How Life Insurance Works – A Conversation
If I could explain life insurance to you in an understandable way in just a few minutes – wouldn’t you want to know? Of course you would – and that’s why your here today.
And in fact, we’ll soon have you more knowledgeable than 95% of
Canadians out there today!
Your lending institution offers “mortgage insurance”… But why settle for an insurance product that does just one thing? Pay off your loan to them which leaves nothing for your family.
When it comes to protecting your mortgage and your other loans and obligations – as well as replacing the very most important thing – your ability to earn income – there are other insurance options to consider that protect your home as well as your family’s future….
In other words, protect more than your mortgage – protect your families future!
So, today, what I want to do is to get you familiar with how life insurance works and the different products that are available out there.
To start with, we’ll go over your four major options for life insurance. And I’ll give you some quotes along the way so that it all helps to make sense…
This is option (A): 10 Year insurance
Now, your first option for life insurance is something called 10-year term insurance. And I’m going to use $500,000 as a starting number, just to use as an example. Then we’ll get into more specific detail as to how much insurance you might really need.
10-year term insurance is your least expensive option available in Canada today. (However, it may not be your best option as we’ll see later).
For example: Take a $500,000 Term 10 Female age 40 non smoker The regular rate is $26 per month – in fact, it could be 15-30% lower for a “healthy person” discount if one is healthier than the Canadian standard…
However, let’s just say that its about $26 a month for you, okay. So there’s no catch to it. It absolutely covers you for $500,000. If you pass away that money’s going to go to your family. They can do with it as they wish – pay off the mortgage or just pay it down-pay off bills … whatever… It’s their call – not the banks!
Okay, now let me explain exactly how this works.
So while it’s only $26 a month, what happens is because it’s called a 10-year term, the rates increase every 10 years you keep this policy – to age 80 or 85 – and then the coverage (or term) automatically ends. That’s it.
So now you’re 40 years old. You’re only paying $26 a month to cover your family for half a million dollars, which sounds great. But here’s what happens. When you turn 50, this price goes from $26 to about $170 a month. It’s a huge, huge jump up in price.
So here’s your scenario. Now you’re 50 years old. They’re not going to ask you to do a new medical. They’re automatically going to give you the $500,000 of coverage, but they’re going to charge you an arm and a leg for it. So instead of paying $26, you’re paying $170. Let’s say for whatever reason you decide, okay, I’m going to keep this insurance, and you’re going to pay that $170. They’re not going to stop there. So when you hit age 60, then it’s going to jump up to $400 a month. And it’s going to keep on going up, and then when you’re 70 it’s $1,200. When you’re 80 it’s a ridiculously high $3,000 a month – and in fact it either ends there or at age 85 depending on the company!
All “term renewable” insurance ends at ages 80 or 85!
So, if you’re using this type of insurance as “mortgage insurance”, you’d better hope and pray that your mortgage is paid off my then!
So we started at $26, we’ve now hit $3,000 a month. Chances are over some of that period you’re going to cancel your insurance. You’re probably not going to want to pay all these jump-up’s in price. So if you cancel your insurance, you don’t get any money back – you paid for coverage – you had coverage for the period of time you had the insurance – now, you have cancelled coverage – end of story!
Now, for example, when you’re 50 and the price jumps up to $170, you’ll probably think about cancelling. Most people are going to think about cancelling their coverage. When you cancel your insurance, that’s it! So you kind of go your separate ways from the insurance company. Now you’re 50 years old, you’re left with no coverage. If you want new coverage, you basically have to reapply for insurance. You have to go through a brand new medical. And now you’re paying rates for a 50 year old. That’s how the 10-year term works?
Okay, so we’ve seen the downside of the 10-year term. So instead of that, you may want to look at something called a 20-year term.
This is option (B): 20 Year insurance
Okay, it’s a very similar product to 10 year term but it’s called 20-year term because the rates increase every 20 years you keep this policy.
