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The following weekend, Sandra and I woke up early on Saturday. The water was still, and the sun was just beginning to burn off the morning haze.
We decided to slip down to the water for a quick swim before the kids woke up. When we reached the dock, we saw Mark and Aunt Lorraine preparing for their Saturday morning ritual dip.
Mark yelled over, “I hope you’re hungry because I’m cooking this morning.”
“I hope you can cook better than you golf!” Sandra shouted back.
Mark pretended not to hear.
We all made the trek over to Aunt Lorraine’s and found Mark at the barbecue grilling sausages and back bacon. Aunt Lorraine was busy inside making waffles, and soon we were all munching happily and sitting on the deck overlooking the bay.
Alice couldn’t resist giving Mark a backhanded compliment. “This is pretty good,” she said. “Maybe if you started offering breakfast as part of a package deal, you’d be able to get a date.”
Aunt Lorraine smiled fondly at them both and announced that she wanted to go down to the harbour to pick up the Saturday newspaper. Even though she could read it on her iPad, she still liked the feel of the newsprint. Scott and Jan volunteered to go with her and take Connor and Paige along for the ride.
After they left, we started to talk while we waited for Uncle Wayne.
“I hate life insurance,” David grumbled. “It’s just too complicated. I have a policy through work and coupled with my inheritance, that ought to be enough. I hope this session doesn’t take too long.”
As soon as we heard Uncle Wayne start his boat, Sally and Alice went down to the dock to greet him while Mark brought out the coffee and some cinnamon buns in case he was hungry.
“I can smell those rolls already,” Uncle Wayne bellowed as he made his way up toward the cottage. “I sure hope there will be enough for the rest of you after I’ve had my fill.”
As soon as he sat down, Uncle Wayne took a sip of coffee, grabbed a roll with great flourish, and announced that the session was on.
“Now, let’s see what you know about life insurance. Open your binders and tell me whether you think you are underinsured or overinsured.”
“If you ask anyone who sells life insurance, they’ll tell you there’s no such thing as being overinsured,” Sandra commented.
“I’ve heard the same thing, Sandra, and sometimes I wonder if it isn’t all just one big con game,” David remarked. “Besides, now that we’ve inherited some money, why do we need life insurance at all?”
“Maybe you don’t,” Uncle Wayne answered, although his tone wasn’t the least bit convincing. “Tell you what, let’s double check for the sake of your family. There’s no reason to be over insured, but if you pull all the papers out of your binders relating to your group policies and any individual life insurance policies, we can determine whether you need additional life insurance after we factor your inheritance into the equation.”
David still seemed reluctant. “Okay, fine. How do we figure out how much insurance we should have?”
Sally was first in with an answer. “The amount of life insurance you need is directly linked to the amount of capital it would take to:
- pay off all your debts;
- provide for your children’s education;
- pay your final taxes, including capital gains taxes;
- provide enough income to comfortably support your dependents when the remainder is invested; and
- create a legacy for your family and/or for a favourite cause or charity.
“What you have to remember is that you’re not really insuring a life, but rather the income that the life would have produced.”
Mark did a double take. “Where did you learn all that?”
“Think back,” she answered. “You might remember that one of my old boyfriends was an insurance salesman.”
“I remember him,” I laughed. “His name was Mike, and he came up to the cottage about two years ago. He was a wild one, the only guy I ever remember going skinny-dipping on the May 24 weekend.”
“Hello,” Sandra said, waving her hand about. “Can we please get back on track? What was that bit about capital gains taxes?”
Uncle Wayne answered. “When someone dies, Revenue Canada assumes that he or she has sold all their assets at fair market value the day before the actual date of death. So if an applicable non-registered asset has gone up in value from its purchase price, it is deemed to have produced a capital gain. Fifty per cent of all capital gains are taxable upon the individual’s death, and those capital gains taxes are included as part of the person’s final tax bill. However, please remember that this does not apply to a spouse, as assets can be rolled over to a spouse tax free. Sometimes this is called a spousal rollover.”
“For Dad’s estate, we had to pay capital gains taxes on his non-registered mutual fund holdings,” I explained, “and on the cottage, since it was not Dad’s principal residence, even though it hadn’t actually been sold.
“The amount of money that was in his RRIFs was included as income in the year of death. There was no tax on his home, which was his principal residence. That’s just the way the system works.”
“Now let’s find out whether or not you have enough life insurance,” Uncle Wayne said. “Jack, you start.”
“I think I’m looking pretty good,” I said brightly. “I’ve got my own permanent life policy for $100,000, and then there’s my policy at the office through the group benefits plan, and that’s worth about $100,000.”
