Life insurance can be a tough task to face, but it’s pretty essential to ensure that your loved ones are looked after you die. Grief is difficult enough without having to deal with the stress of not being able to keep up with mortgage or car payments. But how much life insurance do you need? Here, we cover the different factors you need to take into account so you can arrive at an amount that gives you peace of mind.
What does life insurance cover?
Life insurance covers death. What the payout looks like depends on your insurance policy. And the amount of the premiums you pay depends, of course, on the amount and type of coverage you get as well as your personal details (like age, gender and health).
As far as coverage goes, your life insurance policy guarantees a pre-determined tax-free payout to your survivors if you die while the policy is valid. In exchange, you pay the insurer monthly or annual premiums, usually for the duration of the policy.
Your broker or insurance provider can help you determine the types of coverage you need, from funeral costs to outstanding debt. And that will help you determine which type of life insurance you buy: term life insurance or permanent life insurance.
Term life insurance is a policy for a finite length of time and it has no cash value when it expires; in order to ensure a payout for your survivors, you’d have to renew your policy on a continuing basis. On the other hand, permanent life insurance is a policy that you maintain for life and therefore guarantees a payout for your beneficiaries, without having to renew. There are a number of subtypes that give you more options—policies designed for couples, for example, or life insurance that also accrues cash value (which is the case with most types of permanent life insurance) or can be used as an investment account.
Term life insurance is generally cheaper, making it a good option and better value for people who are still in their working years, and have larger expenses and less room in their budgets to provide for an unlikely event.
The cost of life insurance and policies
As for how much a policy will cost for you, that depends on many factors (which is why you have to give those personal details mentioned above). This quick chart will give you an idea of the difference in cost for different life insurance policies, as outlined above. These averaged rates are for a healthy 40-year-old woman who doesn’t smoke.
Do you need life insurance?
You may be wondering, “Do I even need life insurance?” For some people, the answer will be no; if you’re single with no children and have enough money to cover any debt as well as funeral expenses, you probably don’t need to worry about life insurance. But if you have dependents and/or debt you can’t cover with your existing savings, insurance can be very helpful.
How much you life insurance you need?
The amount of coverage people choose to get varies widely—it really comes down to individual needs. Some need only minimal life insurance—essentially, enough to cover burial and funeral expenses as well as any outstanding debt. At the other end of the spectrum are those who want their beneficiaries’ living expenses to be completely covered, and for them to be comfortable for many years to come.
Among Canadians who have life insurance (roughly two-thirds of the country’s households), the average coverage is $200,000, but experts believe this amount falls short of what most people actually need. An oft-recommended ideal amount of life insurance coverage is 10 times your annual net income, but there are a number of factors that could make it advisable to increase or decrease that number.
Natalie Trimble, financial security advisor and investment representative for Freedom 55 Financial, a division of Canada Life, sees life insurance policies (both term and permanent) ranging from as low as $25,000 up to $2,000,000; the average amount she sees among her clientele is $1,000,000 of term life insurance.
But there’s no ideal amount, she says: “It all depends on the client’s needs—it’s not a one-size-fits-all.” This is where an advisor can be helpful in figuring out a policy that will cover your family’s needs with premiums that you can afford.
“Every client is different: Some want to ensure their family’s priorities are taken care of, some have charitable and philanthropic goals they want to have fulfilled and some have complex business or family situations that require more in-depth fact-finding to determine the optimal amount of insurance required.”
Let’s do the math together
When calculating how much life insurance you need, many advisors will start with the DIME method. DIME is an acronym that stands for debt, income, mortgage and education expenses. Essentially, an advisor will add together:
Any outstanding debt you have
Your annual net income multiplied by the number of years you expect your family will need to rely on it
The amount left on your mortgage
An estimate of what your kids’ educations will cost
Then they subtract any income a surviving spouse would have as well as CPP survivor benefits (which is the deceased person’s government pension paid to the surviving spouse), and the resulting total will give you a good base number to start with.
You can also take into account other assets, but it’s not always advisable, says Trimble. “Most families do not have sufficient liquid assets that they could draw from without compromising their other goals; the money is either tied up in real estate or registered accounts,” she explains.
“The main premise for life insurance is to have capital available so that decisions like selling or liquidating assets don’t have to be a first option. We want to make sure that families have options to preserve what they’ve worked hard to build and peace of mind that they can make other financial decisions when they’re ready to.”
Now that you know roughly how much life insurance you need, what’s next?
“People should be prepared to share what their short-long term financial plans are with their advisor or broker,” says Trimble. “I would suggest doing an inventory of their liabilities and be prepared to discuss how they would have liked to see things happen if something had happened to them yesterday. The more your advisor knows about what’s important to you, the better job they can do with getting you the right-sized solution.”