Life insurance provides a tax-free cash payment to your named beneficiaries (such as your spouse or children) upon your death. A life insurance policy is a legal contract. Find out more about how life insurance works and questions to ask if you are considering getting it.
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What is life insurance?
Life insurance is an insurance policy that can help your family maintain their standard of living if you die. It can also help cover debts or expenses such as funeral costs.
A life insurance policy is a legal contract that sets out:
- How much money you will pay each month to get the insurance.
- How long the insurance will cover you (for a set termor for life).
- How much money the insurance companywill pay to your loved ones if you die.
Life insurance can also be used to:
- Cover estate taxes – When the death benefit is payable to your estate.
- Save for retirement – By using permanent insurance policies that let you build savings as well as provide insurance protection.
- Donate to charity – By making a charity a beneficiary, or the owner and beneficiary, of your insurance policy.
- Protect your interest in a business – By providing money to buy out a deceased business partner’s stake in the business.
If you have debts — or people who depend on you financially — you likely need life insurance.
It can help your family maintain their lifestyle if you die unexpectedly.
The tax-free life insurance payment that is made upon your death can be used to:
- Replace some or all of your income.
- Repay debts or continue debtrepayments on mortgages, loans and credit cards.
- Pay for childcare and any current or future education costs for your children.
- Cover your funeral and estatecosts, such as probate fees and capital gains taxes that may be due on death.
If you’re not sure whether you need life insurance, consider these questions:
- If you are the main earner, or co-earner, will your family have enough money to cover day-to-day expenses if you die and your income is lost?
- If you are a full-time caregiver, will your family be able cover the cost of childcare if you’re gone?
If you answered “no” to either question, consider life insurance to help protect your family financially.
How much life insurance do you need?
Many factors go into determining how much life insurance you might need. You will want to consider:
- How much debt you have.
- Any final expenses and estatetaxes that will be owing on your death.
- Current and future care and education costs for your children.
- The income your family relies on to maintain its lifestyle.
An insurance agent can take you through a detailed analysis of how much insurance (and what types) you may need.
The amount of life insurance you get will depend on your answers to questions such as:
- Do you want the insurance to replace all or just some of your lost income?
- Do you want your family to live debt free or continue to pay down debt?
- Will you spend the capital from the insurance payment or just the investment earnings?
- How much can you afford to pay for insurance?
Most insurance companies have online calculators to help you determine how much life insurance you might need. You will be asked questions such as your age and gender, your income and expenses, and details about your financial situation.
What are the types of life insurance?
It’s important to get the type of insurance that best meets your needs. There are two main types of life insurance in Canada:
- Term life insurance – Guaranteed for a specific length of time.
- Permanent life insurance – Guaranteed coverage for life.
Term life insurance
Term insurance covers you for a specific number of years. It is the lowest cost life insurance you can buy. It’s the most common type of insurance and can meet most insurance needs.
Term insurance provides you with insurance protection for a specific length of time. Policies are generally available for terms of one, five, 10 or 20 years. But you can’t get coverage after a certain age, typically between 75 and 85.
While your annual premium amount stays the same throughout the term, term insurance becomes more expensive to buy as you get older.
Most term policies are renewable, which allows you to extend your coverage for a new term without a medical exam when your original term ends. The renewal premiums are listed in the insurance contract.
Renewal rates for term life insurance are typically expensive and reflect the fact that no medical exam is required.
Permanent life insurance
Permanent insurance provides guaranteed coverage for life. It is best suited for estate and retirement planning.
Permanent insurance is substantially more expensive than term insurance, especially in the early years of a policy. It is best suited for long-term insurance needs. It is most often used to:
- Generate additional retirement income for people who are already contributing the maximum to their RRSP each year, and TFSA each year.
- Provide cash for estate planningpurposes, such as covering taxes or donating to a charity.
There are three types of permanent life insurance: Universal life, whole life, and term to 100.
1. Universal life insurance
Universal life insurance provides guaranteed lifetime coverage. It also includes an investment component that generates tax-deferred savings.
Here’s how it works:
- You make ongoing deposits to the policy — with some flexibility in terms of the amount.
- A portion of the deposit is used to pay the premium.
- The rest is invested and grows tax-sheltered, allowing you to boost the value of your long-term savings.
When you die, the beneficiaries you name in your policy receive the insurance amount and the investment proceeds — tax free.
You may also be able to borrow against the savings you’ve built up and use this money to supplement your retirement income. When you die, the policy proceeds can be used to pay back the loan.
2. Whole life insurance
Whole life insurance also provides guaranteed lifetime coverage. The premium you pay is fixed and doesn’t change from year to year.
Whole life insurance also has a cash value, with savings that build over time. You can use the savings as collateral to take out a loan or use the money for any reason if you surrender the policy before you die. Some whole life policies also entitle you to dividend payments from the insurance company.
