≡ Menu

Risk Management via Insurance – Life Insurance

This is a guest post series by Brian Poncelet who is an independent certified financial planner (CFP) working in the financial services industry since 1994. Along with insurance, Brian Poncelet focuses on mortgage and retirement planning.

The justification for the purchase of insurance is endless but in general, insurance is typically purchased to alleviate the financial burden that is thrust upon the family upon the death or disability of a family member. Even the most well planned investment portfolio has limitations if the family is forced to sell off assets for less than optimal prices in a down market just to be able to pay for capital gains taxes and/or basic living expenses.

A well planned insurance portfolio takes into account many factors, the least of which should include:

  • burial, legal and capital gains expenses
  • living expenses for a minimum of 2 years
  • existing debts (mortgage, lines of credit, credit cards)
  • number and age of dependents (children, parents: allocate $50,000, special needs children: allocate $100,000)
  • future expenses (education: allocate a minimum of $40,000 per child for four years of education, new car, home maintenance, emergency fund)
  • marketability of a stay-at-home spouse to re-enter the job market and find a fair paying job with benefits

Case Study

2 parents age 35, husband earns $80,000, and wife earns $20,000. They have 2 children age 3 and 8 and carry a $200,000 mortgage. They have $100,000 in RRSP/non-register funds. How much life insurance is required on the husband?

  • Mortgage: $200,000
  • Children Education: $80,000 ($40,000 x 2)
  • Two years salary: $80,000 X 2 = $160,000
  • Emergency/Miscellaneous: $30,000
  • Total Minimum Insurance Needed: $470,000

The above example is basic and does not factor in how many years the income stream will be required. For example, you may want your spouse to be able to stay at home until the children are no longer dependent. By searching “income replacement” on the internet you will find some excellent calculators to help you further define your insurance need.

Additional factors to consider:

  1. Pension Income. Pension income from the deceased spouse employer: typically a maximum of 60% is allocated the surviving spouse.
  2. Inflation. The effect of inflation on:
    • The insurance policy: even if debt is paid off, an insurance policy worth $300,000 today will only be worth $245,000 in 10 years assuming 2% inflation.
    • Assets: I frequently hear “my wife will use my RRSPs to fund retirement”. How much will $100,000 be worth in 15 years? Will that be enough to allow the family to make their yearly trip to Florida or buy a new car when necessary or send your daughter to that elite school for artisans in Paris?
  3. Group Insurance. Existing employer group insurance: remember this insurance is only good if you are still working for the company. Unless you have been with the company for at least ten years I would treat this amount as zero.
  4. Bank Mortgage Insurance. Existing Group mortgage insurance with bank: the amount of the insurance decreases with the outstanding mortgage balance. Only the residual mortgage balance is paid off. Also, if you change mortgage carriers you cancel the existing coverage and are forced to reapply at the new institution at higher rates as you are now older. If there are any health issues you may not qualify for the new insurance. More on this topic can be found in the Toronto Star at or a CBC video is the best I have ever seen. Both discuss term insurance. If you are going to consider that route, I recommend Term 20 or 30 rather than Term 10. Many people buy a bigger house around the 10 years mark, will not be debt free and have upcoming expenditures (education). The rate increases can seem to be significant in light of other expenses. It is best to defer this rate change for 20 to 30 years especially with a long term mortgage.
  5. Loss of future asset growth – contributions to RRSP or pension plan or simple long term growth on liquid assets.
  6. Goal modification. Will you have to modify your future cottage or recreational plans if future savings contributions cease or are diminished?

In the next edition of the risk management series, Brian Poncelet will discuss Disability Insurance detailing how it works and all the terminology involved.

If you would like to read more articles like this, you can sign up for my free newsletter service below (we will not spam you).

FT About the author: FT is the founder and editor of Million Dollar Journey (est. 2006). Through various financial strategies outlined on this site, he grew his net worth from $200,000 in 2006 to $1,000,000 by 2014. You can read more about him here.

