Guide to Buying Term Life Insurance
Everyone comes to a point where they need to start thinking about their end-of-life plans. A beneficiary must be designated. Assets should be distributed and accounted for. For the bereaved, some kind of financial plan may also need to be put in place to cover the cost of the funeral and even to financially support the family. Some Canadians try to save for retirement, but another option is to invest in insurance coverage.
Life changes, and so do your insurance needs. Is your policy keeping up?
But is a term life policy worth the investment? For many, insurance can be an excellent way of covering expenses when they die. However, it can be a opaque and difficult to understand.
We’ve put together an in-depth guide about everything Canadians need to know about term life insurance. From basic information to recommendations, to the pros and cons—we break it down so you can make a more informed decision about whether or not this investment is a good choice for you and your family.
The Basics of Term Life Insurance
Term life insurance may seem like a complex thing. However, at its core, it’s actually quite simple.
What is Term Life Insurance?
Term life insurance can be described as a life insurance policy that provides coverage through a fixed rate for a specific amount of time. This period is known as the “relevant term.” Once the relevant term expires, coverage is no longer guaranteed. The policyholder will need to either obtain additional coverage after this point, or pay for an extension of payments. In the event that the policyholder dies during the relevant term, the death benefit from the insurance policy will be given to the designated beneficiary.
Benefits of Term Life Insurance
There are quite a few benefits.
- You’ll enjoy lower premiums. Compared with other insurance types, term life insurance covers a fixed time period, rather than an individual’s entire life, so premium payments are often relatively low. Insurance companies will assume less risk if you’re insured for a set period, especially if you are young and healthy when you buy your term life policy. The premium payments vary, but an individual in their thirties and in good health will usually pay under $40 per month in premium fees.
- Term life insurance is extremely flexible. You can choose how long you want to be covered for, but typically between five and thirty years. Most insurance companies will even offer policies in one-to-five-year increments, so you can get really specific with your policy. This is a great feature because you’ll benefit from the predictability that comes with estimating how much you will pay in premium payments over the entire term of the policy. Whole or permanent life insurance policies are much less flexible and difficult to predict.
- You can usually convert to permanent insurance. A term life insurance policy covers a fixed, specific term. When that term is up, you often have the choice of letting your life insurance expire or to extend it. Most insurance companies make converting a term policy into a permanent policy quite easy. It’ll likely increase your premiums, but converting could be a good investment if you want to be covered for life or have experienced a recent illness or gained a sudden lifelong dependant. Converting your policy to a permanent one after your term is complete will allow you to accumulate cash value within the new policy, too.
- It’s a good idea for those who want to protect their families in the event of sudden, unexpected death. Life is unpredictable. If you’re currently raising a family, what would happen to them financially if you suddenly became ill or suffered an accident? It’s is an affordable way of ensuring that they are taken care of.
- You get the biggest bang for your buck with term life. While all types of life insurance policy will have a mortality charge that will pay for the death benefit (a payout to the beneficiary), term life insurance policyholders will get the maximum death benefit with the least amount of money invested. Permanent life insurance policies often include charges for additional features and needs, which may not be desirable for individuals who want to save money.
Drawbacks of Term Life Insurance
No life insurance policy is perfect—and term life insurance is no exception.
- All of your premiums go toward the death benefit and there is no capital build-up. This can be both a pro and a con, depending on what you’re looking for in a life insurance policy. Term life insurance policies have absolutely no cash value while the policyholder is alive. That means you can’t cash out your life insurance prematurely—it’s only designed to help your family in the event of your death. Some people want an investment component from their life insurance policy. If this sounds like you, a term life insurance policy may not be ideal. However, term life insurance can also be seen as an investment when it comes to paying very low premiums for generous coverage for your family in the form of a death benefit.
- Non-level term life insurance policies often have rising premiums. As the policyholder ages and the risk of imminent death increases, premiums also increase. For those who are young, this isn’t a big deal. But, if you opt for a relatively long timeframe for your policy, you’ll have to deal with escalating fees that can get a bit out of control once you’re in your fifties or sixties. However, this can be avoided by opting for level term life insurance plans.
- Sometimes coverage can be limited. It can be difficult for policyholders to really determine how long they need life insurance coverage for. A typical young family may want an eighteen to twenty-one-year policy timeframe to protect their children, which makes sense. But what about individuals who are currently getting out of debt? It can be impossible to tell how long this will take, and it could be a serious mistake to opt for a policy timeframe that is too short. However, if you can accurately predict where you will be in 20 or even 30 years, then this won’t be much of an issue.
- Taxes can be problematic. Death benefits in Canada, in most cases, are not subject to income tax. Regardless of how big your policy is, your beneficiaries won’t need to report the death benefits they’ve received as taxable income on their tax return. However, every dollar you spend on your term life insurance policy is taxed beforehand. This can certainly add up over time, which can be a pain for some policyholders. Permanent life insurance has a bit of an edge in this regard, as they grow tax-free.
Who Should Get Term Life Insurance?
Because term life insurance covers a fixed period, it’s the ideal policy for individuals who are raising children or paying off debts. It’s also a great life insurance solution for families who don’t want to pay a massive amount in premium payments just to be covered.