Except in this case, instead of paying $26 a month, the initial premium is higher and what you do is you pay $40 a month. And that will cover you for the next 20 years for half a million dollars of insurance. Okay, so from age 40 to age 60, you’ve covered your family with half a million dollars of coverage. So this is great; really low price with a lot of insurance.
20 year term insurance is a very popular option, especially for people who want more value for their insurance dollar spent because over a 20 year period it is 30 – 50% cheaper than 10 year term renewable over the same time frame… (Did you get that? Buying Term 20 vs. Term 10 will save you thousands of dollars in premiums payments over 20 years – that’s just the way it is!)
But just like a 10-year term, it’s got some downsides to it. So when you hit age 60, that rate is going to go from $40 a month to about $600 a month. It’s going to go through the roof there. So chances are when you’re 60, you’re probably going to cancel that insurance. The only way I could see you paying that $600 a month premium is if you were in a state where you were so unhealthy, you were diagnosed with an illness, you couldn’t get any other insurance. Then it might make sense to pay that $600 a month because if you pass away your family still gets $500,000. Okay?
So that’s the– maybe a five percent scenario that that’s going to happen, but chances are you’re going to cancel it, because if you do keep it, in the following 20 years, when you hit age 80, the price skyrockets to $3,000 a month. And I know you’re going to cancel it at that point. But even if you do keep it, it automatically cancels at age 85. They don’t care how healthy you are, if you want to keep your insurance or not, they’re simply going to send you a letter and say, your insurance is done. And they’re going to say thank you, very much for your last 40 years of payments, we’re going to keep your money and we no longer have to pay that $500,000 to your family. Does that make sense?
I trust that it does…
This is option (B-a): Layering Insurance
Now here’s a thought, with this option, rather than going the straight all or nothing 10 year or 20 year term or 30 year term you layer them together…
So if you have a need for $500,000 of insurance (for example a mortgage that you will be paying down over 20-30 years) you may look at something like $100,000 for 30 years, $150,000 for 20 years, and $250,000 for the first 10 years…
That way there is a smooth and gradual transition in coverage (and price) as your mortgage and other liabilities drop way over the years…
This takes you from age 40 to age 70 – dropping insurance coverage from $500,000 to $100,000 over 30 years. Yes, after 30 years there is no life insurance left for you as far as estate planning or legacy planning is concerned at that time but if all you want to do is cover off the liabilities you have over 30 years this is a valid and cost effective strategy on how to craft your life insurance coverage…
Now you may ask: but do we need that much insurance until I die? I’m just looking for mortgage insurance.
Well, you might want to do that, because the reason is when you’re looking at life insurance, you’re not just looking to cover off your mortgage.
In fact, there’s two main reasons why you want life insurance.
You want to cover your mortgage, AND you want to replace your family income. So if you’re making $50,000 a year, for example, and that’s coming into the family, if you were to pass away and you only had $500,000 of insurance, that’s great. You can pay off the mortgage, the family can pay off the mortgage. But they’re not seeing your income that’s coming in every year, right? So that $50,000 you’re making, they’re losing that every single year if you were to pass away. So the only way to replace that is with a large amount of life insurance.
So you can see when you look at it like that, $500,000 is probably not enough coverage. But, yeah, the house is paid off, but now how about everything else?
How about paying the rest of the bills? How about putting the kids through school? That type of thing.
They’re basically– they’re living without your income coming in. So what life insurance is basically doing is supporting your family as if you were still there. As if you were still alive and still making money for the family. That’s what life insurance is replacing.
In fact, a rule of thumb is to multiply your annual income by 10 to get to an insurance amount that will replace your annual income if you die prematurely. If you were making $50,000 a year then that number should be $500,000. So in reality you will be wanting to look at a total of at least 1 million in insurance coverage…
Make sense?
Okay.
So you might be thinking, okay, well, what else is out there? Can I have something that’s going to be a little bit longer than to age 80-85? Because though it’s great for 20 or 30 years -then what?