{ 14 comments… add one }
  • Cavil June 26, 2008, 1:45 pm

    Thank you!

  • FT FrugalTrader June 26, 2008, 1:48 pm

    Part 2 will be posted mid next week guys. Brian does a great job explaining disability insurance.

  • FT FrugalTrader June 27, 2008, 7:14 am

    For those of you interested, I ran the numbers using a similar method explained in Brian’s article.

    https://www.milliondollarjourney.com/determining-our-life-insurance-needs-ii-scenario.htm

  • MunEconomics June 27, 2008, 8:18 am

    I think that is too much insurance for the least amout of insurance. Espically if you are above average salary or your spouse is educated.

    But I do come from a family who doesnt have home insurance.

  • Brian Poncelet, CFP June 27, 2008, 9:02 am

    Hello MunEconomics,

    No Home insurance! Let me see, you are not covered for valuable personal items, such as jewellery, artwork, furniture and computers.

    Also, property insurance protects you against personal liability should anyone be injured while visiting your property or should you accidentally damage a neighbour’s property.

    Also. fire, lightning, windstorm and hail.

    This may cost you about $1,000 or more a year depending on the value of house etc.

    You are also not covered for theft etc.

    If you have any children you need to review your ideas about insurance (all types). Please thake the time to talk to a professional and bring your educated spouse. You may look at the “cost” of insurance as minor vs. what is at stake.

    regards,

    Brian

  • FT FrugalTrader June 27, 2008, 9:38 am

    Mun, i’m with Brian on this one. Property insurance is a must. I believe that most mortgage companies require that you have home/fire insurance. A few hundred dollars to protect hundreds of thousands of dollars …

  • Veronica June 27, 2008, 8:52 pm

    This is a great article. But, I think that term insurance can also be beneficial because you can invest the difference of the low premiums. Money in your pocket will be helpful in the invent of any eventuality.
    It is amazing how much you can save monthly. This site’s quote calculator is fun and informative: http://www.termchoice.ca/
    Check it out.

  • Brian Poncelet, CFP July 1, 2008, 9:41 am

    Hi Veronia,

    The problem with the calculator which I have and 25 Canadian web sites have (done by one person) is this should be only used as a rough guide.

    Some calculators default to a preferred rating, in order to show a better rate…watch out, only the insurance companies can honestly honor those rates and many people do not get the preferred rates.

    Like a hammer, term is a tool not a solution for everything. Example say you have a cottage and three kids. Over the years one of kids uses the cottage every summer the kids don’t. The cottage has gain over $250,000 in value. Who pays the taxes at time of death? Term is too expensive! Assume a 70 year old male is healthy and is a non-smoker he wants term 10 for $250,000 (he must die in ten year for this to work) he will pay about $350 per month!! If he tries to get term insurance after 71 he is too late!!

    Another example, a family business built over the years mainly good will. Two children work in the business one does not. Since most of the family’s wealth is in the business how do you split assets at death? Term will not fix this problem.

    Another example, a successful business man age 59 remarries his new wife is 43. He has two children ages 25 and 28. At his death assets go to his wife. She has two kids from a earlier marriage. What kind of mess is this going to be? Guess what, term will not fix this problem.

    I could go on all day why term does not help many problems. For some it is a solution. But the world is not perfect.

    Also, your cousin “Terry” wrote almost the same comments as you did within two hours to another site http://www.wheredoesallmymoneygo.com

    regards,

    Brian

  • Mike July 1, 2008, 12:35 pm

    Brian,

    I have followed your website for some time and I respect what you have done with it.

    However, it seems that your critique of http://www.termchoice.ca is regarding the absense of permanent insurance solutions.

    Nowhere on that site does it say that it is promoting permanent insurance. It is offering simple solutions for term (hence the name).

