When it comes down to purchasing life insurance to protect your family in case anything should happen to you, it really comes down to two options: term and permanent. While the last couple of posts focused on what the common uses of each are, this one will apply an objective view to pit term versus permanent life insurance to see which one is most suitable for you.
The biggest factor that will affect your purchase and the biggest difference between the two options is cost. For an equivalent amount of death benefit, term insurance, especially term-10, starts out much cheaper. As shown in the graphic below, premiums must be renewed every 10 years for term10 insurance, at a much higher premium than what you were used to paying. Most term policies are renewable with no need to qualify medically up to age 80-85. By then your premiums would be astronomical, which is why we stopped the graph at age 70. It can also be converted to permanent insurance up to a certain age, in case your needs change or you become uninsurable. The premium will be based on your age at conversion, which in insurance is called ‘attained age’.
In comparison, permanent life insurance has a much higher initial cost than term, but it remains level throughout your lifetime. The total amount of premiums you pay throughout your lifetime will be significantly higher in the term-10 compared to the term-to-100, assuming you keep renewing the term-10 until it expires. A common strategy used to avoid paying the higher premium at renewal for the term-10 is to apply for a brand new policy and cancel the old one. The premium on the new policy will be much lower than the renewal rates on the old one. Note that this is an extremely high risk strategy since the future is unpredictable and in 10 years, you may be rated (pay a higher premium) for a medical condition or even worse, may not qualify for life insurance altogether.
The permanent product shown in the graph is term-to-100, which is the most basic permanent product with no cash values attached.
As you can see, term insurance is much more affordable at the beginning of your career when your salary is at its lowest. The downside is you are likely going to outlive the expiry of the term, so after paying premiums for so many years, you will have nothing to show for it. For some people this isn’t a problem because they view insurance as purely for protection and feel that it was worth it to exchange premiums for that protection. For others they have the peace of mind of knowing that as long as they continue to pay the premiums on a permanent insurance product, their beneficiaries will eventually receive a death benefit.
It comes down to your need
So which one is right for you? Consider the following two scenarios.
1) Let’s say you’ve calculated your life insurance needs as follows: $10,000 to pay off your final expenses, $100,000 build your children’s university fund, $890,000 to provide for your spouse and children’s living expenses until they are adults, for a total of $1 million in death benefit now. You are in your late 20’s to early 40’s and since you have a mortgage and bills to pay, you don’t have the cash flow for permanent life insurance. What you need is life insurance purely for protection until your family no longer depends on your income, and that’s why term insurance is the perfect fit for you.
2) Now let’s pretend you are recently retired and have a sizable nest egg. You may want to employ the insured annuity strategy or simply want to ensure your estate is preserved for the next generation. A joint last-to-die policy on you and your spouse’s lives will ensure that taxes on your remaining RRSP and capital gains will be paid off so that your whole legacy is passed on to your children. While you can use term insurance, there’s no guarantee the policy won’t expire before you pass away. If that happens, your beneficiaries receive nothing and your estate goals are shattered. The only way you’re guaranteed to accomplish your goal is to use permanent insurance.
Two completely different scenarios, two completely different products to fit their needs. What it all comes down to in the end is your need. The important thing is after you figure out what that is, you choose the appropriate product to satisfy that need. Sometimes it may be a combination of term and permanent that is most suitable for you.
Is there a life insurance product that fits in between term and permanent? Canada’s innovative insurers are always coming up with new products that may be attractive to different consumers. Next time I will talk about one such product, LifePhases.
Image courtesy of Stuart Miles / FreeDigitalPhotos.net