Friday, July 13, 2012

The Term Insurance Trap

I think that term insurance has it's place in everyone's financial plan. I myself own $500,000 of term insurance on top of my permanent insurance policy. It's a great way to protect ourselves when we are young. It's an excellent way to create an immediate cash surplus in the event that we pass away too soon, and our families need the money to continue to live. But, I find that most people don't completely understand what term insurance is.

The best way to look at it is "rented insurance". It is a finite thing with a definitive start and a definitive ending. The two most popular policies sold in Canada are 10 year term and 20 year term. Essentially these are insurance policies that allow people to rent their insurance for a period (term) of 10 or 20 years. What happens during these terms?

Think of a staircase. The insurance starts out as very affordable, and at the end of the period it jumps significantly higher. And, it does for for a set amount of time until the life insurance company will not insure you any longer due to accumulated age. At this point they get all of your premiums paid for the life of the policy, and they don't even send a thank you letter. Most people are shocked to learn that this what they originally bought.

Here is an example of what it would cost to insure me, a 30 year old male, for $500,000 comparing both policies:


1-10 - $30.45 - $37.66 
11-20 - $97.95 - $37.66 
21-30 - $235.58 - $288.09 
31-40 - $594.76 - $288.09 
41-49 - $1745.23 - $1750.33 
50- Expired - Expired

I think the term insurance trap comes into play when people do not regularly review their insurance policies. Not understanding when the policy is renewing can be quite an expensive mistake for many people. Luckily, the majority of term products sold are guaranteed renewable which means they will reset to these higher rates unless canceled to prevent you from going with out insurance. They are also guaranteed convertible which means they can be converted to permanent insurance with out medical evidence at any time.

So, what is the right solution? For most people it's ideal to buy permanent insurance layered with term insurance when they are young. Our needs for life insurance evolve as we get older, but they almost never disappear. The only time some one wouldn't need life insurance is if their nest egg is so significant that it can cover all of their cash needs at death. Even at this point life insurance is a great tool to cover the tax liability that arises in this case.

If you can't afford permanent insurance, then definitely go for 100% term but make sure you understand the renewal dates. Also, review your situation often to see when the opportunities to buy permanent insurance come up. Don't get trapped by higher rates.

*Note: The rates used in this article are for illustration purposes only. They can and will be different based on a person's individual circumstances.

Life insurance is the greatest gift you can give your loved ones. It's also a great gift to give yourself for your own personal wealth and satisfaction. Many people don't know where to start which is where I come in.

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