Do you need life insurance?

The idea behind life insurance is to have covered liabilities in the event of your death. The old adage about death and taxes is the reason many people consider life insurance. When death and taxes come together, life insurance is a potential cure for the combined effects.

What is the premise behind life insurance? What the insurance company hopes to do is take the money you give them as a premium, invest it over a long period of time, and then return a portion of it to you at your death, while keeping a portion as a return. The easier it is for them to do this, the cheaper your premium will be. This is made possible by the idea of ​​compound interest. To understand how an insurance policy would pay you, you would need a calculator that would calculate the interest on an annuity. These formulas are similar to the ones you saw in elementary school math class. In terms of the concept, the two main drivers of why your money grows over time are the interest rate and the time factor. The higher the interest rate, the faster your money will grow. The longer you can work, the faster your money will grow. One thing to keep in mind is that the rate at which your money grows will speed up the more time you put into it. The accumulation of money will occur faster in the later years of the time period in question. That’s why you see those ads that say: if you contribute $100 a year to an RRSP for 30 years, versus $200 a year for 20 years, you’ll get more money at the end of the term in the first case with less money contributed. The reason is that if you start earlier, you’ll get more time for the composition to do its job.

This concept of compound interest appears in all forms of debt, interest-bearing investments, bank accounts, and annuities such as life insurance. The word annuity just means a bunch of payments going into an account over time, followed by a bunch of payments going out of the same account at a later time, usually at a set frequency like monthly or quarterly. Typically, you pay money over a period of time at a set frequency and then receive money as a lump sum or over another period of time at a set frequency. These terms are detailed in the contract, that is, the life insurance policy.

When should you consider life insurance?

Do you need life insurance? The famous answer to this question is “it depends”. The first questions to ask yourself are: why do I want life insurance? Who do I want the money to protect?

The first common scenario is: “If I die, I want my children to be okay because they are too young to take care of themselves.” This is fair enough: make sure that when your children are able to care for themselves, this strategy is reviewed. This would generally mean a “term policy”, which is insurance that lasts for a set number of years. If you have other reasons under the other scenarios below, you want to get a “universal life policy” that covers you until your death.

The second scenario is “When I die, my estate will be affected by a huge tax bill, and I don’t want my children to have to deal with that reality.” Again, this is a good reason to consider life insurance. The real problem is “how do I minimize the huge tax bill?” Life insurance is an attractive method of doing this, but there are others. You can divide your estate while you’re still alive to avoid the “presumptive disposition” that triggers the huge tax bill. Deemed disposition means that something is automatically considered sold due to an event (such as death), which means that capital gains taxes are due in the next tax year. This does not apply to primary residences, so if you own your home, the tax issue is resolved in most cases. If you have assets that would be taxed at a later date (tax deferred), such as investments that would produce a capital gain, perhaps they can be sold in a timely manner before your death to minimize the tax consequences? There is also the use of a corporation, where the corporation would pay the taxes instead, or where the beneficiaries may receive salaries, dividends, or shares in the company over a longer period of time rather than all at once at the time of death. If you only have an RRSP and you have a spouse, the income from the RRSP can be rolled over tax-free to the spouse, which would also defer the tax bill beyond your death.

The third scenario is: “I want the insurance to be an investment in addition to an insurance policy.” This is also a good reason to consider life insurance. You’ll also need to consider the return on investment versus the alternatives, the tax implications (these policies tend to be tax-exempt, but tax rules can change if too many people start taking advantage of them), and restrictions on access to your money.

Considerations for buying life insurance

What should you take into account when making the decision to purchase life insurance?

The first thing to consider is your age. The older you are, the more expensive your life insurance will be, because there is less time for compounding to accumulate money.

The second thing to consider is your health. Generally speaking, the more likely it is that you will die sooner, the more expensive your life insurance premium will be. Again, this is because there would be less time for compounding to work. If you know you want life insurance, get it when you’re younger and in optimal health.

This brings me to the third thing: can you simulate life insurance by getting an achievable return? If you can generate a return as well as the insurance company, and you have a long period of time to do so, and you don’t have issues with early death (such as a situation where you have no dependents or tax issues), you may want to Simulate a life insurance payout by putting a certain amount of dollars into a separate account each month, invest it, and at the end of a long period of time, you will accumulate a large sum of money. How do you know what profitability the insurance is giving you? Use one of the annuity calculators below and enter how many years you are paying the premium, the monthly or annual premium amount, and the final value of the insurance company’s proposed lump sum payment, if known. You should be able to get an interest rate. Compare this rate to what you normally earn on your investments and see if you can consistently beat it. Take into account taxes and expenses. There are tax issues with this simulation, as well as the risk of generating returns, so this method is for people who are knowledgeable about investing. This method also requires discipline in funding the account.

The fourth thing is the assets that are protected. If you only have a home and no dependents, you probably won’t have additional taxes at death. You probably don’t need life insurance. If you have no assets but need to protect your children, you may need life insurance if there are no other ways to protect them. If you have investments that will generate a large tax bill and there aren’t many other options, life insurance can be helpful.

Combined with this fourth thing is if you have a financial plan and if you have a complex tax situation. This would be if you have complicated investments, a corporation, multiple companies, foreign assets, etc. This scenario will require specific professional help from your financial planner, attorney, accountant, and perhaps a few other specialists for various needs.

The sooner you do your estate planning, the better. There are personal considerations such as “I don’t think my children can manage the money” or “If I divide my estate before I die, there may be family disputes.” These are very important considerations. Most of the time, decisions are driven by your feelings rather than your reason. If a consideration like this prevents you from making an estate plan, it should be examined before doing something financial, such as buying life insurance. If you deny an issue like this, be aware of the limitations it creates for your plan and the possible additional costs to your estate as well. The more harmonious you are with your money on all levels, the easier it will be to make these decisions, such as life insurance or estate planning.

The point is that not everyone needs life insurance; It depends on what happens to your finances when you die.