had a chance to receive the payout), the money will go to their estate.

If you would prefer to control exactly who receives your payout, you can get around this issue by adding a contingent beneficiary or two—individuals that are designated to receive the funds if your primary beneficiary has passed.

How does life insurance work as an investment?

Some life insurance policies can work as an investment. Some permanent or universal life plans have an investment component. Essentially, a portion of your premiums are directed towards an investment portion of the policy.

Depending on the rules of your plan, you can access these funds during the life of your policy.

It may seem like a good deal, but premiums for permanent and universal plans tend to be so high that you’re likely better off purchasing a cheaper term life policy and investing the difference. You’ll have more agency in how you invest this money and you won’t be subject to any policy rules in terms of how much and when you can withdraw your funds.

Is life insurance a waste of money?

No, life insurance is not a waste of money for those who need coverage.  If you have unpaid debts, financial obligations, and dependents that rely on you to support them, then life insurance is a necessity to ensure that they are protected if you unexpectedly pass away.

It also gives you peace of mind, knowing that they will have the funds needed for their day-to-day expenses and their future. But if you don’t need life insurance, then you should direct your funds elsewhere, towards things that you do need.

Helene Fleischer

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