Wealthsimple is a whole new kind of investing service. This is the latest installment of our “How To” series, where we lay out smart and easy-to-understand advice on navigating the financial world.
You could make the argument that buying life insurance is the pentathlon of adulting. In service of being responsible and planning for the future, you fill out forms, estimate your living (and dying) expenses, and navigate phone calls with financial professionals to discuss things that are probably boring to financial professionals. There’s even a medical exam portion of the event. Until, finally, the marquee moment: You write your first large-ish cheque to a faceless insurance corporation — a practice of yearly cheque writing that, if you're lucky, will last decades — knowing full well that you may never, ever see that money again during your life here on earth.
If the life insurance industry practiced honesty in advertising, its motto would be: It’s boring! It’s moderately expensive! It’s morbid!
So, you may ask, why do it? Wouldn’t that money be better off in a low-fee portfolio built with beautiful software, by intelligent humans, using Nobel Prize–winning financial theory? Or spent on that trip to Machu Picchu because we’re all supposed to be living in the moment anyway? Well, the short answer is: You do it because, after you die, you don’t really want the people you love living under a bridge, huddled around a barrel fire, cursing your name. And because it makes financial sense.
So how does it work? Who should sign up for it? And how do you even do it? To answer these and other insurance-y questions, we devised this short guide to probably the morbid-est part of being a financial grown-up.
How do I know if I really need to get life insurance? Like really really.
If you have children, or a spouse, or anyone else who depends on you financially, then life insurance is probably for you. Especially if you have debts, mortgages, loans, and other things that those nice people are going to be liable for paying. And double especially if your bank statements don’t reflect a sum so large that it will cover the living expenses of those nice people who depend on you in perpetuity.
But even if you are untethered by any human who needs your money, it may be something you want to do out of courtesy. A small policy can cover the costs of whatever funeral or memorial you’ve stipulated in your will. (You do have a will, right?) Untimely death should be sad for your loved ones, not sad and expensive.
There are all kinds of life insurance. I think. At least they advertise all kinds of life insurance. What kind should I get?
For most people, the answer is something called term life insurance. That type of policy means you pay a premium every year for a certain number of years, typically 10, 20, or 30. It’s the same amount every year, determined when you get the policy. If you die during that period of time, the insurer pays the beneficiary (i.e., the person you told them to pay when you got the policy) a predetermined amount of money. If you don’t die, which is also nice, the insurance company keeps the money and you never see it again. It’s as simple as that.
Term life insurance makes sense because it serves the most basic purpose of life insurance: It gives you peace of mind that your loved ones will not become destitute. And it does this at the lowest possible price. It’s so common, it’s what people generally mean when they say “life insurance.”
Are there other options to term life insurance?
The other major category is called whole life insurance. Whole life insurance and similar policies (other flavours include universal, permanent, and variable life insurance) sound pretty tempting at first blush. Unlike term life insurance, these policies never expire as long as you pay the premiums. That means your beneficiary can get a big payout even if you kick it at the ripe old age of 90. Whole life insurance policies and their brethren also have a cash value component — money that you can either borrow against or withdraw while you're still alive. What's more, the cash you contribute is tax-deferred and appreciates every year. Sounds like a combo of life insurance and a retirement account, doesn't it? But it's not for everyone.
Whole life is a good option only under the right circumstances. It's sometimes recommended by financial advisors (like the ones who work here at Wealthsimple, whom you can trust because they don't actually sell life insurance) when their clients have maxed out contributions to tax-reducing accounts (retirement accounts, accounts for their kids' education) and still have more savings than they could spend in a lifetime. It can also be a tool for certain types of estate planning or, in certain circumstances, reducing your tax burden. If you suspect this is the case, a wise move would be to ask a financial advisor for some advice.
So maybe I should get whole life insurance?
For most of us, these types of policies aren't the best use of our resources. First, whole life premiums are extremely expensive, up to 10 times the rate of comparable term life insurance. Second, the policies usually come with high fees that erode the overall rate of return. Unless your financial situation fits those described above, or you have some special financial concerns you think can be addressed with a policy like this, the vast majority of folks are better off buying term life insurance and investing the difference in a tax-advantaged retirement account.
Here’s an example: A 25-year-old woman in excellent health in California will pay $7,932 dollars a year for a $1 million whole life policy (and if you’re not a young healthy woman, the premiums are more expensive). A comparable 30-year term life policy would cost only $410 dollars per year.
The difference is a little over $7,500 per year. At the end of 30 years, this woman's whole life insurance policy will have a cash value of a bit more than $430,000. But lets say she bought term life insurance and invested the $7,500 she saved every year in an efficiently balanced, low-fee investment portfolio over the course of 30 years. Using historical returns on these types of investments as our benchmark, she'd have more than $777,000 instead of that $430,000.
If you'd like to check the math, or enter your own information and compare the difference, a brokerage called Huntley Wealth & Insurance Services has a nifty calculator for you to try.
If it’s better to invest, why not just invest my insurance premium instead of buying life insurance at all?
Because investing should be a long-term proposition. You’re saving money so it will grow and be available later. Most people want insurance in case your family needs that money before you've had time to save enough.
