6. Insuring Your Most Valuable Asset

The Canadian Money Roadmap

Insuring Your Most Valuable Asset

September 09, 2020

Evan Neufeld, CFP®


EPISODE SUMMARY

This episode covers a basic overview of life, critical illness, and disability insurance so you can protect your most valuable asset.  You!

DOWNLOAD FREE RETIREMENT READINESS CHECKLIST

TOPICS IN THIS EPISODE

1. Life Insurance: Pays tax free benefit upon death. Term vs Permanent. Aim for total coverage of Debt + 7x Income

2. Critical Illness: Pays tax free benefit upon diagnosis of a covered condition.

3. Disability: Pays benefit based on your inability to earn employment income. If you have benefits at work, you might already have sufficient disability coverage but double check the variables so you know what you have.

4. Creditor Insurance: Typically more expensive and less comprehensive than a personally owned policy but can be a good option if your health prevents you from getting a policy on your own.


OTHER EPISODES

12. Buying a House Featuring Kindra Sowden 

15. Mortgage Masterclass with Bud Jorgenson

If you enjoy listening to the podcast, please leave a 5 star review on Apple Podcasts


Become a client - Plan for your retirement and invest with Evan


Become a client

Financial Foundations Course - Save 25% with code PODCAST25

Full Financial Picture Spreadsheet




Transcript:

Hello, and welcome to the sixth episode of the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today's episode we're going to continue to talk about your financial foundations by looking at insurance. We’ll mostly cover the basics of life insurance, critical illness and disability insurance and a brief touch about creditor insurance at the end of the episode. 

As I mentioned in the intro, insurance forms are part of your financial foundation.  The reason that I say that is because if you become sick or disabled, or in the worst-case scenario, if you die, you'll want to make sure that your most valuable asset is protected. Now, what is your most valuable asset?  Some people might say your house or something like that.  I would argue that it's actually you and your ability to earn an income because if you had enough time you'd pay off your debt, save enough for retirement, save enough for your children's education and everything that you want to do with your money over the long term.  But if an unforeseen circumstance shortens your timeline on those things, insurance can step in and take care of it for you.  Since insurance steps in and covers off some of those expenses on your behalf in the worst-case scenario, we refer to insurance as something called a risk transfer. Those are the risks that you carry of getting sick or dying and so to be able to get rid of those, we transfer them off to an insurance company in exchange for a premium. The premium is the price that you pay for the coverage.   

I'm going to talk about life insurance (which should really be called death insurance, but the branding isn't very good on death insurance), critical illness insurance, and disability insurance as well. 

So first off, life insurance is designed to do three things. It's designed to replace your income, pay off your debt and preserve an estate. Now replacing your income when you buy insurance, it's typically not directly tied to your income or an asset like your house or anything like that.  A main feature of life insurance is that it is a tax-free benefit to your beneficiaries upon your death. When we say it replaces your income, we mostly just mean that you would be buying enough coverage so that the benefit that beneficiaries receive would be enough to replace your income for a period of time. 

The second one that I mentioned is paying off your debt. This isn't creditor insurance where it's directly tied to your mortgage provider or your car loan provider or something like that. But in most cases, if you were to pass away, you'd want to make sure that your spouse, your kids or whoever is left behind isn't having to pay off that debt on your behalf with their own cash flow. It makes sure you have enough coverage to cover off your debt as well.  

Preserving an estate is a little bit more complicated. I always say that it doesn't matter how young or old or rich or poor you are, no one dies for free.  The costs that come upon your death could include something relatively small like a funeral, but there's often deaths that are left outstanding or with taxes in most cases. Insurance can be a predictable and, in many cases, an affordable way to cover off some of those after life expenses. 

When it comes to the two main types of life insurance, there's term and permanent.  Sometimes I refer to it as term and perm.  Term is kind of like renting insurance while permanent is like owning insurance.   

Term is much cheaper, but at the end of your term, it'll automatically renew for a higher price.  Let's use term 10, for example. If you have term 10 insurance, at the end of your 10 years the insurance company knows that you're 10 years older and 10 years sicker.  So, they're going to charge you accordingly. The cost of owning that policy is going to go up kind of like a staircase that gets considerably more expensive as you get older.  As a result, most people don't own term insurance into their later years, but they usually use it to cover off things like their mortgage and replace their income in their earlier years while they're still working.   

Permanent insurance is like owning insurance, like I mentioned before.  In most cases, your premiums are going to be level for your whole life and then the benefit is going to be there whenever you pass away. In some cases, permanent insurance is referred to as term to 100. Which means that you're going to pay it until you turn a hundred years old.  But if you happen to live to say 110, it's going to still pay out regardless. 

