Life Protection

Now I'm going to talk about something that most people hate talking about. Proper protection, i.e. Insurance. For some reason when people hear this word they tend to run for cover, lock all their doors, turn off all the lights, and disconnect their phone lines. Yet, the thing is, most (if not all) families need some sort of insurance. There are a few different types of insurance, but in this post I will discuss Life Insurance only.

If I were to ask you, 'what is your biggest asset', most people would answer "my house" or "my car" or some other form of tangible object. But, what if I were to tell you that you're wrong? The most valuable asset you have is your ability to earn an income. YOU are your most valuable asset. Now ask yourself, if your income was not there anymore, what would your family's situation look like? What would the repercussions be? Who would be affected?

If you had a machine in your basement that printed off $50,000/year, would you insure it? Of course you would. Why? because if that machine broke down or had to be repaired you want to make sure that you're still getting the income that its providing for you and your family. However, the reality is, YOU are that machine!

Insurance is something that is very key in providing a sound financial foundation for you and your family. We protect our homes and our cars because we're legally obligated to. But why are many too afraid or too lenient on the fact of insuring themselves?

There are many reasons why people get insurance. Replacing your income, education funding, home/property protection, funeral expenses, debt protection, taxes etc... The list goes on and on, not every family gets insurance for the same reason. At the end of the day, you want to make sure that when you do pass on, that your family will be okay! Your kids will be able to go to school, your family can still live in the home, they can still eat, buy clothing, pay the bills etc... When you pass away, it is going to be a emotional/psychological tragedy, no doubt, but at least you can make sure there is not a financial tragedy in the house as well.

Let us take a look at the different type of protection that you can get. Essentially there's 2 main types of insurance you can get: Term or Permanent. Their names pretty much say a lot about them, but let us go into a little bit more detail.

Remember, Insurance is a privilege, not a right, so every person must qualify for it as well.

Term

As per its name, term insurance will only cover you for a set period of time. Up until recently, most companies have covered for either blocks of 10 years or 20 years; recently some companies have come out with a 30 year policy. Basically, we can imagine term insurance to be like 'renting' a house. Every month you're paying money and at the end of everything, you walk away with nothing (unless you pass away within the policy term, in which case your beneficiary will get the lump-sum payment).

Say for example you buy a 10 year term policy. Every month for 10 years you will pay a premium that will cover you only if you die within those 10 years. If you die after 10 years and 1 day, and you did NOT renew or replace the policy, then there is NO payout to your beneficiary.

Term insurance is usually the cheaper of the two at the beginning, but over time it can be very costly. For example, if you're 35 today, and you buy a 20 year policy, it can be pretty affordable (based on your health conditions). However, if we fast track now 20 years later, that policy is now done; most companies have what's called a 'renewable' feature where you can renew your policy after the term has been completed. At this point, you are now 55 years old, but maybe you realize you still need coverage for another 20 years. What you will notice is that the premium will drastically increase, maybe even 4 or 5 (or more) times what you were initially paying.

These are actual numbers that I have pulled up from a Canadian Insurance Company (which is often in the top 3 or 4 in pricing). This situation is of a 35 year old male, non-smoker, with average health, getting $500,000 of coverage for 20 years.

Years 1 to 20 -- Annual Premium $440 ($39.60/month)
Years 21 to 40 -- Annual Premium $5450 ($490.50/month)
Years 41 to 50* -- Annual Premium $31,990 ($2879.10/month)

*Only to year 50 because most companies will only insure a person to age 85 (starting at age 35 plus 50 years of coverage) on a Term Policy.

As you can see, the premium spikes up very significantly from the first 20 years to the next 20 years. This is something to be aware of. Many insurance agents sell this product because its cheaper, but don't explain the consequences of having to renew the policy in the future. The reason that it is so expensive upon renewal is that there is no need for medical underwriting upon renewing the policy. So this means, if within the first 20 years you get some sort of medical sickness or disease, you can still 'keep' the insurance upon it renewing -- the insurance company cannot decline you based on your health situation. Once you are approved the first time, there is no need to re-qualify again if you are renewing. That being said, if you are healthy and your insurance comes for renewal, its actually a lot cheaper just to do a new insurance application and go through the medical underwriting again - the rates are much cheaper!

People often ask, "what happens when the term is up?", and that's a great question to ask. At the end of a term, you essentially have 4 options:
1. Renew the Policy
2. Cancel the Policy
3. Convert the Policy into permanent (you do not have to wait until the end of the term to do this, often this can be done any time along the way)
4. Apply for a new policy - this is cheaper than renewing IF you are in good health and can qualify for standard (or preferred) rates.

Now, term is not a bad product, IF its used for the right purpose. For example, if you know you will have a liability for a fixed period of time only (i.e. a mortgage or loan), then it might make sense to get a term policy. Every situation must be assessed individually.

Permanent

Now lets swing over to the Permanent plan - there are 3 types of plans out there (Whole Life, Universal Life, T-100), but in this post we will focus on one, which is called a Universal Life (UL) policy. The reason I use UL in this example is because it allows me to give the most detail on how a cash value Permanent Insurance Policy Works. [Note: the T100 is not a Cash Value Permanent option].