OK, so how many insurance brokers do I need to call to get the best deal? I hope the answer is not, “Talk to 15 and one for good luck.”
Here’s a secret about the insurance business: Whether you shop at one of the web-based companies, like PolicyGenius or Quotacy, or visit the office that sold your dad life insurance, chances are you’ll end up with practically the same set of offers, from the same group of big insurers, for the same prices.
The insurance industry is heavily regulated. While rules vary depending on where you live, in most places the same set of insurance policies from the same set of insurance companies are available for sale by all agents. And everyone has to charge the same price for the same policy. Your best bet, then, is to buy from an independent insurance agency that you like, offers a large menu of policies, and knows the market.
A bonus is if you can find someone with a strong financial planning background who can scope out your needs.
Do I really need to give blood to make it all happen?
If you are young and looking for a policy less than $1 million, maybe not. More and more insurers now offer smaller policies that are available right away and require no medical exam. But they can cost extra. Otherwise, you follow the traditional process. First, you answer a long list of health questions online or over the phone designed by actuaries to figure out how big a risk you are. What’s your height and weight? Do you smoke or use drugs? Do you have a sibling or parent who died of diabetes or cancer before age 70? Then you’ll be presented with a handful of policy options from various life insurance companies. And then, yes, the insurance company will send a physician or nurse to your house to perform a medical exam. Insurers use all that information to sort you into different pricing tiers: smoker or nonsmoker first; then “standard,” “preferred,” or “preferred plus,” which is the healthiest. The premium differences between these are substantial — each class typically costs 25% more than the next healthier one, and smokers can pay 20% more than nonsmokers.
What if I tell them I don’t smoke to get the cheaper rate?
If you’re a regular smoker, they’ll be able to see that when they check your medical history, and they may find evidence of cigarette use in your blood test. If it turns out you lied, they can deny you coverage or not pay out your policy. Better to be honest up front.
Who should I name as my beneficiary?
Usually your spouse, if you have a spouse; your kids (see below if your kids are under 18); or the loved one you trust most to care for your dependents. If your combined estate will be worth over $10.9 million, estate taxes may be an issue, in which case you might consider setting up a trust to help alleviate that tax burden. If that’s your situation, find a good lawyer and a financial advisor.
About leaving the money directly to your kids: Insurance companies can’t pay money out to minors until the court appoints a guardian, a process that can sometimes take months. If you want your money to go to your kids, it's better to set up a life insurance trust, name the trust as the beneficiary, and appoint a friend or family member as its trustee. That way the trustee can award the money to the child right away, or otherwise pay it out as you see fit. An estate lawyer can help with all this.
How big should my policy be?
The easy rule of thumb is between seven to 10 times your annual salary. If you want a more accurate number, you can calculate all the expenses that your family would need to cover — mortgages, groceries, college tuition, etc. Many insurance sites offer handy calculators to help with this (Life Happens, a nonprofit insurance advocacy group, has a good one). Make sure to factor in your outstanding debts and the nonmonetary contributions you make to your household as well. For instance, if you take care of the children, include the cost of childcare.
If I need $1 million of life insurance according to the calculators, but I can’t afford the premiums, what should I do?
Don’t feel guilty; just buy a smaller policy. It’s far worse to not buy anything or to buy too much insurance and stop paying your premiums because you can't afford it — that’s wasted money. It’s more important that your family gets some help, rather than none.
How do I know how long my policy should be for?
It’s best to buy life insurance that covers you at least until your mortgage is paid off and the kids are securely out of college. After that, if all goes well, it’ll be your turn to leech off them!
Oh, wait. I just remembered I bummed a Marlboro at a cookout last week. Should I have come clean about that to the insurance doctor?
Most often insurers ask about your last cigarette, even if it was the only one you’ve had all year. Unfair, right? While we would never tell you to lie to anyone, we will point out that your practice of superoccasional smoke-bumming is extremely hard to prove. Insurers typically run a check using medical records databases, like one called the MIB (you can get a copy of your report here), and if they see you’ve lied, you’ll risk getting your coverage denied. But smoking two cigarettes a year most likely won't show up on that.
What about weed? Does that count as smoking?
In the old days, smoke was smoke. More recently, insurers have gotten hip to the cannabis trend and started classifying medical marijuana in its own category. A few chill insurance companies will cover you as a nonsmoker if you smoke weed recreationally. Even so, your drug habit will knock you out of the cheapest health class. Not being a marijuana smoker will save you money.
OK, now to some practical questions. What if my spouse decides to murder me to get the cash?
Sounds intriguing but insurance policies come with a contestability period to prevent you or your so-called loved ones from taking advantage of most sorts of fatal loopholes. If you commit suicide within 2 years, for instance, the policy is void. Meanwhile, insurance companies won't pay any beneficiary who is a suspect in your murder at any time. Just make sure to tell your significant other about this bylaw, especially if you notice that the brakes on your car have been cut and you find wire clippers under your bed.
How long will the whole thing take? The insurance application I mean, not my life.
In most cases, it will take a couple months to apply, get your physical, and activate the policy. But it’s worth it, and you only have to do it once. So get going.
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