So going back to the four options we were talking about.
This is option (C). Permanent insurance
So with permanent life insurance it’s a little bit different. But, it’s just how it sounds. It’s going to last forever.
So you’re going to pay one price today and that price is going to stay set for the rest of your life. Okay?
Now, the price is a little bit higher. The price is $180 a month, okay, so it’s higher than the $26 and the $40 option, obviously. But what happens is that the $180 is guaranteed not to increase forever. Whether you pass away at age 75 or age 105, you don’t care – the insurance company is on the hook now forever.
So this is where you’re paying $180 a month and this is where you’re going to keep insurance forever, okay. So it’s a lot more expensive than term insurance, of course. But what you’re doing is you’re putting the insurance company on the hook forever. I mean, everybody eventually passes away. What that means to your family is eventually you’re going to pass away, so your family is definitely going to receive that $500,000. That’s a guarantee. So let’s give you a scenario. Let’s say you passed away in 45 years. So you’re paying $180 times 12 months times 45 years which equals $97,200. So you’ve paid $97,200 after 45 years to give your family a guaranteed $500,000 payout tax-free. Is that a good deal? Of course it is!
So it’s basically a guaranteed return on your money. If you think about like this, what you’re essentially doing is you’re buying money.
You’re buying a guaranteed half a million dollar payout for your family. There’s nothing that’s going to affect that payout. There’s no interest rates that are going to affect it. If the economy goes in the tank, doesn’t matter. As long as you continue to pay that premium, your family’s going to get that half a million dollars. Does that make sense?
Okay. So that’s option (c). Permanent Insurance
This is option (D). Permanent – Paid off in 20 years.
Now, I’m going to give you the another option now which is option (d).
It also falls under the permanent life insurance category.
Except with this option, it’s called a 20-year paid off insurance. So it’s just like permanent insurance, option (c), it’s going to last forever. But you only have to make payments for 20 years. So in this particular option you’re paying $300 a month, okay.
So it’s the most expensive option, obviously compared to all the prices. But in the long run, it’s the best value for your money.
Look at it like this.
If you pay $300 and times that 12 months, you times that by 20 years, over 20 years you paid $60,000. So you’ve paid $60,000 by the time you’ve hit age 60, you’ll never have to make another premium payment again. And now your family’s going to get $500,000. So it’s a guarantee that if you pay that “x” amount of dollars, your family will get $500,000 and they’ll never ask you for another payment again. So when you’re 60, when you’re getting to retirement age, your insurance is paid off. It’s like paying off a house.
And there’s a bonus feature attached to this particular policy.
So we know after 20 years you’ve paid $60,000 to buy this insurance for your family. Mind you, it kicks in immediately, so if you passed away over these first 20 years, they’re going to pay out that $500,000 as well. But I’m talking about the long term. I’m talking assuming you passed away at age 90, right. So at age 60, you get to stop making your payments, your family gets $500,000. There’s a bonus feature attached to this which is basically a cancellation cash value. What I mean by that is that over time if you decide to cancel your policy, the insurance company will pay you more than 100 percent of your money back. More than all the premiums you’ve paid.
So let me explain that option a little bit better.
So at the 20-year point, you paid off your insurance.
Now the insurance company they’re going to say, well, your cash value for this policy is $50,000. Knowing you’ve paid $60,000. So what they’re saying to you, is if you take this $50,000, we’ll give it to you in cash, but we’re going to cancel your insurance. You no longer have the $500,000 of coverage.
So your question to me might be, well, why in the world would I take the $50,000. I just paid off my insurance. And I agree with you; you wouldn’t. It doesn’t make sense to take that $50,000 when your insurance is now paid off. But it’s a back-up solution.
In case you needed money for whatever reason, at least you could take that $50,000. Now what the insurance company is going to do is they’re going to sweeten the deal every single year. They’re going to offer you more money back every single year to try to cancel your insurance. It’s kind of like that game show “Deal or No Deal”. Every year they’re going to offer you more money and you’re going to say, no, I’m going to keep my insurance, or no, I’m going to take the cash out.