 Term is cheap, considerably cheaper than permanent anyways, and so it should be used to cover up your major debts and replace your income while you're in your accumulating years. While permanent can help pay for your final expenses whenever you die and help pay for any taxes your estate would have owing.  Now that's a much more complicated and nuanced conversation, but I'll just leave it there for now.  

So how much life insurance should you have? Well, working with an insurance agent, you can do a comprehensive needs analysis for life insurance. But if you're looking for a general rule of thumb, the one that I usually like to use which gets pretty close to the comprehensive needs analysis results, is that you want to add up how many debts you have or the total value of your debts.  This includes your mortgage, car loans, student loans, and anything like that. Then add seven times your income. So your total debt plus seven times your income should be a good place to start for how much life insurance you should have.  

Now, if you start looking at that dollar figure and thinking, my goodness, that's a lot of money.  You can start doing an exercise in your own head where if you were to die tomorrow, put yourself in your spouse's shoes. See how quickly that life insurance cheque would be spent. So eliminate all of your debts, if you have kids at home set aside some money for their school. Maybe allow for your spouse to stay home with the kids so that kids don't now have to go to a babysitter because your income is forcing your spouse to go back to work. That “seven times your income” figure goes pretty quick.  So that rule of thumb of covering your debts plus seven times your income, isn't going to get anybody rich by any means, but it will be sufficient to make sure that your family is taken care of. 

Critical illness insurance is a little bit different than life insurance. Now if I go back to my life insurance explanation, and I think it should be called death insurance because to have your life insurance benefit paid out, you have to die. Whereas your critical illness benefit is referred to as a living benefit.  So you actually have to survive 30 days after a diagnosis of a critical illness. Now, depending on your policy, a critical illness definition can be very different.  But in most cases, it'll at least cover cancer, heart attack, stroke, coronary artery, bypass surgery, things like that. But depending on your policy, it might even cover up things like Parkinson's, severe burns or a loss of a limb.  Just make sure you know, what you're applying for when you get your critical illness coverage.  

So critical illness protection provides a lump sum benefit if you're diagnosed with a covered condition and just like life insurance, it's tax free as well. It can be used for whatever you want to use it for.  It's not tied to what your medical costs may be.   In some cases, if you have critical illness coverage, you might just want to take some time off work, you might want to take your kids on a trip to Disney world, or you might want to go down to the Mayo Clinic for a second opinion or something like that.  But that's what a critical illness policy covers.  

The reason you might want to consider having critical illness coverage is that in some cases, depending on what you're diagnosed with, critical illness can actually be more financially burdensome than dying because you're still alive, but your family has to take care of you.  You might have some increased prescription costs or medical procedures that you have to do on an ongoing basis. And in some cases, your ability to work is limited, but you might not be able to be covered by a disability policy in the meantime.   Another reason why critical illness can be good is if you're a stay at home parent. Disability insurance, which I'm going to get to in a second, covers your ability to work. But if you're not employed outside of the home anyways, you won't have disability insurance. So critical illness could be something similar that can step in on those worst-case scenarios. 

I've alluded to disability insurance already, but I’ll backtrack again. So if life insurance covers you if you die and critical illness covers you if you are diagnosed with a critical illness and survive for 30 days after your diagnosis, then disability insurance covers your ability to go to work and earn an income.   

Disability insurance has a lot of variables and so I won't get into all of them and the pros and cons of each. Some of them are the maximum benefit period. So some cases, your disability coverage could only cover about two years’ worth of payments, but in many cases it can cover you up to age 65. 

The second variable would be your elimination or your waiting period, which is the time between when you make your claim up until when you get your first payment. Many cases this is 90 days. Sometimes it's as few as 30 and sometimes a much higher than 90 days. But again, depends on your policy. The main variable that you want to take a look at is your monthly benefit, which is based on your income.  And so you'll never be able to apply for more disability insurance than you would actually be able to receive in employment income. The insurance company doesn't want to have your incentive be greater on disability than to get back to work. So there is a maximum amount that you can apply for, which is based on your employment income. 

When you apply for disability insurance, you generally have to report what your income is so that they can actually verify what your maximum monthly benefit would be. Now, a little bit more of an interesting variable here is the policy might have a definition of what disability actually is depending on your occupation. There could be a stipulation on something called your own occupation versus any occupation. So if you're disabled to the point where you can't do any work at all, that would be covered under an any occupation definition. But if you're disabled to the point where you can't specifically do your previous occupation, but maybe you could do something else, you would want to make sure that you have an own occupation definition on your policy.  An own occupation policy is best used for professionals or highly skilled people that would be limited in their ability to earn a high income as a result of increased training, lots of experience or many years of education.  Examples would be doctors, veterinarians or things like that.  

