There are 2 main types of life insurance that can provide a financial safety net for your family which are most often referred to as being Term versus Perm (Permanent). The difference can be confusing especially when you're shopping around so I thought I would provide some information here for easy reference about the differences.
Term Insurance is Temporary Insurance
Term Life insurance can be easier to understand than Permanent Life Insurance and can be fairly inexpensive. Term insurance provides coverage for a certain predetermined period of time or “term”. Sometimes and for group term insurance in particular, it can expire at a certain age like 65, 70 or 75. If you die within the term of the policy... the policy pays out. Common terms for life insurance are 10, 20 or 30 years. You may be able to renew after those terms are up, but the rates will be more expensive because you're older. Often a term policy will allow you to convert to a permanent policy along the way. That can be a worthwhile option if cost is a factor. The idea behind term coverage would be to cover the term when your family’s needs are greatest; when you are paying a mortgage, saving for the future education of children and for retirement. A premature death during this period could be really devastating as financial needs are high. Ideally, the term would expire when your house is paid off, your kids are independent and other savings might be available to leave as a legacy if needed and so it's not as necessary to have any insurance. Term insurance is cheaper than permanent insurance because the odds are in the insurer’s favour that you won’t die within the term. But as we know; bad stuff happens sometimes. Permanent insurance on the other hand will eventually payout something; it’s just a matter of what and when.
Permanent Insurance is for life
Permanent life insurance provides for lifelong coverage while the policy is in force with a guaranteed death benefit. Permanent policies can be more difficult to understand, cost more but offer more benefits and so it's important to review those benefits. Permanent insurance includes 2 different versions; Whole life insurance which is simpler to understand and a more popular version of Permanent insurance as compared to Universal life insurance. Permanent insurance includes a death benefit but also an investment component known as a cash value. The cash value within a policy grows inside a permanent life insurance policy on a tax advantaged basis and can be borrowed by the owner of the policy at a set interest rate A cash value within the policy also provides for a surrender value should the policy be terminated at some point before the death of the insured. It's another reason that Term life is cheaper, because a temporary or term policy does not provide any cash value if it’s surrendered. Term insurance is like paying rent which will give you peace of mind while you live there; but no residual value when you move out. Permanent insurance includes cash values which can add great value to a permanent policy and be really worthwhile. Cash values grow at a guaranteed rate within a permanent policy. The longer you pay into your policy and hold onto it, the more the cash value accumulates.
Participating (PAR) permanent life insurance policies versus Non-Participating
Yet another complexity when talking about Whole life Permanent life insurance policies is the fact that they also come in 2 different versions. Participating versus Non Participating policies. Participating policies (or PAR policies for short) have the ability to earn annual dividends based on the insurer’s financial surplus earned. Such dividends are not guaranteed and are most often tied to long-term interest rates and company performance as well as mortality, claims experience and taxes. Many of the larger and more popular insurers like Canada Life, Manulife, Empire Life, Equitable Life and Foresters have a long history of good investment performance that has resulted in commendable "dividend scales" that benefit whole life participating life insurance holders. In the past 20 years or so dividend rates have exceeded both average 5 year GIC rates as well as Government of Canada 5-10 year bonds. During the past years, the average dividend has been between 4-7%. While past performance is not indicative of the future; dividends on participating life policies can be worthwhile tax advantaged investments.
Multiple dividend options exist which include:
- Taking those dividends in cash (on deposit) to earn interest
- Using the premiums to reduce premiums (Premium reductions)
- Using those dividends to buy additional insurance (Paid up additions)
- Using those dividends to buy paid up term insurance (Term insurance option)
Non Participating policies have no dividends and so the value of such plans can be guaranteed.
While the difference cash values and dividends can make to a policy can be significant in the long term can provide not just insurance but investment accumulation, those benefits add to the cost of a permanent policy, . If cost is a factor it might be an option to start with a term policy to protect your family especially a young family, with an option to convert to a whole life permanent policy at some point in the future when needs change and when money is more available. Age will make the premium cost more but health won't be a factor as medical evidence of insurability maybe waived up until a certain point with Convertible term policies. The most important concern when buying life insurance is to make sure the death benefit is large enough to take care of your family.
But how much do you need anyways?
No matter the choice of permanent versus term or temporary insurance, a thorough needs analysis should be done to calculate how much insurance you need. Everyone has different needs. A needs analysis takes into account your future earning potential and your family's ongoing expenses and obligations along with inflation. I and other financial professionals would be happy to do that calculation without cost or obligation. Many of us are also able to shop the market so as to determine your best choice of insurer because costs can vary.
Let's chat.
