When you buy life insurance, it is one of the most unselfish purchases you can make. This financial product is something that you put into place to protect those you love. Even though you pay for it, you don’t see the benefit from it. Instead, the beneficiaries you choose will receive a payout from your insurance company once their claim has been processed.
You want to make sure that you are giving your loved ones the best possible protection in case you should pass away. How do you know how much life insurance you should buy? What is the right type of coverage for you and your family? These are important questions and you need answers if you are going to find the right coverage.
How to Decide how Much Life Insurance Coverage is Enough
Generally speaking, a good rule when trying to decide how much life insurance to buy is to start with the amount of your annual salary. Next, you’ll want to determine the amount of your net income (how much you earned less your deductions for Canada Pension, Employment Insurance and taxes). You can find the number on your tax return or your Notice of Assessment.
Take the figure for your net income and multiply it by between five and seven. The sum you get will give an idea of how much life insurance to buy. You will be looking to replace a minimum of five and seven years’ of income if you pass away.
Other considerations you will need to look at before deciding how much life insurance to buy are as follows:
- Are you supporting a dependent spouse or children? If you were to die prematurely, how much would need to cover their expenses?
- Do you have anyone else who depends on you for at least some financial support (parents, grandparents, brothers or sisters)? How much do contribute to their support each year?
- Do you own your home? Would you like the mortgage paid off from your life insurance proceeds if you were to pass away?
- Would you like to have enough money from your life insurance policy to be able to pay for your children’s post-secondary education?
- Are you paying child support from a former marriage or relationship? You’ll probably want to ensure that you have enough life insurance to cover the amount of these payments until your youngest child turns 18.
- Do you have any organizations or charities to whom you would like to leave money?
When you add up any of these costs that apply to you, it’s likely that you will need more coverage than just between five and seven years’ worth of your net income.
Types of Life Insurance Coverage
Once you have decided how much life insurance you need, the next step is to choose a type of policy.
Term Life Insurance
Term life insurance policies cover a policyholder for a set amount of time. This “term” can be for a certain number of years or up to a specific age, and then the policy expires. The insurance policy’s death benefit will only be paid out to your beneficiary if you die during the term of the policy. It is usually the most economical choice, especially for young people who are in relatively good health.
This type of insurance coverage is usually offered in terms for five, 10 or 20 years at a time. They may also be offered to age 60 or 65. During the term that the coverage is in place, the amount that you pay for your premiums doesn’t change. If you wish to renew your coverage at the end of the term, the premiums are likely to increase.
Permanent Life Insurance
Permanent life insurance has premiums that stay level over the entire lifetime of the policy. The insurance company charges higher rates in the early years of the policy than the risk that a policyholder represents. They are invested by the insurer and form policy reserves that subsidize the premiums you will pay when you are older (and your risk to the insurer is higher).
The policy reserves accumulate a cash value. The cash value can be used as collateral if you want to borrow money from the insurance company against your policy. You can also decide to cancel your coverage (surrender the policy) and get a payout of your accumulated cash value. The cash value is usually not added to the amount of money paid to your beneficiaries if you die.
Universal Life Insurance
Universal life insurance is a type of permanent insurance. It offers the advantage of allowing you to accumulate cash value in your policy over time. You may be able to borrow against this accumulated cash value in your insurance policy if you need to access funds. Unlike borrowing from a bank, you do not need to qualify for funding before you will be allowed to access the money.
Since the universal life insurance policy has a built-in cash value, you may be able to skip premium payments if you need to. The insurance company will allow this as long as you have enough funds built up in the cash value component to cover the amount of the premium payments.
Depending on the policy you choose, you may be able to change the amount of the death benefit (increase or decrease) if your circumstances change. This option gives you flexibility to keep the insurance in place but vary the coverage.
You may decide to increase coverage if you expand you marry or remarry, or expand your family. Circumstances where you may choose to lower your coverage include paying off your mortgage or when your youngest child completes their post-secondary education.
Consider your Life Insurance Choices Carefully
Before making a decision about life insurance coverage, you should look at your financial obligations carefully. Once you have a clear idea of how much coverage you need, then you can start thinking about what type of insurance makes the most sense for you.
Get quotes from more than one insurance company before you make your final decision. That is the most effective way to make sure that you are getting the best combination of a good policy at the best possible price. For more information please contact us.