If you have a benefits program at work, you'll often have disability insurance already.  If you go back and listen to the different variables that would be present for disability insurance, have a look at your policy and see what your policy would actually cover.  In many cases, it might not be up to the standard that you want, even though it's already included in your policy.  So there may be an opportunity for you to offset what your employer offers with something that you could own on your own.  But make sure that you take a look at that because you can't have two disability policies pay you to the point where you would actually earn more than you would earn while working.  If you're self-employed or don't have benefits at work, I would make sure that you take a look at a disability insurance policy to make sure that you're covered in the case where you're disabled so that your income can continue to make sure that your family is protected. 

Now the last little bit of insurance 101 here that I want to cover refers to creditor insurance. If you've ever applied for a mortgage or got a car loan or things like that, they'll often ask you if you want to have life insurance or disability insurance attached to that loan. So let's use a mortgage, for example. Say you have a mortgage of $300,000 and you have life insurance coverage on that loan. What that really means is if you were to die at any point while you still have that mortgage, the mortgage would be paid for from the insurance company.  So as you continue to pay off the loan, the benefit to you for having that coverage decreases as well.  In most cases, your premium actually stays the same through the duration of the loan, but your benefit decreases. So as a result, it's often much more expensive for less coverage and more expensive, mostly because of a process we call underwriting. So I haven't talked about this at all yet but for life insurance, critical illness, disability, or any of those policies that I talked about before, you'll have to go through a process called underwriting.   

Underwriting is essentially just figuring out whether you are in good enough health for an insurance company to take on the risk of giving you a policy.  With creditor insurance, they might ask you a few questions. It really depends on the loan that you're applying for and the dollar amounts and things like that. They might ask you some of the big ones, like if you're a smoker, if you've ever had cancer, if you have HIV or some of those things.  But because they're not asking much more nuanced questions and getting a blood sample and things like that, they are giving creditor insurance to many more people. So the risk pool that you're a part of with creditor insurance is much riskier perhaps than your own situation and so as a result for the convenience of being approved right away, you'll pay a higher price over time. 

So if you're in good health, I would highly recommend that you look into applying for your own personally owned life insurance, critical illness and disability insurance, as opposed to going with creditor insurance. But if you're unable to have any of that life, critical illness or disability insurance on your own as a result of your health, but you would qualify for creditor insurance, definately make sure that you get that. You want to make sure that even if it's a bit more expensive that those assets are covered. 

Now, that was a bit of a whirlwind tour through insurance. As I mentioned before, you want to make sure that your most valuable asset is insured to protect your family, to protect yourself and to protect your estate from taxes and things that you might not have sufficient assets to pay for upon your death.  

I talked about life insurance term versus permanent.  If you're looking for short term needs, look at term. If you're looking for preserving an estate or some long-term benefits, look at permanent, or maybe a combination of the two depending on what your budget is like.   

Critical illness is a type of coverage that pays out a lump sum benefit based on you surviving a diagnosis of a covered condition. Disability insurance covers you if you're unable to go to work, keeping in mind those variables of your benefit period, your elimination period, your total monthly benefit and your own/any occupation definition.  Make sure you take a look at your benefits at work and make sure you're covered off. 

The main thing that you want to keep in mind is that you have enough coverage. Some people say I have some coverage through my work benefits already. So that's good enough. And I'm speaking about life insurance here mostly.   But for life insurance, if you only have your work coverage, which in most cases is two times your salary that you're earning, that's not going to be sufficient to make sure that you cover off those needs for your family, if you were to pass away. 

And so the rule of thumb that you want to aim for when it comes to life insurance is to make sure you cover your debts and aim for about seven times your income after that. That should be a reasonable amount of insurance to have. 

Thanks for joining me today on the Canadian Money Roadmap podcast. If you enjoyed today's episode, I'd really appreciate if you left me a review on Apple podcasts with your biggest takeaway. If you have questions or ideas for topics you'd like me to discuss on future episodes, please reach out via my contact info in the show notes. 

This podcast is intended to be educational in nature and you should always consult your Financial, Tax and Legal advisors before making changes to your financial plan. Any rates of return discussed are historical or hypothetical and are to be used for educational purposes only. Evan Neufeld is a Qualified Associate Financial Planner and Registered Investment Fund Advisor.  Mutual funds are provided through Sterling Mutuals Inc.  

Previous
Previous

7. Tax Basics and "The Next Bracket" Myth

Next
Next

5. Budgeting for people who hate budgeting