“Well, since Jack has both a term policy and a permanent life policy, let’s use him as an example to determine if he has the required amount of insurance for what he wants to do.”
“Wait a minute, Uncle Wayne. What’s the difference between a term and a permanent life insurance policy?” Sandra asked.
Uncle Wayne explained. “The difference is sort of like the difference between renting and buying a home. An apartment will satisfy your short-term needs, and you’ll pay less every month, but you’re not building any equity. When you buy a house, the mortgage may cost you more on a monthly basis, but at the end of twenty-five years, the payments are finished, and you own it.”
“Okay, that sort of makes sense. Term Life insurance is like renting, and permanent life insurance is like buying a home. So for shorter-term needs, you use term life insurance, and for longer-term or permanent needs, you use permanent life insurance. Is that correct?” Sandra added.
Uncle Wayne smiled and continued. “That’s a good summary. Okay, Jack, let’s proceed. First, if anything happened to you, what would you want to leave behind for Sandra, Connor, and Paige?”
“To tell you the truth, I haven’t thought about it all that much. However, based on what Sally said earlier, I suppose I’d need to leave enough capital to ensure that, when invested, it would produce a yearly income equal to the income I produced when I was alive. How much capital would that be, anyway?”
“I’m looking at the Government of Canada life insurance calculator,” Alice said while looking at her iPad. “Let’s fill it in using your circumstances. What additional living expenses on top of what Sandra earns would she need?”
“It’s probably safe to say that Sandra needs another $35,000 a year after tax on top of her own salary to support the kind of lifestyle she and the kids are used to.”
“Speaking of the kids, have you started their education funds yet?” Sally asked.
“No, we haven’t. Mark, your kids are in university now. What do you figure it’s costing you?”
“Well, I’d say the full cost these days for four years is somewhere in the $100,000 range, assuming they want to go away to school,” he answered.
Uncle Wayne said, “I assume that after our discussion a few weeks ago, you’re no longer carrying any debt, right?”
Sandra and I both nodded. “And we have no capital gains considerations,” I added, “because our only investments are the house and our RRSPs.”
“Okay,” Sally continued, “so I have entered that you have $200,000 of life insurance. You need $35,000 a year for twenty years of additional income/spending, and you need about $200,000 for an education fund, and the answer is that you need another $700,000 of life insurance.”
“That’s incredible!” Sandra sputtered. “Surely Jack doesn’t need that much insurance.”
“Should I also deduct the value of our RRSPs and the house?” I asked.
Alice jumped in. “No, don’t include your RRSPs because you would have to pay about 50% in taxes if you had to liquidate them now. If you leave Sandra as the beneficiary of your RRSPs, they’ll then become RRSPs in her name. There will be no taxes payable until she starts withdrawing funds after she retires.”
Then it was Uncle Wayne’s turn again. “That’s correct, Alice, and we’ll discuss this later when we cover minimizing estate costs. To get back on track, what about the second part of your question, Jack? Would you want Sandra to sell the house?”
“I most certainly hope not!” Sandra interjected before I could even open my mouth.
“Of course not,” I agreed. “I’d want them to keep the house and all their wonderful memories of me along with it! So if I’m not including the value of the house or the RRSPs, that means that all I really deduct from the $700,000 is what’s left of the inheritance, which is about $50,000 after paying off our mortgage, so I need another $650,000. Well, Uncle Wayne, I guess you would say I’m underinsured. Seriously underinsured.”
“If we had a policy that size on Jack, what would happen if he was hit by lightning on the golf course?” Sandra asked. “Do I just notify the insurance company? Do they send a cheque for the full amount? Do they hold back any taxes?”
“You sound a little anxious, dear,” I remarked. “However, I happen to know that life insurance proceeds come tax-free. All you would have to do is invest the money wisely to provide an income for yourself and the kids … well, that and visit my grave frequently. By the way, how come I’m the one who has to die?”
“When your number’s up, you go!” David said with a laugh. “And since Jack’s on his way out, what kind of additional insurance should he buy? Right now, he’s got both permanent and term insurance.”
“The answer depends mainly on timing,” Uncle Wayne replied. “Sandra, how long would you need Jack’s income if you were raising the kids alone?”
“Hmmm, I guess about twenty years, maybe less, but certainly until they’re in university and I could return to work full time.”
“Well, if you would only need the money for twenty years, then Jack only needs the life insurance protection for a twenty-year period. In this kind of situation, I’d recommend term insurance,” Uncle Wayne told us.
“Why term and not permanent life insurance?” I asked. “Doesn’t term insurance get more expensive as you get older?”