3. Term to 100
Despite its name, term to 100 insurance is not term insurance. Most policies provide coverage for your lifetime. If you live past 100, you no longer have to pay premiums, but the coverage will continue. Your premiums remain level for your lifetime, or in some cases, may be payable over 20 years.
Term to 100 typically has no savings component or cash value. For this reason, it is the lowest cost permanent insurance available.
A term to 100 policy can be a good choice if you need long-term insurance protection but don’t want or need the additional savings of a universal life or whole life policy.
Permanent insurance guarantees coverage for life and has other savings benefits. It is best suited for longer-term planning needs.
Life insurance policy types and coverage
life insurance policy
|Premiums and coverage time
|How this insurance might be used
|Insurance coverage guaranteed for a pre-defined term, typically 5, 10 or 20 years
Premiums stay the same for length of the term
Renewal of term is guaranteed, but at a higher premium rate
Coverage ends at a specified age (often age 75 to 85)
Lowest cost form of insurance
|Often used during working years to provide the capital needed to replace income when a key breadwinner dies
Coverage is not guaranteed for life, so may not be appropriate for estate planning goals
|Term to 100
|Permanent insurance guaranteed for life
Premiums stay the same until age 100, or may in some cases be payable over 20 years
Typically has no savings component or cash value
Lowest cost form of permanent insurance
|Pre-retirement – can be used to replace income if you were to die unexpectedly
Retirement – can be used to cover your estate’s tax liability or add to your estate’s value
|Permanent insurance guaranteed for life
Premiums are adjustable depending on savings and insurance needs
Policy provides both insurance protection and tax-sheltered savings
|Retirement – savings can be used to cover ongoing premiums, increase the policy’s death benefit or used as loan collateral to provide money in retirement
Estate – can be used to cover your estate’s tax liability or add to your estate’s value
|Permanent insurance guaranteed for life
Premiums stay the same for life
|Retirement – savings can be used as loan collateral to provide money in retirement, or withdrawn if you end the policy
Estate – can be used to cover your estate’s tax liability or enhance your estate’s value
What optional coverage is available as part of life insurance?
Life insurance policies often come with features that are built into your premium cost – or optional coverages, known as riders, that you can add to your policy for a price.
Common features and riders include:
- Joint policy – Pays a death benefit to the surviving spouse, or to your estate after both of you die. It is similar to a term life insurance policy for both you and your spouse, but it can cost less than buying two separate policies.
- Disability waiver of premium – Waives your premium during any period in which you become disabled.
- Accidental death benefit – Provides your beneficiary with an additional death benefit if your death occurs by accident.
- Conversion right – Lets you switch from a term to a permanent life insurance policy without getting a medical exam.
- Guaranteed insurability – Allows you increase your death benefit without getting a medical exam.
- Children’s life insurance rider – Provides life insurance protection for all children in your immediate family.
Ask your insurance agent about the features and optional coverages available to you.
How can your life insurance policy cover estate costs?
Life insurance can be used to pay the taxes and other expenses that your estate must cover.
This can avoid the sale of estate assets, such as a home or cottage, that beneficiaries may want to keep in the family.
In addition to funeral costs, your death can trigger costs to your estate that you may not have anticipated. This could include:
- Probate fees – The fees to settle your estate can be high depending on the province you live in. In Ontario, the fees equal almost 1.5% of your estate’s value.
- Tax on capital gains – You’re deemed to dispose of all capital property at death. Your estate must cover the tax on any of these capital gains.
- Tax on tax-sheltered savings plans – Registered plans such as RRSPs and RRIFs can be transferred tax free to your spouse’s plan. If you don’t have a spouse, these savings become fully taxable at death.
To use insurance to pay estate costs, you can simply name your estate as the beneficiary. Your estate will pay probate fees on the insurance proceeds, but it gives your estate cash that can be used right away to help cover estate costs.
How can you donate your life insurance policy to charity?
There are two ways you can donate your life insurance policy to charity.
- Name your chosen charity as the beneficiary of a life insurance policy. Your estate will be able to claim a donation tax credit for the death benefit paid.
- Donate your permanent life insurance policy to charity — and get ongoing charitable receipts for your premium payments.
Here’s how it works:
- Apply for a permanent life insurance policy.
- When the policy is approved, transfer the policy ownership to the charity of your choice and name the same charity as beneficiary.
- Pay the annual premium and get a tax receipt for that amount.
The charity is guaranteed the amount of the death benefit as long as you continue to make premium payments. The death benefit is paid outside your estate, so the charity receives the proceeds quickly and your estate won’t pay probate fees on the amount.
Life insurance provides financial protection for your family in the event of your death. Remember:
- Term life insurance is guaranteed for a specific length of time.
- Permanent life insurance is guaranteed coverage for life. It includes term to 100, universal life, and whole life insurance.
- Most insurance companies have calculators on their websites, to help you determine how much coverage you may need.
- Life insurance can cover estate costs if you name your estate as the beneficiary.
- You can donate your life insurance policy to charity by:
- Naming the charity as beneficiary of your policy.
- Transferring policy ownership to a charity.