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 pay out, you have to die during the term of your policy. Sounds a bit bleak, right? Reasonable life insurance rates.
Unlike term insurance, 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.
Why most people don’t need permanent life insurance
Deciding between term and permanent life insurance may seem like a no-brainer. If term insurance covers you for only a fixed period of time whereas permanent insurance covers you for life, it seems obvious that you should choose permanent insurance.
But here’s the thing: most people don’t need life insurance protection once they’re retired.
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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 if 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.
Why you shouldn’t pay for more coverage than you need
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.
Is the cash value component of permanent life insurance an advantage?
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.
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So here’s the bottom line: pay for insurance when you need it (most likely in your 30s, 40s, and 50s) and drop it when you don’t.
At PolicyMe, we use a proprietary approach to life insurance advice that assesses your life insurance needs today and every year in the future. We then analyze your coverage patterns to find you the most cost-effective way to give your family the protection they need.