“Yes, it does. But remember, you’re young now, and you only need this coverage for twenty years. After that, you needn’t worry about life insurance to replace your income because your kids will be fully grown, and Sandra will be able to support herself by working full-time. You might also wish to add a contingency fund, as it may take Sandra a few years to get her income level up to what is needed. At your age, term insurance is going to be cheaper if the period it spans is twenty years or less.”
“As usual, Uncle Wayne, you’re making a lot of sense,” I said with admiration. “I’ll look into additional term insurance this week to make sure my family’s need for income replacement is covered.”
“Good stuff,” Uncle Wayne replied. “Now, how much life insurance do you have on Sandra?”
“Just her basic policy through work. Is that a problem?”
“Could be. How would you replace her income if anything happened to her? And do you have any idea how much it would cost to provide full-time daycare for Connor and Paige, or for that matter, hire a live-in nanny?”
“I haven’t got a clue,” I replied, looking over at Sandra. “It’s not something we’ve ever considered.”
“Well, you really should.” It was a gentle reprimand. “I think it’s a good idea to insure all working spouses, and I would definitely include someone who stays at home to look after the kids in my definition of a spouse who works. I’m sure Alice would agree. Anyway, by doing this, you will have covered all the bases in case something should happen to either one of you.”
David was starting to lose his skepticism. “Let me make sure I’ve got this straight. We need enough insurance to pay off all liabilities, final taxes, including capital gains taxes, and provide an income for the family, as well as care for the kids, and create a legacy if I wish to?”
Uncle Wayne nodded, so David continued. “From my binder of what I own and owe, I can ascertain:
- the after-tax income my family needs to maintain our current lifestyle,
- the amount of money that I owe (debts),
- estimated education costs,
- potential capital gains and final taxes, and
- legacy desires.
“This much I understand,” he said, “but I’m still not clear on the difference between permanent life insurance and term life insurance. Somebody tell me again why term insurance is the best buy for Jack.”
“I’ll try, but the best buy really depends on your age, how long you’ll need the insurance, and the purpose behind getting it,” Sally said. “As we discussed, since Jack only needs the insurance for about a twenty-year time period, and cost is a factor, term life insurance is the way to go. Remember the analogy that the difference is sort of like the difference between renting and buying a home, where the term is renting, and permanent is owning?”
Sally then went online to an insurance company site and started to enter the information for a non-smoking forty-year-old born March 1, 1979, and came up with the following cost for twenty-year term insurance. She told us the estimated annual premium Jack would pay for a $650,000 20-term policy:
AGE TWENTY YEAR TERM
40–60 $ 709—annual premium
61–80 $10,146—annual premium
“That premium isn’t too bad until age sixty,” I commented, “but after sixty, it gets expensive. Uncle Wayne, do we have any value in the policy after we’ve paid into it for twenty years?”
“No, Jack, no value. All you have is the insurance coverage as long as you pay the premium, but once you stop, the coverage stops, and you have no cash value. If you wanted to use the life insurance to create a larger estate or to pay potential taxes down the road, you would have to invest in a permanent life insurance plan, but the annual premium would be more.”
“Why the price difference?” asked David.
Sally answered his question with one of her own. “Would you agree that regardless of which type of life insurance Jack buys, his chances of dying remain the same?”
“Sure.”
“Insurance companies think so too. With a permanent life policy, the company invests the amount of money paid over and above what’s paid on the pure life insurance costs, and then permanent life policyholders share in the profits from the investments. And you don’t have to pay any income tax on the build-up of the cash value over time.”
“I see,” David said. “So that’s where the cash value of a permanent life insurance policy comes from, and it can provide some tax advantages.”
Sandra had a quizzical look on her face. “Let me get this straight. With term insurance, your coverage stops as soon as you stop paying the premiums, whether it’s after one year or twenty. There’s no pay-out, unless of course the reason you stopped paying your premiums is that you happened to die. However, with permanent life insurance, you may have built up some ‘cash value’ with your policy.”
David looked thoughtful. “I’m with you now. Jack only needs to provide an income for his family for the next fifteen to twenty years, so he only needs life insurance for that period.”
“By George, you’ve got it!” exclaimed Uncle Wayne.
“So, Jack,” David said with a grin, “it looks like you were sold a bill of goods when you bought that permanent life policy.”
“Not really, brother dear,” Sally added. “Permanent life insurance does have it place in a financial plan. It can be used to create a larger estate for your family or to support your favourite cause or charity. Again, this is from my insurance agent friend.”
