If you have a term life insurance policy, there are a couple of key words you should be looking for in the fine print.
When purchasing life insurance, there are a couple of initial factors to consider: determining the correct benefit amount and determining the correct coverage type.
To determine the correct benefit amount, I take my clients through a comprehensive needs analysis. We first identify all their needs for cash upon death (i.e.; funeral expenses, outstanding mortgage balance, emergency fund, etc.) and compare that with the various sources of cash they already have on hand (i.e.; savings accounts, RRSP investments, other insurance in place, etc.). If completing this analysis with a couple or any one with dependents, we next take into consideration the income of all involved. What percentage of the combined family income would be needed by the survivors after the death of one income earner? People can easily identify the debts they would want paid off, but few consider how their loved ones would survive on a reduced income. I always say to my clients, “It is one thing to own your home. It’s another thing entirely to afford to keep the lights on and the fridge stocked.”
For most middle aged clients with kids, the result of this needs analysis can typically generate an insurance need in excess of $1 million.
Determining the correct coverage type can be less straightforward since your cash flow will inevitably factor into the equation. For example, a 35 year old, non-smoking female could purchase $1million of Term 20 life insurance for approximately $55/month. That same amount of coverage purchased in a permanent Universal Life policy will run about $565/month!
The best solution normally combines layers of various term insurance with a smaller permanent amount. For mortgage debt and the cost of raising small children, 20 year term policies are recommended. Whereas, 10 year term policies are better suited for shorter liabilities like student debt and car loans. End of life costs such as funerals and legacy considerations are reserved for the permanent stuff. For example, that same $1 million need could be addressed with $750,000 of Term 20, $150,000 of Term 10 and $100,000 of Permanent coverage. As a liability is paid off (and, hence, the death benefit no longer needed), the life insurance drops off and the premiums freed up for other priorities, like saving for retirement.
However, if all you can afford is Term Insurance, make sure your policy includes these two features:
The biggest risk of postponing the purchase of permanent life insurance is that when you are ready to purchase you will no longer be able to qualify medically. As we age our health typically declines and insurers are less likely to take on the risk of providing us with coverage. One of the reasons term insurance is so much cheaper than permanent is because statistically there are only a small percentage of those policies that will ever be paid out. On the other hand, 100% of permanent policies will have a death benefit paid.
If your term policy is convertible, you will be able to change it to a permanent policy in the future without having to provide any evidence of your health. You have the option to simply purchase whatever permanent product the company offers then and pay the rates associated with your age at that time. There will normally be a limit as to when you can convert (i.e.; up to age 75) and stipulations as to how much of the original amount can be converted (i.e.; full or partial conversions). Even with these few restrictions, having a term policy that is convertible is a must!
Typically, term policies will have renewal rates built right into the contract. Most contain a table that shows how much your premiums will increase by if you choose to keep the same amount and term of coverage when the existing term is up. Again, since the companies do not require any updated info on your health when you renew, the rates are much higher. Most tables show rates jump by 7 to 10 times the original cost. Though not ideal, if you have been told you have a terminal illness, it’s comforting to know you have the option to keep your policy in force and guarantee some financial comfort to those you leave behind.
A good financial plan gives you choices. A good life insurance policy should do the exact same thing.