Once again, the type of insurance, essentially tells you how it covers you. This type of policy will cover you 'permanently' until you die - it doesn't matter if you die at 35 or 52 or 93, your beneficiaries will still get compensated. Remember how I said term is like 'renting' a house? Well permanent is like 'owning' a house. Every month you're paying into the policy, but you're also building a kind of 'equity' within the policy, which is known as the 'cash value' or the 'savings component'.

This UL product is like Insurance & Investment combined. Traditionally, the two industries (insurance and investments) have had their pros and cons. The insurance industry has been great with tax 'sheltering', but hasn't really been great at getting returns on investments. On the other hand, the investment industry has been pretty good with returns on investments, but hasn't been very strong when it comes from minimizing taxes. This UL product pretty much a 'hybrid' strategy that combines the best of both worlds; where you can have the potential for good returns, as well as the benefit of tax minimization.

Because the investment is within the insurance policy, it is not treated as an 'investment' for tax purposes. Essentially any gains within the UL policy are not subject to tax. This is a great added feature which can help people save thousands in taxes over the years. The premium is broken down into 2 components: Cost of Insurance (COI) and the Investment. For example, if you were to put $100/month into the UL policy, x % will go towards the COI and the remainder y % will go towards the investment. Anything over and above the COI will go towards the investment -- the younger and healthier you are, the lower the COI will be, so best to get this policy when you are young.

Now, when it comes to the amount of premium, initially, the UL policy will require a larger investment; because it is covering you for your entire life and there is also an investment component built into it. I say "initially" because over time, the UL policy can cost less overall then a term policy. You can structure so that you're paying the same x $ of dollars every month for a certain period of time and 'pay up' the policy -- similar to how you have an ammortization on a mortgage where you will pay off your house in 25 or 30 years.

But also, same as if you were to pay off a house, you have 'equity' available in the policy. Depending on how much you invest and how long you invest for, this can be a substantial amount of savings.

Wouldn't it be great to be covered for your entire life AND have some money saved up for retirement? From my experience, most life insurance policies cost less then car insurance policies; car insurance is covering you for what, $20,000 or $30,000? Whereas life insurance is usually going to be covering you for an amount into the hundreds of thousands, and for some, millions!

However, just like I said a Term policy is not all bad, a Permanent policy is not always suitable for a person either. I said it above also, that every situation has to be assessed individually. Best to sit down with your advisor and do a needs analysis and see how much investment each type of policy requires and budget yourself that way.

Using the same example as above, covering someone for $500,000 with a Permanent Product (whether Whole Life or Universal Life) would be quite expensive -- premium would be in the hundreds per month! So some people would ask, why even get a Permanent Product? The reality is that the vast majority of families will not need the full amount of their 'required coverage' as permanent. Often you'll see advisors who will 'ladder' or 'bundle' their insurance policy with both Term and Permanent. Most people WILL have some sort of permanent needs, whether it be funeral expenses, taxes, leaving money for charity or family, or any number of other things, so having a portion of your Life Insurance protection as Permanent likely will make sense.

One strategy that I find works well is doing something like a 80/20 split - Where 80% of the policy is Term and 20% is Permanent. This will keep the overall cost of the policy low and will still allow for having a portion of your policy to cover off long-term/permanent needs. So, for example, if you and your advisor decide that you need $500,000 of coverage, something like $100,000 Permanent and $400,000 as term Coverage might work out nicely for you, both for cost and for your overall insurance needs!

Even for young people who don't have the same responsibilities as some who are older (i.e. kids, mortgage, debt etc...), having a Permanent Insurance policy is a GREAT way to start your financial foundation.  Eventually, they will need to get protection, so why not get it when they're young and in good health, and also when the Cost of Insurance would be a lot lower?

Just one last thing, most term policies have a feature called "Renewable and Convertible" (R&C), which means that they can convert the term policy into a permanent policy at any time within the policy term. This is usually the case for those who are not able to invest the necessary premium required to fund the permanent policy properly right from the beginning. If you cannot afford permanent, at least start off with term and then work your way from there.

One last thing. Be CAREFUL of Insurance Advisors trying to push Permanent Policies on you. As great a strategy that it CAN be, to use it, it is not suitable for everything. The most number of "bad insurance sales" that I've come across has been on the Permanent (specifically UL side). In regards to UL's, they are priced with an expected ROR that you and your advisor feel you will get within the policy. I would be VERY cautious and suspicious of any advisor saying he/she thinks you will get anything above 3.5% ROR within the UL policy. Just because the underlying fund within the policy has averaged 6% or 7% over the last number of years, it does not mean YOUR investment within the policy will average the same. There are many fees and also other taxes (not income taxes) associated with using a UL, so usually your overall return will be maybe 3% or 3.5% below the underlying fund. Most advisors I have come across are not aware of how these fees affect the return and many aren't even aware that these fees and costs exist, which is why I said I would be cautious and suspicious, mainly of their intention and their knowledge/understanding of the product itself.

If you feel that you have been given something that might not suit your needs or that you want some clarification on something you have been sold, I would be happy to answer questions or provide information for you.

I hope this has been helpful. You can contact me for more information or if you have questions!