Money Matters

By Jennifer Marche

The party is bustling. People are milling about. There’s one guy everyone seems to be avoiding. Someone whispers in your ear, "That’s Jack over there. He sells life insurance." Whaddaya know! Now you’re avoiding Jack too.

A reaction like this is often because you or someone you know has had an experience with an insurance agent who sold something not wanted, needed or even understood.

How do you really know if you should be buying life insurance? If you decide that you do need life insurance, how do you know how much you need and what type to buy?

LOOKING AT YOUR SITUATION
When people die, first and foremost their families grieve. Unfortunately, the creditors aren’t always as sympathetic as we would like. Quite often, money matters arise that must be dealt with by the still-grieving surviving family.

There are many ways to prepare for the financial burdens that arise when someone dies. Saving before the fact and borrowing after the fact are two ways. People often find out, however, that these are not always the best methods. Either there hasn’t been enough time to save what is needed, or borrowing is not possible because the surviving spouse has no means to guarantee the money will be paid back.

Life insurance can be an effective tool in planning for financial security. The way life insurance works is that a large number of people pool their funds now, where only a few will die in any given year. The beneficiary receives a predetermined amount from the pool of funds. In this way, the financial burden is shared with those who participate.

Cash and Income Needs
With death comes a need for large sums of cash for the repayment of debts. If one or both of the spouses are working, their incomes are usually essential. Therefore the family’s financial situation would change drastically if one of the breadwinners were to die and their income cease. Life insurance is often used to replace that lost income.

Final Expenses
While funeral expenses are the first to come to mind, there are many other final expenses, which are often the first the family is burdened with after the death of a loved one. Medical bills, legal and executor fees and unpaid income taxes are just a few.

Mortgage Fund
Some people choose to provide for cash at death to pay off a mortgage in order to leave a debt-free home for their family. Not only does this eliminate a major monthly expense to the family, but it can save years of interest payments which can greatly increase the cost of keeping a home. Eliminating the monthly mortgage payments reduces the continuing income need as well.

Dependency Period Income
This is income toward the raising of children up to a certain age -- usually 18, but increasingly the early twenties is the age being selected.

Education
Life insurance is sometimes used to pay for post-secondary education for the surviving children. A single parent is often unable to afford this cost.

Emergency Fund
Many financial advisors recommend that families have an emergency fund equivalent to at least three months’ income to provide for things like serious illness, accident, home repair, etc. Quite often, people provide for this as part of their life insurance benefit, as a single parent may be less able to cope financially in emergency situations.

Estate Taxes
People whose estates have accumulated considerable wealth during their lifetime can be charged with an astronomical tax bill at the time of death. Most properties or assets owned that have increased in value since the time of purchase are subject to tax.

Many people use investment vehicles during their lifetime in order to defer paying taxes. The time of death is the time at which these investments may become taxable. An RRSP, for example, becomes taxable income unless transferred to the surviving spouse’s RRSP.

There may also be substantial probate fees associated with the distribution of the estate, to be paid at this time. If the cash is not available to pay the fees and taxes due, assets may need to be sold for the proceeds. For example, the family home or business may need to be sold. This would create a new and often immediate need for accommodations or income. Life insurance can eliminate the need to sell off these or other types of assets., e.g. artwork, heirlooms, or family car, to pay the taxes and fees.

Business
The business uses of life insurance are many and can be very complex. The most common need arises when a surviving spouse or the children do not wish to, or are not able to, take over a deceased’s role in a business partnership or as acting shareholder of a company. Life insurance can be used for the surviving partners or shareholders to purchase the deceased’s share of the business. This provides needed cash for the family members and ensures that the business survives in the hands of qualified individuals. These arrangements are typically accompanied with legal agreements.

LOOKING AT THE SOLUTIONS
Now that we’ve looked at some of the reasons why people buy life insurance, we must examine the issue of what type is suitable for each need.

Term Insurance
Term is the cheapest of all types of insurance and comes in many forms. This is a policy which provides life insurance for a specific term or period of time. Many term policies automatically renew every year, five years or ten years. The cost increases each time the policy renews, while the amount of insurance remains level. Term policies usually expire between age 65 and 80. Because many people live well beyond the end of the policy, it is typically used for short-term needs. For example, a term insurance policy might be purchased and renewed until dependent children are self-supporting, at which time the coverage can be cancelled.

Permanent Insurance
Permanent insurance falls into many categories:
- Term to 100: While this policy is called "term," it is actually a form of permanent coverage because the term is so long. It is the least expensive permanent insurance because it does only one thing: It provides a death benefit. Typically, the premium you pay each year as well as the amount of insurance remain level for the life of the policy. There are some term to 100 plans which have a cash value in the later years, making them more expensive. With these, you receive either the cash value or the death benefit, but not both. If you take out the cash, the policy is cancelled. There are many uses for this type of insurance plan. It can be suitable for any type of permanent insurance need. Ideally, this insurance is used for a financial need on death, with the amount remaining constant and which will be needed no matter when death occurs.

- Whole life insurance: This type of plan not only provides cash at death but also has a cash value. This means that the insurance policy can serve other purposes besides simply providing cash at death or when the policy is cancelled. This cash value is made up of two elements: amounts guaranteed in the policy relating to the premium paid, as well as dividends paid by the insurance company. Dividends are based on the company’s claims experience and represent a refund of premiums not used to pay death claims.

The cash value may be borrowed against, making interest payable to the insurance company and reducing the death benefit by the amount borrowed and not repaid. Dividends may be withdrawn, used to buy extra insurance, used to reduce premiums or left on deposit to accumulate with interest.

A whole life policy is used for permanent or long-term insurance needs and can provide cash for retirement, emergencies, education and many other future financial needs.

- Universal life: This is the most flexible and perhaps versatile of the permanent coverages. This type of insurance is used for long-term and changing needs. Coverage can be increased or decreased quite easily to keep pace with changing family structure, business agreements and tax liabilities. After premiums are put in, raw insurance charges, premium tax and expense charges are withdrawn from the plan. The insurance costs are set out in the policy and are usually guaranteed. What is not used to pay the costs remains in the policy and earns interest.

Premiums for the universal life plan are more flexible than other types of insurance. The owner chooses the amount deposited, within a range between a minimum and maximum. The larger the deposit, the more tax-deferred growth and accumulation of cash in the policy. As long as there is sufficient cash in the policy to pay the costs, no deposits need be made. This allows the policyholder freedom to pay when cash is available and take premium holidays when this is desirable.

One of the key features of any universal life or whole life policy is that the growth is tax exempt. The growth portion of the cash value is taxed when the money is borrowed or withdrawn, but not if paid out as a death benefit.

This type of insurance is used for long-term cash needs before and after death. Because of its flexibility, this plan is ideal for ever-changing needs such as business insurance, estate taxes and even continuing income for family. Some people may choose this type of coverage because of the attractive feature of the tax-deferred growth.

It has been said that term insurance is like renting a home because while it is inexpensive, when you give it up you take nothing away. At the same time, permanent insurance has been compared to owning a home because, in the long term, you have equity if you want to move, sell or borrow against it and can even pay it off and still own it.

There was a time when one’s financial situation was the only issue in deciding whether to rent or buy a home. Today, this decision even more closely parallels purchasing insurance. Because of the fees, expenses and greater initial outlay associated with buying a home or buying permanent insurance, we have to look closely at what our needs are. If we’re only going to be around for the short "term" -- we rent. But if our needs are long-term, and we want to build equity, we invest the money required to buy.

(Jennifer Marche works with PPI Financial Group in Toronto.)