So, for example, at age 65, they’re going to offer you $75,000 to cancel, knowing that you’ve only paid $60,000. So now they’re offering you more money to cancel. But you might say, you know what, no. I’m going to leave that. I’m not going to take the cash out, and if I pass away, my family’s still going to get that half a million dollars. Then they’re going to keep on sweetening the offer. So when you’re 75, now they’re going to offer you $125,000.
So here’s your scenario. You’re 75 years old, you’ve paid off your insurance when you were 60. If you pass away, your family gets half a million dollars, but you might say, you know what, I’m 75 years old. I’m still very healthy. I don’t plan to die for another 25 years. Give me my $125,000. They will give you your $125,000 and that’s it; you go your separate ways.
So it’s an either-or scenario. You can take the cash out while you’re alive or you can leave the insurance there and give your family half a million when you pass away. Does that make sense? I trust that it does!
Okay. So we’ve gone through those four options.
Now, I’m going to give you some of my insurance insider tips…
This is option (E). Combination Plan.
Yes, term insurance is great. Everybody loves term insurance because it’s inexpensive, right. So people are very attracted to that. Forty dollars a month, that’ll cover me for half a million, that’s good. I’ll take that policy. People are very attracted to that. But you’ve seen what happens in the long run. The insurance company has increased the prices so high that they know you’re going to cancel the insurance. And essentially that’s how they’re making money off of you. They’re upping that price so high that they know, there’s no way you’re going to pay that $600 a month increase. You’re going to cancel it and they’re going to say thank you, very much for your last 20 years of payments. We’re keeping your money, and we no longer have to pay $500,000. So that’s the downside of term insurance.
The upside is the price.
Now we look at permanent insurance.
The upside is I’m giving my family insurance forever. I’m giving them $500,000 of coverage that’s going to be there no matter what age I pass away. The downside, as you can see, is the price. It is more expensive than term insurance, right? Right!
It’s a great value for your money if you can afford it, but not everybody can afford to pay $300 a month for insurance.
So here’s my recommendation.
Instead of choosing one or the other, you can do a combination of both.
Let’s say we’ve determined you need $500,000 of life insurance. Instead of doing $500,000 of permanent insurance, what we’re going to do is maybe $250,000 of the 20-year paid off insurance and $250,000 of the 20-year term.
So the 20-year term portion of $250,000 costs $40 on that. That covers you for $250,000 over 20 years. The $250,000 of the 20-year paid off portion, that’s $174. So you only pay that $174 over 20 years.
So here’s your scenario.
Over these next 20 years, you have $500,000 of coverage.
If you pass away, your family will receive $500,000 tax free.
Let’s assume you live longer than 20 years. That term portion, because we know how term works, that rate is going to skyrocket on you. So what you’re going to do is you’re going to cancel that policy. You’re going to cancel that $250,000 of term insurance at some point.
Now you’re going to be left with $250,000 of permanent insurance that’s been paid off after 20 years. So you never have to make another payment again.
So over these important 20 years when the mortgage is high and the kids are little, you’ve got a large amount of $500,000 of insurance. After 20 years, when you may not need as much insurance, you cancel the term portion. But now at least you’ve got the $250,000 of lifetime coverage for your family. Does that make sense? I truly hope that is does…
So a good analogy– because I’ve given you a lot of information, a good analogy to remember the difference between term insurance versus permanent is think of it like this. This is a loose analogy, not exactly true, but it helps you remember.
Basically, think of term insurance like renting a house. You can rent a house for these next 20 years. As soon as you leave, the landlord is not going to give you part of that house. They’re going to put a roof over your head but as soon as you walk away, you don’t get anything back. That’s like term insurance. So you can get a large amount of coverage for your family. As soon as you walk away, you’ve got nothing to show for it.
