If you’ve put off looking into a life insurance policy, you’re not alone.
Whether it’s the fear of realizing and acknowledging our own mortality or the fact that it’s nearly impossible to sift through a sea of life insurance rates and quotes, there’s no shortage of barriers that stop us from buying insurance.
Plus, tomorrow always seems like a better time than today.
Term life insurance is designed to support your dependents if you die prematurely. In other words, if you die within the term specified on your policy (usually 10, 20, or 30 years), your insurance company will pay your beneficiaries a certain amount of money, which is known as your death benefit. (“Benefit” is an unfortunate choice of words—we know.)
On the other hand, if you don’t die before the term expires, your beneficiaries won’t receive any money. You also won’t get any of your premiums, the money you paid toward your policy, back. So yes, if you want your insurance company to payout, you have to die during the term of your policy. Sounds a bit bleak, right?
Unlike term insurance, whole life or permanent life insurance is, well, exactly what it sounds like: it’s permanent. (Just like the marker your son used to draw all over your freshly painted kitchen wall.) This means your beneficiaries will receive your death benefit no matter when you die.
Whole life insurance premiums are usually much higher than the premiums on term life insurance policies. Whole life insurance premiums are locked in for life. That’s because your premiums are designed to build cash value over your life. But don’t be fooled: this is NOT a cost-free financial investment, and it turns out to be much more expensive and inflexible than other ways of investing your money.
Deciding between term and whole life insurance may seem like a no-brainer. If term insurance covers you for only a fixed period whereas permanent insurance covers you for life, it seems obvious that you should choose permanent insurance.
Why? The purpose of insurance is to protect dependents who rely on you financially - your kids, spouse, and any other dependent friend or family member. These people are counting on your future income (at least part of it) to cover their future expenses. If you die, they’d have to find another source of money. They would need to make up for the fact that you would no longer be earning an income that would be used, in part, to support them. But once you retire, you no longer have a future income. And because there’s no loss of future income to protect dependents from at this point, you don’t need life insurance.
It’s also important to remember that your family’s financial needs change over time. As you get older, your family’s future expenses go down. For example, your mortgage gets paid off (finally!) and your kids become independent. (Yes, that kid who just drew all over your wall will have a real job one day). As these needs decline, your life insurance needs begin to decrease too. This usually happens around retirement. But if you’re ahead of the game in saving for retirement, it may happen even earlier. You know what they say: the early bird catches the worm.
Having life insurance protection for longer than you actually need it for may not seem like such a bad thing. But why pay for something you don’t need? Would you pay for an all-you-can-eat buffet if you’re going to eat only one bowl of soup? Of course not! You’d just order the bowl of soup off the menu. Buying term life insurance is like buying the bowl of soup off the menu (just not as delicious). It lets you pay for coverage only during the years when you think you’ll need it.
Still not convinced that term life insurance is the way to go? Keep in mind that insurance costs tend to skyrocket as you get older. This makes it even more important to stop coverage when you no longer need it.
What about the cash value component of permanent life insurance? Isn’t this an advantage of this type of policy? The cash value component is an investment component of a permanent life insurance policy. It allows you to set aside money and invest it tax-free. The investment accrues separately from the money needed to cover the cost of your life insurance. Making money off your insurance premiums? This sounds like a pretty sweet deal.
But what’s actually happening here? A permanent life insurance policy has much higher premiums than a term life insurance policy does. You end up overpaying during the early years of your policy to account for the fact that you’re much more likely to die during the later years of your policy. Insurance companies recognize this overpayment and allow this amount to earn tax-free interest in an investment account until they need it to cover your policy later. But this “investment feature” is rarely as affordable, effective, or efficient as other tools available to do the same thing (like your RRSP or TFSA). If you’re looking for a get-rich-quick scheme, this isn’t the place to find it.
Whole life insurance can be up to 10x more expensive than a comparable term life policy. The chart below compares the monthly cost of a 20-year term policy and a whole life policy for men and women at different ages.
Here are 3 reasons why you should choose term life insurance over whole life insurance