Last year it was reported that Kanye West took out a $10 million life insurance policy with his wife Kim as beneficiary. Last month however when their prenuptial agreement became public it would seem that Kanye actually took out a $20 million permanent policy. With a total net worth in excess of $100 million, Kanye’s estate needs certainly could justify that type of policy. But what about your needs? Do you need permanent or temporary insurance?
The short answer is: it depends. Many Canadians are confronted with the decision over buying life insurance when they are married or become new parents. These are often difficult times, when couples are supporting young children on a single income or hoping to buy a home. The task is made even more challenging when having to weigh the differences between permanent and term insurance.
Nowadays, every financial personality and celebrity from Oprah and Suze Orman to the West’s are weighing in on the debate. You don’t necessarily need to be a multi-millionaire in order to warrant owning a permanent policy, but it’s certainly important to understand the differences.
What is term insurance?
Term insurance provides a benefit if the insured person dies within the time of the term. You work out the term with your insurer, according to your own life needs. The term might be until your children are grown, or until you reach retirement age. You pay for the coverage period and at the end of the term the contract, or policy, expires. If no claims are made against the policy during the term, you don’t receive any benefits after the policy expires.
What is permanent insurance?
Permanent insurance never expires. Like term insurance, it provides a death benefit, but it also acts as an investment vehicle. A portion of the premium goes toward investment account, which can build up savings for you. You can borrow against this investment during your life or put it towards your retirement. In many situations, a term life insurance policy may be the best way to provide financial protection for you and your family. The policies are usually straightforward and simple, and the premiums are low, particularly at younger ages.
What they’re saying?
American celebrity Suze Orman who is Oprah’s resident financial guru has a purely Term-centric view of life insurance: “With the exception of a few situations, the only kind you need is term”. Orman believes strongly that insurance was never meant for permanent needs and that you’re better served investing the rest in your 401k (similar to our RRSP in Canada). This 2010 video crystallizes Orman’s view.
Contrast that to the opinion of Canadian finance expert Gail Vaz-Oxlade who takes a slightly more pragmatic approach: “Some of your needs may be short-term. Declining term insurance is often the most cost-effective way to cover mortgage debt. On the other hand, the need to meet your funeral expenses and minimize the tax hit on your estate is permanent. So permanent insurance will be your best bet here.”
Seek an advisor.
Much of the bad rap that permanent insurance gets is due to the fact that advisors earn a handsome commission through their sale of such products. The reality though is a competent financial advisor has a full understanding of both the various types of insurance policies available, and the needs you should be considering. He or she can provide guidance and help you develop solutions which may include, among other products, term and/or permanent life insurance, other insurance products, or a combination of insurance and other financial products that can best meet your present and future needs.
An advisor can walk you through the process of assessing what kind of insurance you need. To properly assess those needs, you need to prepare a checklist of obligations, income sources, present and potential expenses and, most importantly, dreams and wishes for the future. Family responsibilities are a first priority. If you have, for example, a disabled child or relative who may need long-term care, your insurance needs will be more extensive.
The product is just a supplement to the advice.
No product or product type can be prescribed without careful analysis of your needs. There is NO COOKIE CUTTER approach for life insurance. Your analysis would include all your current or potential assets such as insurance policies, including those from work, your savings, RRSPs and other investments, and equity in property or a business. Next you’d need to look at all your liabilities including mortgages, taxes, credit card balances and so on. If you own a small business, it is important to plan for the succession tax that anyone who takes over your business must pay.
The final stage would be to work out, with the help of your insurance or financial advisor, the long-term income needs of your family and any dependants, your retirement plans and ongoing financial obligations. Then it’s a question of calculating the shortfall, if any, that you need to cover with insurance.
The bottom line.
Due your due diligence. Have a trusted advisor shop around on your behalf, or shop around yourself. Ensure that you have struck the right balance between your current and evolving needs, but always ensure that you’ve properly captured those needs through analysis and have them adequately covered in your policy.