You are on track to reaching your goals in life. You may have landed your first full-time job, moved out of your parents’ home and purchased your own home, be thinking of getting married or just landed a big promotion. You might also be thinking of getting life insurance to protect yourself, your loved ones or your assets. Life insurance can help you protect your family and dependants from financial hardship and debt when you are no longer there to provide for them.
How does it work?
Life insurance, like all types of insurance, works by spreading financial risk among a large group of people, who pay into a pool or fund. This minimizes costs for an unexpected event like death. Think of it like depositing money into a safety net that will safeguard your loved ones and your assets, and repay your debts when you no longer can.
You may have heard from your family and friends that getting life insurance at a younger age is a benefit to you. But why? Because when you apply for term or permanent life insurance, the insurer assesses the degree of risk that you represent. They look at things like your age, gender, weight and medical history and then place you into risk categories which help determine your premiums and your coverage. Usually the younger and healthier you are, the lower the risk and the lower the premiums.
Your life insurance policy is a contract between you and an insurer. You agree to pay a fee called a premium, and the insurer agrees to pay your beneficiaries or your estate an amount of money upon your death. The payout to your beneficiaries, known as the death benefit, is a tax-free lump-sum which can be used to pay for your funeral. It can also be used to pay off student loans and other debts, provide for your loved ones, donate to charity or set up a trust.
When you die, all of the assets and debts you leave behind (except your primary residence) are called your ‘estate’. Before your loved ones can inherit any money or property, your estate must pay for:
- any debts you left behind;
- Capital gain tax (you are considered to have disposed of all property at fair market value immediately before death, and the value of your estate is taxed accordingly);
- Estate administration tax, formerly known as probate fees (a tax applied to your estate to cover administration fees such as checking your will and paying creditors).
Your estate will have to pay off your debts with whatever assets you had. Your house, cottage, car or other investments could be used to pay off your debt. If your estate doesn’t have enough assets to pay off your debt, it will be considered insolvent, meaning your debt cannot be paid. Unpaid debt does not get transferred to your family.
If you name a beneficiary on your life insurance policy, the insurance money (death benefit) does not go to your estate, it goes directly to the beneficiary. The beneficiary may keep the money for their own purposes, or they may put the money toward settling your estate. Make sure your beneficiaries know how you want the death benefit used, or make provisions in your will to ensure your wishes are met. Be sure to keep the beneficiaries section in the policy up to date as the years go by.
Example: If there’s a cottage that the family would like to keep, the beneficiary can decide to use the insurance money to pay off estate debts or capital gains tax so that the cottage doesn’t have to be sold. Although the beneficiary is not legally obligated to use the insurance money to pay off estate debts, it would be easier for other living family members to not have to pay off the estate debts.
The Ontario Insurance Act ensures that when you name a beneficiary, the insurance money is protected from creditors. In most cases no income tax will have to be paid by the beneficiary on this amount, but you should discuss all tax implications with your insurance agent or company.
Some Common Questionaire regarding Life Insurance
Do You Need Life Insurance?
If you aren’t sure if you need life insurance, ask yourself these questions:
- How much do I contribute to my family’s budget? If I die, will my survivors (partner, children and dependants) be able to take care of themselves?
- Do I have any other dependants such as parents, grandparents or siblings?
- As a single parent, what kind of support payments am I receiving or paying? If I die, how will these continue?
- Do I want my mortgage paid off in the event of my death?
- Do I want money put aside for my children’s education?
- Do I want to leave money to any other family members or organizations?
- Will I leave behind unpaid debts that will reduce the value of my estate or that may burden my family?
- How will my business be affected after I die?
- Could life insurance play a part in my long-term financial goals? Permanent life insurance policies build cash value, an amount of money that accumulates in the policy. In the future you could use the cash value of your policy to boost your death benefit, pay your premiums, supplement your retirement income, or take out a policy loan.
Life insurance isn’t one-size-fits-all. Your unique situation will determine if and when you should buy it and how much you’ll need.
How Much Life Insurance Do You Need?
How much insurance you need depends on a number of factors including how much your survivors will need when you die and the value of your assets. Completing a financial needs analysis which evaluates your current financial situation, your assets and debts, your personal situation, your personal goals and the needs of your family can help you.
It’s a good idea to review your life insurance policy at important milestone events such as having children, getting married or a major purchase, so that you can make adjustments as needed.
An exclusion is something your life insurance policy does not cover. Exclusions can include death by suicide within two years of purchasing your life insurance policy, death from high-risk activities such as sky-diving and death from pre-existing medical conditions. For other exclusions, speak with your insurance agent or company.
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