    I feel that most people are looking for easy solutions. 95% of the people out there are not looking for strategies as complex as the ones you suggest. For the ones that are it is necessary to consult professionals such as yourself.

    I feel it should be much easier for folks to shop insurance without having to go through complicated and cluttered websites that promote everything under the sun. Also, as I am sure you are aware, most agents don’t always promote the right insurance for the right reasons.

    You are right in saying that term doesn’t solve every problem. However, for young families who need a lot of insurance for many different reasons it does make sense.

    People’s insurance needs change a great deal over the course of their lives. Term definately plays a role in some of those stages. As does permanent.

    I visited your website and it clearly promotes term insurance over other mortgage insurance. As a method of self promotion I wouldn’t critique websites that are using the same methods as yourself.

    …….same goes for using an excellent blog to promote your business.

    Mike McKay

  • FT FrugalTrader July 1, 2008, 2:16 pm

    Mike, for the record, some of the readers requested that Brian post his ideas on risk management with insurance. These are not sponsored posts.

  • alice August 5, 2008, 6:09 pm

    dNLWyZ xf78fg623fv0skghlq56fd

  • Grad Student August 12, 2008, 1:48 pm

    Okay, I have a different question about term life insurance vs. permanent life insurance

    I am 25 years old and I have a universal life insurance. My parents bought it for me when I was 4 and I am supposed to keep on contributing to my life insurance for about 350$/year until I reaches 100 years of age (or die). The current policy value is of about 9300$ and the death benefit of the poicy is 93000$. As I keep contributing to it and become older, the policy value will increase and the death benefit will increase as well. By the time I reach 100, if I do, the policy value will be of about 700000$, and so will be my death benefit.

    So here is the problem. I crunched some numbers and computed that the life insurance pays between 6-7% interest on the cumulated premiums that I pay. This does not seems a lot to me, as this 6-7% interest is not guaranteed and fluctuates depending on the dividends paid by the company. I ran another simulation: what would happen if I was to sell off the life insurance and put everything, the value of the life insurance + the premiums, in the stock market. In the event that the stock market pays back, on average, 8%/year, then by the time I will reach 65 years old, the value of my stock portfolio will have surpassed my death benefit. Given that I can make these contributions within my TFSA, these contributions should not generate any taxes when I die.

    So what is the advantage of keeping that life insurance over selling it off and simply buying term life insurance when I need it?

  • Brian Poncelet, CFP August 27, 2008, 12:00 pm

    Hi Grad Student,

    It is hard to say if your UL insurance is good or not. Since you are getting older you can bet life insurance will get expensive.

    A lot of weathly families buy UL or whole life insurance on their kids for estate plans.

    The question I would have would be how much insurance do you have, is it level or increasing? Where is the “extra” monies going, ie, gics, mutual funds?

    Look at life insurance to cover a debt, or for tax-shelter, or esate planning (in the case of UL or whole life).

    Also, what will you earn in the future? If you are going to making some big money, the UL policy may look good if you buy a cottage or other real estate. Many banks make you buy or have life insurance for loans for businesses. If you have a term policy for say ten years this will go much higher at the end of the policy.

    Plus, I have seen some UL or whole life plans taken off the market because they were priced too low!!

    Hope this helps,

    Brian

  • Brian Poncelet,CFP August 21, 2011, 7:15 pm

    I thought I’d revist this topic since the markets have been doing poorly and why there is a need for life insurance as investments are not guaranteed.

    This of course includes real estate, stocks , etc.

    The question to ask is what reasonable rate of return would my family need to get today with a lower amount of risk? Also inflation?

    A tool I have online,gives some idea of how much one may want to maintain a lifestyle for X amount of years.

    http://www.rightinsurance.ca/tools-income-in.html

    The answer most people think is not so much the coverage is how much is this going to cost?

    For that one may re-read the story on Annuities

    https://www.milliondollarjourney.com/how-annuities-work.htm

Leave a Comment