Think of permanent insurance like owning a house and paying a mortgage. You’re going to pay a lot more for that up front, but in the long run there’ s a value to it. There’s a long-term value to it. Just like owning a house.
So think of permanent like a house. So permanent is like having a mortgage. Think of term like renting a house—
Being in the Vancouver real estate market everybody talks about housing, so that kind of helps you remember the difference of permanent versus term insurance.
Now that being said, ideally the more permanent insurance you can purchase the better, because as we can see, the value in the long run is the best. But what we have to do is now we have to find a mix of what you’re comfortable with. So if we’ve determined you need $500,000 of insurance, what we’ll do is we’ll find a mix of– perhaps it’s only $100,000 or $200,000, and the rest we’ll fill up with term. Does that make sense?
Because at the end of the day, I’m not going to tell you that term insurance is bad. ‘Cause it’s great for some people. I mean, if you can only afford “x” amount of dollars, and term insurance works, great. That’s what we’ll make happen for you. We’re not trying to push you to spend money on life insurance if you can’t afford it. But if you see the long-term value of permanent insurance and you understand why, though its price point it higher today, what’s going to happen in the long run for you?
And we haven’t even talked about how permanent insurance (not term insurance) can be used for estate and legacy planning for you and your family… (We’ll have to save that conversation for another day).
At the end of the day, we must look at the different types of life insurance and how to put them together to correctly anchor your financial situation.
So to summarize:
There are several options for life insurance, including (but not limited to):
A) 10 year term insurance. This is the cheapest insurance today, but the price skyrockets every 10 years, becoming very very expensive over time. You can cancel at anytime, but you get no money back. Assuming a case where you continued to pay the increasing prices it will automatically cancel at age 80 or 85 anyways.
B) 20 year term insurance. This is the same as a 10 year term, except the price won’t increase for 20 years. However, after 20 years, the price usually increases by 10X the amount. It will then increase every 20 years thereafter and automatically cancel at age 80 or age 85.
(B-a): Layering Insurance
Layering 10, 20 & 30 year term insurance for a gradual transition in coverage (and price) as ones mortgage and other liabilities drop away over the years…
C) Permanent Life insurance, Pay for life. With this option, the rate will never increase, so you will have insurance forever. A great option for this is Universal Life insurance.
D) Permanent – Paid off in 20 years. With this option, you only pay for 20 years guaranteed, and then the insurance is paid off forever. The bonus feature is you can get more than 100% of your money back as time goes on. This also falls under Universal Life insurance category.
E) Combination Plan. With this option you take some Term and some Permanent to meet both your current needs and future needs and budget.
Now in closing, the last thing to know is that getting insurance is a process – and its not guaranteed that you will even get coverage.
Contrary to popular belief, getting insurance is not a right – in fact – it’s a privilege…
So, if you think that you want to “think about it” so in fact, does the life insurance company…
They want to make sure that you are a worthy candidate to do business with. They want to know that you will be a healthy person who can commit to paying for the privilege in accepting an insurance contract from them – and being able to pay for it…
In fact, it takes approximately five to seven weeks for the insurance company to “think about it”, make the medical reviews etc., before making up their mind that you may (or may not) get approved by them for life insurance.
The point being, is that you should feel very special if they come back with an offer to do business with you – because there are allot of people who apply – that are turned down because of either their health status or their families health background issues…
So it is going to take some time. The reason it takes time is because the insurance companies are very thorough when they’re doing their checkups and — it’s actually a good thing. You want them to be that thorough up front because once you’re approved, now they’re on the hook. Now you’ve got them. So they’ve been very thorough and they’ve done their checkups, that type of thing, so if you– in a worst case scenario, if you should pass away, they’re going to pay out for your family.
So to sum up: Why did I put this information together for you?
Well, because I believe that an informed client will be able to make better decisions for what is right for their needs and situation.
You know, if insurance were free we would all own allot of it.
But because it’s not, we need to review the need, the amount and the price – and make adjustments accordingly – to find what is suitable for you and for your pocketbook…