“Don’t worry about it, Jack.” Uncle Wayne stepped in to soothe my feelings. “A lot of families are underinsured, and just as many buy the wrong type of life insurance for their needs. It’s a complicated business, but permanent life insurance is a smart buy when the need for insurance is going to last an entire lifetime, which is the case when you’re covering off the potential for taxes on capital gains or for a charity. In fact, I have a permanent life insurance policy, which I’m leaving to the greatest university in the world, Wilfrid Laurier University. In one of our later sessions, we’ll talk about a situation where permanent life insurance is an essential part of estate planning.”
“Hey,” David ventured, “I went to Western. It’s the best university in Canada.”
“Now, David, we all know that Western sucks!” I howled as I got up to gather another cup of coffee. “You know, I went to WLU as well, with my friend Frank. Whenever one of us would say “Western,” the other would say, “Sucks!”
“What are you, like fourteen years old, Jack?” David said with a grin on his face, as this was not the first time he’d heard this.
Mark finally got back into the conversation. “I don’t think I need any life insurance since I don’t have any liabilities, and I’ve already provided for my children’s education. I don’t imagine that Sally needs life insurance either, at least not at this point in her life.”
Alice looked piercingly at Mark. “Are you saying that you don’t have any capital gains exposure? Not even with your business?”
“Gee, I hadn’t thought of that. I’d better check with my accountant. I can see that permanent Insurance could be a great solution for my capital gains exposure. Thanks, Alice.”
“There’s one other detail I forgot to mention earlier,” Uncle Wayne said. “There’s a not-for-profit life insurance company organization called Assuris, and it protects policyholders in the event a life insurance company fails. If this happens, the policy will be transferred to a solvent life insurance company, if it’s a member of Assuris. The amount of coverage that will be transferred is up to $200,000 per person, or 85% of the promised value, whichever is higher, per company.”
“That’s a pretty important point,” I commented, “especially since I may be buying term insurance worth $650,000.”
“You should also do some research and use only companies with the strongest financial position,” added Uncle Wayne.
“How about disability insurance?” Alice asked. “Do you think we need any on David, or are we okay now that we have his inheritance?”
“You’re getting too sharp for the rest of us,” Uncle Wayne replied. “I almost forgot about that, along with most of the rest of the population.”
Sally perked up and once again displayed her considerable knowledge on the subject. “Everyone should have disability insurance. If you can’t perform your job due to an accident or illness, it pays you up to 65% or 70% of your regular income. Most people who work for large companies may have some disability coverage through group plans, but the coverage may be limited, and you might want to consider an individual plan custom-tailored to your needs.”
“Well, now,” I said, “what does our insurance expert have to say about Employment Insurance and the Workers’ Compensation Plan?”
“These are very basic plans, Jack. A pay-out from EI only lasts from about fourteen weeks to a maximum of forty-five weeks, depending on where you live, while Workers’ Compensation only covers on-the-job accidents, and besides, when you look at the deficits so many governments are racking up, do you really think you can rely on them to take care of you?”
“I wouldn’t,” I laughed, “unless, of course, I was a Member of Parliament and could give myself an indexed pension, where I get a lifetime guaranteed income that can increase every year with inflation when I retire.”
“Do you think I need disability insurance?” Mark asked.
Sally was starting to run out of patience. “If you couldn’t do your job, a disability policy would pay you a monthly income so you could cover your bills, buy food, and put gas in the boat. Perhaps you’d rather use your inheritance to pay for those things and risk the comfortable retirement you had planned, while leaving behind less money for your kids. It’s your choice.”
“Okay then,” Mark asked, “under what circumstances would I not need disability insurance?”
“You could forgo a disability policy if your financial assets would produce approximately the same income that you earn on the job. Your ability to earn an income over the years is really your largest asset, and it should be insured. By the way, at your age, you have a greater chance of becoming disabled than you do of dropping dead.”
“Isn’t that a lovely thought,” I said.
“What about our policies through work?” asked Sandra.
Uncle Wayne handled this one. “If I were you, I would find out what the monthly benefit would be and how the policy defines the word ‘disability.’ If the policy doesn’t provide about 65% of your current income, you should at least investigate buying an individual plan to top it up. Assuris protection provides guarantees for disability policies, but only up to $2,000 per month per payment. So as we discussed in the case of life insurance, you should not only look at the premiums but the strength of the insurance company.”
Sally grabbed another cup of coffee and asked Uncle Wayne, “What do you think about critical illness insurance? My friend mentioned it to me.”