When it comes down to it, you only really need life insurance if you have dependents and want to avoid putting a financial burden on your family in the event of your death. Term life insurance is ideal for most people. If nobody depends on you financially, long-term—such as a disabled child or spouse—then term life insurance is a good idea.
If you’re interested in life insurance policies that have varying fixed timeframes, term life insurance could also be good for you. These policies can last anywhere from five to thirty years, and come in as little as one to five-year increments.
How Much Life Insurance Do You Need?
This depends significantly on your individual expenses, assets, goals, and many other factors. In general, insurance companies will tell you that a reasonable amount for a life insurance policy is around 5–10x your yearly salary. However, this isn’t always necessary and sometimes families will need even more coverage.
Luckily, there are many insurance coverage calculators out there to help you get a general idea of what you may need, including:
- Edward Jones Life Insurance Needs Calculator
- Policy Genius Life Insurance Calculator
- Bankrate Life Insurance Calculator
How Much Does Term Life Insurance Cost?
Typically, term life is the least expensive method of purchasing death benefits via a coverage amount per dollar basis over a fixed period. However, the cost of insurance varies significantly.
Costs depend on everything from your age to your current health to your annual salary to your ideal policy timeframe. It’s usually recommended that individuals purchase insurance when they are young and in good health, in order to get the best possible life insurance premiums. Different insurance companies will underwrite each of their applications in different ways, so it would be a good idea to shop around to find the best insurer for your unique needs.
For example: A healthy 35-year-old woman purchases a term life insurance policy for twenty years and gets half-a-million dollars in death benefits. She will probably pay around $25 to $30 per month in premiums.
The Takeaway: Is Term Life Insurance Worth It?
We believe that, for most families, term life insurance is the way to go. Here are some key reasons why an individual should seek term life insurance rather than whole life insurance, or no insurance at all:
- You are paying off debts or a mortgage.
- You are raising children.
- You want a guaranteed death benefit and have little interest in cash value.
- You don’t plan to cash out your life insurance policy during your lifetime.
- You want a policy that has no risk of coverage loss.
However, it’s worth noting scenarios in which term life insurance is not ideal. If you have a lifelong dependant who will require ongoing care after your death, a whole life insurance policy may be a better choice. If you have heirs who will have to pay inheritance and estate taxes, a whole life policy would probably be a better choice.
Frequently Asked Questions
The following questions pop up often when we talk about term life insurance.
Can you cash out a term life insurance policy?
The short answer is no. A term life insurance policy will pay a death benefit to the policyholder’s beneficiary in the event of their death during the policy term. While the policyholder is still alive, the policy doesn’t actually have any cash value.
Permanent life insurance (like whole life or entire life insurance, variable life insurance, and other types of life insurance) is the only type of life insurance that actually has a cash value account. This account grows over time, and the policy will cover the policyholder for life.
While this may seem like a downside to term life insurance, it’s actually one of the biggest reasons why it is so popular among Canadians. Because term life insurance only covers a specific period, it’s substantially less expensive than permanent life insurance and provides a very affordable method for ensuring that a policyholder’s family is taken care of when they die.
Term life insurance shouldn’t be seen as an investment in which you can pull out cash whenever you’d like. Rather, it should be seen as a secure investment that is completely dedicated to assisting your family with finances after your death.
What type of life insurance is better, term or whole?
This totally depends on your unique needs and financial reach. Term life insurance is substantially less expensive than whole life insurance. But, the coverage term is much shorter for term life insurance than whole life insurance.
Ultimately, term life insurance is better in general than whole life insurance. Individuals should choose term life insurance if they want to replace their income over a specific period. It’s a better choice if you want more affordable coverage. Also, most term life insurance policies can easily be converted into more permanent coverage, though the deadline for such conversions will vary between policies and companies. If you think you are capable of investing your money better, a less expensive insurance policy will free up your finances so you can invest what you would have otherwise spent on a whole life policy.
There are some cases where a permanent life insurance policy is preferable, however. If you have heirs who need to pay inheritance and estate taxes, this type of policy could be better. Individuals with lifelong dependents (such as a spouse or child with a disability) can use whole life insurance to fund trusts that will continue to provide ongoing care. Outside of these scenarios, though, term life insurance is usually a better choice for the average family.
What happens if I outlive my term life insurance?
This is a common question that many people have when learning about term life insurance.
A term life insurance policy is purchased for a set period, usually between five and thirty years. The policyholder pays premiums during that set term. If the policyholder dies during that term, their family will receive the entire death benefit payout outlined in the terms of the policy.
However, once the relevant policy term of one’s term life insurance policy has reached its end, the policyholder is no longer covered. This isn’t always a bad thing. Many people will get term life insurance while they are raising children or paying off debts and a mortgage. If someone in those scenarios finishes raising their children and paying off their debts, their need for life insurance really doesn’t apply any longer.
However, for others, there are options for extending term life insurance. Most insurance companies offer extensions for term life insurance or secondary plans to invest in. To be safe, make sure you connect with your insurance agent around six months before your policy expires to explore a different plan, extension, or amount of coverage.