The following article was published in the September 2000 edition of Canadian MoneySaver. For other important financial advice articles like this, Compulife recommends that you subscribe to the Canadian MoneySaver on-line magazine. The annual on-line subscription fee is only $19.99 CAD per year. Visit the Canadian MoneySaver website to learn more.
My last article for Canadian Moneysaver was titled and asked the question, "You're Worth How Much?" In that article I discussed the fact that your financial value, for life insurance purposes, was directly linked to the income that you earn and how long you'll earn it. The article then elaborated on how to calculate the lump sum of money your family would need in order to generate an alternate source of income.
For those who have encountered the kinds of insurance "needs analysis" that the life industry typically uses, which I like to say "baffles insurance buyers with trivial information that confuses and confounds", you may have read my first article and thought that I left some important things out. This article will cover the kinds of things an agent will typically bring up, which you can completely ignore if you followed the simpler approach that I used in the previous article.
To summarize: I recommend that you buy enough life insurance to replace your paycheque if you die. Having said that, what about:
If you own enough life insurance to replace your paycheque, mortgage insurance is not needed.
What is mortgage insurance and what does it do?
Mortgage insurance is life insurance that will pay off the balance of your mortgage if you die. Sounds good, but why focus on insuring just that? Think about it, how are you dealing with that mortgage now? Each month you bring home a paycheque and each month you make a payment against your mortgage. If you keep on making enough of those payments, the mortgage will be paid off: and is no longer an issue.
If you die, and you have enough insurance to provide your family with the income that you were earning before you died, then they can take that income, make the mortgage payment, and things go on as they did before (just like the song).
Of course if you do die, and your family had the $540,000 of death benefit that I used in last month's example, and also had an $80,000 mortgage, the most sensible idea would be to take $80,000 of the $540,000 and eliminate the mortgage. While that would leave less money for income, your family will need less income because there is no more mortgage payment.
Managing the death benefit in this way means lower taxes (because there is less income to be taxed) and a better return on your investment. The highest guaranteed interest rate that you can earn (in this case, interest that you no longer have to pay) is the interest that you pay on your mortgage loan. Paying off the mortgage, and living on less income, is a win-win strategy.
But in the end, the amount of your mortgage can be ignored for insurance planning purposes providing that you have used the income replacement calculation and providing that you can now afford your mortgage payment. If not, it's time to downsize.
A lot of life agents will toss up a calculation for your children's education. That is a redundant calculation if you carry enough insurance to replace your paycheque.
Question: Where will the money come from for your children's education if you are alive?
Answer: Your paycheque.
If you follow my advice, and if you die, your family will have that paycheque. Whatever they were able to do while you were alive, they will be able to do if you die.
While some people can't figure out how they'll afford their child's university education on their current pay level, I do not advocate attempting to raise your family's lifestyle by dying. The fact is that you probably won't die, you'll probably live. Don't count on insurance to do for your family what you can't financially do anyway. Apart from that, insurance premiums are an expense; albeit a necessary one. The point I have been making is this: don't buy too little insurance! I also advocate against buying too much, but this is a mistake very few people make. Many are over-premiumed but underinsured because they don't buy term.
Spouse's Retirement Fund
If you only insure your income until your retirement (such as age 65), and the money stops coming in, what will your spouse do for retirement?
Given that you'll probably be alive when you and your spouse retire, the question is what were the two of you planning to do anyway?
Whatever you save or set aside for your retirement should end up in your spouse's hands if you die. If you provide your spouse with an income to the point that you were going to retire, then they'll be able to complete the retirement project.
Once again, like the mortgage, it may make more sense for your spouse to make a lump sum retirement investment if you die, and then live on less income given that there is no need for an annual contribution to your retirement fund.
This brings me to the real problem which most people have with retirement saving: Most people do not save enough for retirement. Instead of setting aside a sizable portion of their annual income, people will buy better cars, bigger houses, elaborate vacations, etc. Having done that, they'll argue they just don't have enough left over to save for retirement. Folks in that situation will end up in a pickle barrel in their retirement. I fail to see why you should plan to die to get your spouse out of that pickle.
The fact is that you'll probably live long enough to retire, and you'd better start planning for that now, not later. Whatever you plan to do for your retirement will come from your paycheque. If you carry enough insurance to replace the paycheque then your spouse can carry on.
Don't be Baffled, Confounded or Confused!
By this point I hope you've got the idea. All these side trip issues, mortgage insurance, education and retirement funds, etc., which many life insurance agents raise while purporting to calculate how much insurance you need, become a trivial pursuit if you have done the right thing and bought enough life insurance to replace your paycheque.
If your family has the paycheque they had before you died, they'll continue to live (financially) as they did before. With respect to all this other stuff that agents want to add in: forget about it. Do not get baffled with trivial information that confuses or confounds. If you are dealing with an agent that can't explain it simply enough for you to understand, it's time for a new agent.
Having said all this, there are valid reasons to lower the amount of life insurance that you will need to buy, and we'll talk about that next month.