“Well, Sally, critical illness insurance pays out a lump sum if you have a heart attack, stroke, or develop cancer, as well as covering some of the other medical issues, depending on the company. I’ve had a few friends who had prostate cancer, and it has paid out, which was valuable as it covered the short time they were off work. It’s something that I think you all should review with your financial advisor and see how it could fit into your plans.”
Sally continued. “He also mentioned long-term care Insurance. I’m searching it right now, and the Sun Life Financial website says, ‘Long Term Care Insurance helps you manage the risk of losing your independence due to an unexpected illness, chronic condition or dementia by transferring the risk to Long Term Care Insurance. It provides a comprehensive income-style benefit when you’re dependent. It’s designed to help cover the cost of care services you need in any environment, including your personal residence, a retirement home and a long-term care facility.’[1] What does this really mean?”
“Well, Sally, as you get older, and if you’re unable to care for yourself and/or have a cognitive condition like Alzheimer’s, the insurance company will provide you a weekly or monthly payment to help cover the extra costs for care at home or in a facility. You really must look at the specific company policy to see what you may be covered for. This type of policy must be reviewed carefully as part of your entire retirement and income plan.
“We’ve talked about why you need insurance, but we haven’t really discussed why you may want insurance, as it can be a very useful tool for tax sheltering income and for potentially generating retirement income.”
“How does that work, Uncle Wayne?” asked Sally.
“Well, simply, the extra money that you pay into a permanent life insurance policy above the cost of insurance can grow tax-free. For example, some of my friends with large investment portfolios have transferred some of their conservative, higher-taxed investments into a permanent policy. Once inside the policy, the funds grow tax-free, and if structured properly, they can pay out tax-free to the beneficiaries. With this strategy, my friends pay less tax today and reduced tax on death.
“As for income, if they decide they wish or need to generate income from the permanent policy, they can borrow from it to create tax effective income.”
“That sounds complicated,” I added.
“Well, it can be, which is why you need an insurance expert who can help you make sure your insurance strategies are in alignment with your financial and estate plan.
“And, my young friends, I think that thoroughly covers the topic of insurance. By the way, your Aunt Jen asked me to invite all of you over to our cottage for breakfast next Saturday. She’s been complaining that she never sees you anymore! As for me, I’ve seen quite enough of you for today, and I’m off to play golf. During the coming week, I want you to make sure you have enough insurance coverage, and then you can review your wills and powers of attorney documents for our next session.”
With that, Uncle Wayne headed down the stairs and toward the dock, with Sally and Alice close behind. Sandra went back to our cottage while David and I helped Mark clean up the breakfast dishes.
As we clattered around in the kitchen, we summarized the major points from our discussion about insurance:
- Many people underestimate the amount of insurance they need and/or buy the wrong kind.
- For short-term needs (less than twenty years), buy term insurance.
- For needs that last a lifetime, consider permanent life insurance.
2. Families with young children should insure both spouses.
3. You are not really insuring a life but rather the income that the life could produce. In the case of spouses who stay at home to care for children, you are insuring the cost of replacing that care.
4. The insurance policy should provide enough money to:
- Pay all debts;
- Cover the cost of university for the children;
- Pay final taxes, including those on capital gains;
- Replace a person’s income and/or provide for daycare or a nanny in the case of spouses who provide childcare in the home; and
- Provide for a legacy if desired.
5. Everyone needs disability insurance, which will replace your income if you can’t perform your job.
6. The only circumstance under which you wouldn’t need disability insurance is if the investment income from your financial assets equals the income you’re able to earn.
7. Verify that your disability coverage at work provides about 65% of your earned income. If it doesn’t, consider topping up your coverage with an individual plan.
8. Be sure to review critical illness insurance and long-term care insurance to see if they are required in your financial plan.
9. Be aware that Assuris will transfer a policy to another life insurance company if a life insurance company fails, but only within certain limits. Protect your family by using a financially strong life insurance company.
10. Even with an inheritance, the ability to earn an income over the span of an average working life is most people’s largest asset.
11. A permanent life insurance policy can be a good financial tool to tax shelter income today and potentially generate income in retirement.
12. A permanent life insurance policy is also a great tool for business owners to pay for capital gains exposure for their estate and/or family.
13. An insurance expert can help you tailor your plan to your specific needs and make sure it’s aligned with your financial and estate plan.
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This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see me for individual financial advice based on your personal circumstances. The information provided is for illustrative purposes only. Commissions, trailing commissions, management fees and expenses, may all be associated with mutual fund investments. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated. Please read the Fund Facts and consult your Assante Advisor before investing.
Insurance products are services provided through Assante Estate and Insurance Services Inc.
[1] Source: www.sunlife.ca, Sun Long Term Care Insurance
