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My husband is about to turn 60 and we have to make a decision to continue with a life insurance plan or to let it go.
We no longer have a mortgage, and we are in process of taking care of our own funeral arrangements, so our kids don’t have to worry about it.
I’ve been retired for over a year, and he plans to retire at 62.
Our question: Do we need life insurance still or should we be OK to let it go?
—Teresa
Should you cancel life insurance?
Teresa, I never want to tell someone to cancel an insurance policy. What if you were hit by a bus tomorrow?
It’s got to be your decision. To help you decide, I will give a quick review of why purchasing insurance makes sense and the two types of insurance available. You can then relate the reason for purchasing insurance to your current need for insurance.
Why do Canadians need life insurance
Ultimately, Canadians buy life insurance because they want to take care of others should something happen to them. They want to protect their survivor’s lifestyle or maximize the inheritance with insurance when they pass away unexpectedly, or naturally after a long, healthy and happy life.
There are two financial needs to consider when determining the amount of insurance needed: How much income would be needed, as well as current and future debts. Current debt may be a mortgage, and future debt may be children’s university expenses or future taxes.
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How much life insurance would you need?
A simple method in determining the how much insurance you need to replace your income is to divide the income needed by a safe investment return.
If you need to replace an annual income of $50,000, and you think you can safely earn 5% on the invested insurance proceeds a year, then divide $50,000 by 5%. This gives you a need for $1 million of insurance, or $1 million minus your existing investments. That is earning 5% a year on a $1 million gives $50,000 a year.
You could argue that you don’t need the $50,000 annual income replacement for life because, your expenses will be lower as you age, you will have other income such as the Canadian Pension Plan (CPP), Old Age Security (OAS), and so on. That’s all true— but this calculation does not take into consideration inflation. Over time inflation will whittle down the value of that $1 million.
Does life insurance cover debt?
Yes, and once you know how much insurance you need to replace income, then just add on the debt.
Maybe when you purchased the insurance your situation looked a bit like this: A $750,000 mortgage and anticipated post-secondary expenses of $250,000 for children, if any, means upping the insurance from $1 million to $2 million.
This gives you a starting point. Now look at your current and future resources and consider how your lifestyle expenses may change if your partner passes away tomorrow. Taking stock like that may cause you to want you to reduce or increase the amount of insurance.
What kind of life insurance do you need?
Knowing the amount needed leads to the next question: What type of life insurance do you need?
There are two main types: Term and permanent life insurance. In my opinion term life insurance works best for income replacement and to pay off most debts. Permanent insurance, such as whole life insurance, is for people wanting to live a full life knowing that life insurance will benefit their children or special interests in some way when they pass.
Probably the most important consideration in selecting the type of insurance is getting the correct amount of insurance. If you need, and can afford, $1 million term insurance coverage, but can only afford $200,000 of permanent coverage, buy the term policy.
Believe me, your survivors will care more about the money they receive than the policy it came from.
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What happens if you cancel a life insurance policy
Those are the simple reasons for buying insurance but what are the reasons for cancelling a policy? If the reasons for purchasing a policy no longer exist for you, then maybe cancelling a policy could make sense for you.
Teresa, ask yourself, if your husband doesn’t come home tonight, what would you do? Would you be OK financially? Would work pensions continue or be reduced?
One OAS payment will stop, and there may be no survivor CPP if your husband is already receiving the maximum, there would be no pension splitting and taxes will likely be higher as a single than a couple.
Maybe your OAS could be clawed back. You may spend less on expenses as a widow, but maybe not by as much as you might think. I don’t know your situation fully, but be sure to take a good look into the future and your needs.
The premature death of a spouse can have low probability, but when it happens, it can create a catastrophic financial event. And one might not recover from the lost income of a partner without insurance. It sounds like that’s why you initially purchased the insurance policy. And my guess is you have a term policy. Much of what I have written about here is based on maintaining or cancelling a term policy.
With permanent policies (such as whole life and universal life), you need to consider the tax consequences of cancelling. If is it an old policy and is affordable, you may just want to keep it, or maybe there is a way to use the cash value to your advantage. There are a few more considerations with permanent insurance.
As you get older and accumulate wealth, the need for insurance to replace income and pay off debts decreases, which may be your situation. One caveat, though, is that if either of you has a shortened life expectancy, consider keeping the policy and even converting it to a permanent policy, so it doesn’t expire before you do.
Read more about life insurance:
- The best life insurance in Canada
- How does life insurance work?
- Do I really need life insurance?
- 5 reasons to buy life insurance—right now
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