What is life insurance?
A common belief about life insurance is that it’s complex and difficult to understand. And at times, it can seem to be. When you consider all of the options available to you such as types of life insurance, additional riders, face amounts, cash value accounts, etc. the details can get overwhelming. But life insurance as a concept is fairly easy to understand. Life insurance is a contract involving three parties – an insured person, a life insurance provider and a beneficiary. Depending on the product, it is designed to pay a benefit to the beneficiary or beneficiaries when the insured person dies or becomes critically ill.
Life insurance death benefits are generally free from federal income tax,1 making them an attractive option when it comes to legacy planning.
Types of life insurance
Technically, there are many different types of life insurance, but for the purposes of this exercise, we’ll stick to the most common ones: term, whole, and universal life insurance, as well as critical illness insurance.
Term life insurance
Term life insurance provides coverage for a defined number of years. You generally pay a fixed premium for a policy that covers you for a specific period of time and pays out a set amount if you die within this time period. As term life insurance is the most basic type of life insurance, it’s also typically the most affordable.
Although life is full of happy milestones, we all have to deal with unforeseen challenges that can result in financial hardship. Term life insurance can help your family to continue to meet financial obligations such as mortgage payments and college tuition in the event of your unexpected death.
Term insurance highlights:
Duration of coverage: Choose from 10, 20 or 30 years
Premiums: Stay the same for the duration of the selected term, although will generally increase if coverage is renewed
Cost: $*
Death benefit: Fixed
Cash Value: No
Whole life insurance
If you’re looking for a lifetime of protection, whole life insurance may be the ideal choice for you. As the name suggests, it is insurance designed for your whole life. Unlike term insurance, some whole life insurance products can build cash value that you may be able to borrow against to pay for things like home renovations or children’s college education.
What is cash value?
When you pay your premium, a portion of it is pooled into your cash value. Whole life insurance cash values are usually guaranteed and grow based on calculations from your insurer. These calculations generally take factors such as your age, gender, and smoking status into consideration. Guaranteed cash values are usually lower in the early years but build over time. The guaranteed cash growth can also help supplement your family’s overall savings strategy. Depending on the policy, the cash value can also provide much-needed funds in the event of an emergency because the policyholder may be able to access the cash value as a loan, make a partial withdrawal, or use the funds to pay their life insurance premiums. Withdrawals or loans may reduce the death benefit and cash value, may affect how long the insurance contract is in effect and may have tax consequences. For loans, interest may be charged.
Additionally, some whole life insurance products pay dividends to policy holders. This is called participating whole life insurance. Such dividends may not be guaranteed. Whole life policies that don’t pay dividends are known as non-participating.
Whole life insurance highlights:
Duration of coverage: Life
Premiums: Typically stay the same for the duration of the insurance
Cost: $$*
Death benefit: Fixed
Cash Value: Yes
Universal life insurance
Similar to whole life insurance, universal life insurance provides a death benefit and the cash value feature that lets you accumulate and earn interest, generally tax free, while the cash remains in the policy. One of the main differences between universal and whole life is that universal life insurance is designed to be flexible as it provides premium flexibility within maximum and minimum premium limits. As long as your policy is valid, some policies may allow you to increase or decrease your coverage to suit your needs at various life stages. For example, you can choose to decrease your death benefit as you pay down your mortgage. Keep in mind, if you want to increase your coverage, you may have to undergo a medical exam, even if you submitted to one when you first bought your universal life insurance.
Universal life insurance is also different from whole life in that you may be able to choose from a minimum guaranteed interest rate or a competitive non-guaranteed interest rate for the cash value portion of your policy. If you choose a non-guaranteed rate, and interest rates go up, your cash value account earns more. If they go down, it earns less. Partly because of this risk, your premiums may be higher than those of a whole life policy. However, you might be able to skip premium payments for a period of time if there's sufficient cash value to cover the premium bill. Alternatively, if interest rates go down and you don’t have enough cash value, you may see your premiums rise.
Universal life insurance highlights:
Duration of coverage: Life
Premiums: Flexible, may change throughout the duration of the insurance
Cost: $$$*
Death benefit: Fixed or Increasing
Cash Value: Yes
Critical illness insurance
Critical illness insurance can provide a lump sum payment if you are diagnosed with a serious illness that is covered in the policy. This allows you to protect your family’s finances and lifestyle, even if you are unable to earn an income.
Who needs critical illness insurance?
Consider the following factors when determining if critical illness insurance is right for you.
- Coverage you already have
Before making any type of decision, it’s important to understand your existing coverage, if you have any. If you currently have life insurance, what options might be available through your policy? Does your employer have a group benefits plan? If yes, does it provide appropriate and adequate coverage? Do you have a drug plan? What does it cover? What might it not cover? - Your financial obligations
Have you thought about how you might pay your bills if you were unable to work? Do you have enough savings to cover your expenses if you need to take time off work? While your provincial healthcare plan might cover costs associated with treatment of your illness, it won’t pay your mortgage or any outstanding loans you might have. - Your family situation
If you’re not working, could your family maintain their current lifestyle? Will you need childcare or housekeeping services while you focus on your recovery? Expenses unrelated to your illness could arise that you may not foresee.
Which illnesses and procedures are covered under critical illness insurance?
While every insurance provider is different, there are some standard illnesses and procedures that are covered by most critical illness insurance plans. They include events like heart attack, stroke, life-threatening cancer, kidney failure, major organ transplant, coronary artery bypass and more. The more illnesses covered by your plan, the more likely the premiums will be higher than a plan that covers fewer illnesses. When shopping for the right plan, be sure you understand which illnesses you’re covered for and which ones you’re not.
418390 CAN (10/22)
1 Proceeds from life insurance paid due to the death of the insured are generally excludable from the beneficiaries’ gross income for income tax purposes. Foresters, their employees and life insurance representatives, do not provide, on Foresters behalf, financial, estate, legal or tax advice. The information given here is merely a summary of our understanding of current laws and regulations. Prospective purchasers should consult their financial, estate, tax or legal advisor regarding their situation.
*Life insurance costs can be dependent on a number of factors such as length of policy, death benefit amount, age, gender, lifestyle, medical history, etc. Costs outlined are in general terms and are in no way representative of actual, individual costs.
The information described above is intended to be general in nature and may not be applicable for all types of life insurance products. Life insurance products are subject to eligibility requirements, underwriting approval, limitations, contract terms and conditions and variations. Refer to the specific contract terms for your specific jurisdiction.