ABC’s of Life Insurance

ABC’s of Life Insurance

With marriage and children in the not too distant future, I thought I’d get selfish for a moment and dig into the world of life insurance. Keeping with the theme of previous posts, I’ve kept to the basics.

Let’s start with the “when.” Keeping in mind life insurance is about providing for dependents in the case of premature death, typical starting spots for policy number one either be on marriage or the birth of your first child. Depending on income levels of you and your spouse, reasonable arguments can be constructed for not purchasing on marriage. I’ll suggest politely, however, that it is irresponsible for the family’s breadwinner to not have life insurance once that first bundle of joy comes into the picture.

On the flip side, there is also such as thing as too early as it pertains to your first policy. I’ll draw from personal experience to illustrate. Starting my career as a young professional not too long ago and thinking about retirement savings (sadly I did more thinking than saving), I encountered various financial planners (I use the term loosely) offering to satisfy all my life insurance needs. This was in addition to all the sales material ending up at my doormat and inbox. On the basis I was single with no dependents, paying for life insurance premiums at this time would have been a total waste of money. Think about it – you’re going to slow your retirement savings (compound interest, baby) by paying life insurance premiums so that when you get clipped by a bus you leave a nest egg to whom? In all likelihood your financially secure retired parents. How does that make sense? At this stage in your life, critical illness and/or disability insurance would come before life. These coverages insure your dependents and yourself.

The right amount of coverage is impacted by myriad factors: age, level of retirement savings, number of dependents, spouse’s income, debts, etc. For this reason, I’ll only say two things as to extent: 1) integrate coverage as part of an overall family financial plan and 2) a common rule of thumb is 10 times your current salary. Actually let’s keep this going: for the financially strained (and who isn’t really?) some coverage is better than none. Finally be certain to also integrate with the amount of coverage from your work policy. Its safe assumption that early in your career your work policy isn’t enough on its own (but keep working hard and move up that corporate ladder you keener, you). Share the heavy lifting here with Rosie from HR rather than trying to interpret the 200 page work insurance manual solo.

The next thing to consider in your starter policy is the length. We have two options here: fixed term or permanent. The former is self-explanatory while the latter stays in place until you die and thus guarantees a payout. For this reason, it’s easy to predict which is more expensive – permanent. Keeping with the theme of the young cash strapped professional with newfound financial responsibilities, in most cases your first policy will be fixed term. My goodness, it wasn’t long ago that our financial responsibilities started and ended with rent and Lucky Lager beer – am I right? Permanent insurance can form an integral part of one’s financial plan, but generally requires an amount of wealth accumulation not afforded to the typical young professional.

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The most common term lengths are 10 and 20 years. As you’re young and in good health, consider the 20 year term. You will pay a lower premium in comparison to two back-to-back ten year terms. This is because you’ll be that much older on renewal (ten to be exact) and the cost goes up on each and every birthday. The down side to the 20 year term is that you commit to a premium payment for ten more years. This becomes a factor if your financial situation worsens and any payment is a hardship. Let’s assume you’re moving upwards and thus go for the 20 (or perhaps 30).

Let’s come back to the amount of coverage. For those who don’t delve into the world of permanent insurance (which is perhaps worthy of a future post), a common approach is to wind down as retirement approaches, which will save on premiums. The rational being that you’re building up a retirement savings nest egg which offsets what your dependents will need from an insurance payout. Look at it this way – in theory you start retirement with enough savings to cover you and your spouse for the rest of your life (and hey maybe a little something for junior when it’s all over) – so no need for life insurance in retirement. Truthfully at this point in my life, my plan is to buy term policies, with declining payout, until I reach retirement and then pull the cord on life insurance.

So there we are – we’ve covered the when, why and amount (accepting the “amount” is individualized) of life insurance for the young professional with newfound responsibilities not to be avoided! Stay tuned for future insurance post(s) which dive into the where, who and how (much) –also known as sourcing and cost. Heck, we just may even get into how to prioritize amongst retirement savings, debt repayment and other forms of insurance such as disability and critical illness…I may not be able to sleep tonight.

The author, Pat Kenney, is a Certified Professional Accountant. He has worked in public practice at a local boutique CPA firm in Mississauga for 9 years. He currently holds a senior management position.

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