Wednesday, March 28, 2007

Financial Planning - Life Insurance

Insurance planning is an important element in most people’s financial plan. Many people need life insurance or other types of insurance for a variety of reasons. Here are a few reasons why someone needs life insurance:

1) Debt – the presence of any level of debt in your financial situation may indicate a need for insurance. Some people like to have enough insurance to pay off all of their debts should they die and other people just have enough to make the payments for a given time providing their survivors with some time to make decisions such as selling a home or car. Generally, it is wise to cover at least the mortgage and car with basic life insurance, especially if you have dependents.

2) Children/dependants – if people depend on you for financial support you need to seriously look at the amount of insurance you need to continue to provide the necessary financial support to them should you die. Review this with a financial planner or insurance professional for an in depth and personalized analysis.

3) Tax and Estate Planning – leaving a legacy to a family member or charity or just paying the final tax bill are also important reasons to consider life insurance in your situation as well. Working closely with an estate planning expert on this type of situation is critical.

There are different types of life insurance for different situations:

1) Term life insurance provides affordable financial protection for a specific period of time that would help your family in the event of your death. Term plans provide a death benefit only and do not include cash values. The premium for term coverage may change periodically, for example, every 10 years. Term life insurance is ideal for the majority of life insurance needs such as providing for dependents or insuring debt because the needs are mostly temporary and term insurance is the most cost effective way to meet this planning need.

2) Permanent life insurance is designed to provide insurance protection for the entire lifetime of the insured person. Many people appreciate this kind of security. If the insured person dies, his or her beneficiaries will receive the tax-free insurance benefit. There are two main types of permanent life insurance:

  • Whole Life Insurance is designed to be kept for your entire life provided premiums are paid as specified in a policy. Premiums are fixed for the duration of the policy's existence (your lifetime or as otherwise indicated in your contract). There is a cash value component that grows over the length of the policy and can be withdrawn if you give up (surrender) the policy, or can be borrowed if you take out a policy loan. Cash withdrawals may be subject to taxation.
  • A universal life insurance plan combines lifetime protection with a tax-sheltered investment fund. The policy is designed to help your family cope when you're gone, but it can also build you another nest egg for your retirement. Based on individuals’ needs, universal life options can, in some cases, be complex.

As always, you should consult with a professional before making any decisions and get a second opinion before being pressured into doing something you aren't comfortable with or don't understand.


Warren said...

Wow, not a lot of interest in this topic. Well I thought I'd get some conversation going. I'm not an expert, as this will clearly reveal. I have a life insurance/investment plan which (as I understand it) allows me to cash out at any time, tax free. The money I've put into it is after-tax, and the cash-out value has been less than my contributions until about now (7 years into the plan). I signed up because my employer at the time was contributing. Now I still have the plan, which is also worth a fair chunk if I croak.

My main need for life insurance was a debt (mortgage), which is now almost zero. I have no debts or other obligations, should I cash out? Can anybody comment on the efficiency of these types of plans?

I think something that is closely related is a will: everyone should have a well defined will so that the government doesn't jump in when you die and say "all your base are belong to us".

Etienne de Cochon said...

Hey Mohican and M-, I really enjoy this blog for the commentary on real estate as well as the substantive advice on financial planning. I've never come across a financial planner in real life that wasn't only interested in trying to sell me their bank's mutual funds and other assorted products. Thanks for writing this.

mohican said...

Thanks for the compliment grover. I try my best to be impartial and provide objective advice.

The way the financial system is setup in Canada it is very challenging to do practically do this but not impossible.