Main types of life insurance
There are several types of life insurance, including term life insurance, whole life insurance and universal life insurance. This guide explains the main differences among these types of life insurance and contains information that will help you find the type of insurance that best meets your needs.
Term life insurance
Term life insurance offers coverage over a fixed period, which means that you’ll only be covered for a predetermined period. For example, if you buy 20-year (T20) term insurance, the insurance will only cover you for 20 years. At the end of those 20 years, your contract will terminate and so will your life insurance coverage.
Although you can buy term life insurance for various periods (e.g., 10, 20 or 30 years), these contracts are usually renewable. Therefore, when your 10-year contract ends, you’ll be able to purchase new T10 coverage. Generally, you won’t need to prove that you’re still in good health to renew the contract.
However, the price will increase with age. When you renew a term life insurance contract, it will cost you more than for the previous period. However, if you purchase a new insurance contract with medical evidence, the cost will normally be lower than on a non-evidence basis.
Term life insurance in the first years of the contract costs far less than whole life insurance. However, if the insured lives a long life, the insurance cost increases significantly.
Inexpensive, but without savings component
One of the reasons term insurance costs less is that you’re only covered for a fixed number of years. However, the risk of dying young is much lower than of dying at an older age.
Another reason is that there’s no “savings” component with this type of coverage. You only pay for the cost of the insurance.End of the insight
- Funeral expenses.
- Taxes. On death, most of a deceased's assets are considered to be sold. Therefore, tax may be payable. (The amount of life insurance paid out by the insurer is always tax free.)
- The insured’s debts: credit cards, mortgage, personal loans, etc.;
- New expenses following death. For example, if a spouse took care of the children while the other spouse worked, childcare services might have to be arranged.
These are just examples. The insured might have enough money for his or her burial or other expenses. If so, the life insurance wouldn’t be needed to cover these costs. Take, for example, amounts in an RRSP that would be taxable on death. The beneficiary could simply use these funds to pay the taxes owing.
Term-100 life insurance
Some insurers offer 100-year term insurance. This type of insurance generally covers you for your entire life, even if you live beyond 100.
Some insurers will stop charging you premiums when you reach 100.
However, term life insurance does not provide a cash surrender value as is the case with whole life insurance. See the following section for information on the cash surrender value.End of the insight
Whole life insurance
Whole life insurance provides coverage until the death of the insured person. As long as you’re insured with this type of insurance, you can be sure that your beneficiaries will ultimately receive the amount for which you are insured.
Whole life insurance can be very flexible in terms of premium payments. For example, with some contracts, payments have to be made for a fixed period rather than for your whole life.
In general, whole life insurance covers the same needs as term life insurance, in addition to being used to leave an inheritance.
Cash surrender value and loans
Whole life insurance contracts generally include a cash surrender value. This value is the money you can receive upon cancelling the insurance contract.
Before cancelling an insurance contract for the purpose of receiving the cash surrender value, contact your representative (financial security advisor) for information about the financial and tax consequences. Terms and conditions vary from one policy to another. If you want to cancel your insurance because you need money, you should know that you might be able to borrow against the cash surrender value. In doing so, your insurance remains in force. However, this will involve a loan that you will have to pay back with interest.End of the warning
Universal life insurance
Despite its name, universal life insurance is not suitable for everyone. It combines a life insurance component with an investment savings component.
The insurance premiums may therefore be higher than the cost of the insurance. For example, the insurance costs $400 a year, but the insurer allows you to pay up to $1,200. The additional amount you pay accumulates tax-free in a capitalization fund, provided you do not make any withdrawals. However, the insurer must pay a 15% tax on the investment income generated in the policy (some conditions apply and there are limits on the amounts that can be “invested” under the policy). Although the insured does not pay this tax directly, the amount might be built into the fees that the insurer charges. Furthermore, when you withdraw amounts from the policy, taxes may be payable. If so, the insurer could be reimbursed the 15% tax on investment income that it paid.
In addition, a 3.48% tax is deducted from the amount you pay into the contract, including from the savings portion. The insurer can pay some or all of the tax amount. If necessary, ask your representative for details. You have the option of investing in several products, such as segregated funds. The amount accumulated in the fund can be used to pay the cost of your insurance. You may also make withdrawals. Therefore, tax may be payable. Moreover, you don’t have to pay the premium every year although you must make sure that there is enough money in the capitalization fund to pay the cost of the insurance.
Two types of universal life insurance are sold: one with premiums that increase with age (stepped premiums) and another with fixed (level) premiums.
Example of a universal life insurance contract
Anne takes out a $200,000 universal life insurance policy. The policy costs $700 a year. However, Anne can opt to pay up to $1,500 a year. She decides to make an annual payment of $1,300, and let the difference between the $1,300 she is paying and the $700 that goes to the insurer accumulate in her account. Here’s how it breaks down:
Start of first year:
Amount paid by Anne:
Insurance cost, including fees and expenses:
Amount accumulated in the capitalization fundA capitalization fund is the amount accumulated in a universal life insurance policy.:
Anne decides to invest $600 in a segregated fund offered by her insurer. She anticipates that her investment will generate a net return of 4% per year.
Start of the second year:
Value of account (previous year)
Return credited to fund: (4% x $600)
Amount paid by Anne :
Insurance cost, including fees and expenses:
Amount accumulated in the capitalization fund at the end of the second year:
Anne decides to let the interest accumulate in her account for 25 years.
Start of the 25th year:
Amount accumulated in the capitalization fund:
With $24,988 in her account, Anne can decide to stop paying her insurance premiums. She could also withdraw the funds and use them as she likes.
Universal life insurance is often sold using projections showing the amounts you would accumulate based on various scenarios. They are not guarantees of the returns you will earn. Ask for projections with realistic figures. You might even like to see an illustration of an unfavourable scenario, such as a year when your investment loses money.