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Insuring your life

June 22, 2016

How much life insurance do you need?

When buying life insurance, it’s important to take into consideration your annual income, debt and net worth.

Life insurance is something you don’t buy for yourself — you buy it for the benefit of others. When should you think about buying it? Certainly, when you get married, have children or have someone who is dependent on your income. Then the question is: How much do you need?

Take a common-law couple in their early 30s we’ll call Carly and Jack. They have been in a relationship for three years and recently purchased a $350,000 two-bedroom condo in a Toronto suburb. But what if Jack suddenly died? It currently takes both Jack and Carly’s incomes to afford their $2,000 monthly mortgage payments and condo fees. Carly could sell the condo and downsize but she’d like to avoid that hassle. So, the couple decided to get life insurance to protect their new home. That way, Carly or Jack would have the money to pay off their mortgage if something happened to one of them.

Many people believe the coverage provided by their employer is sufficient. But let’s do the math. Your employer’s group insurer would likely pay your beneficiary three times your annual salary, at most. If you earn $70,000 a year, that’s $210,000. Let’s say you have a husband and two young children counting on that income for mortgage payments, daycare costs, education savings and day-to-day living expenses. It won’t take long for that lump sum to disappear.

So how much do you need? An insurance advisor will help you to fill out a needs analysis questionnaire to determine the appropriate amount, taking into consideration your annual income, net worth, debts and existing life insurance.

A general rule of thumb is you should be covered for at least 10 times your annual income, so if you earn $70,000, you’d be looking at $700,000 in coverage. But every individual situation is different and should be examined as such.

An analysis would determine what you need the money for, how much you need each month and how long you need it to last. Let’s take Jackie, a 39-year-old married mother of two. She has three goals for her insurance coverage:

  1. Pay off the $300,000 mortgage.
  2. Top up her two children’s registered education savings accounts.
  3. Replace her $60,000 income.

In simple terms, Jackie is looking at a $1 million policy. If she died, the money from her insurance could be spent this way:

  • $300,000 toward the mortgage
  • $100,000 toward the kids’ RESPs ($50,000 is the maximum amount you can contribute to an individual RESP).
  • $600,000 (her annual earnings times 10) to invest to cover day-to-day expenses that her husband Bob and children will incur over the years.

How term insurance works

Term life insurance provides temporary protection for temporary needs. Specific terms usually range from one to 20 years, so it can be an excellent, affordable option for parents with young children. For instance, a typical $1 million term policy on a woman in her late 30s like Jackie could cost about $77 per month. For a man of the same age, it’s closer to $111. Experts recommend 20-year term policies for younger couples who are buying their first homes, are recently married and have significant debt. For couples in their 40s who have little debt and have almost paid off their mortgages, 10-year term policies might be sufficient. Couples should consider joint-term, first-to-die policies, which insure two people and pay out on the death of the first insured person.

Jackie and her husband Bob decided they needed a $1 million, 20-year joint term first-to-die life policy, with a monthly premium cost of $177. They thought about going with a $500,000 life policy instead, but reconsidered at the last minute. With a significant mortgage to pay off, they wanted the security of knowing that in a worst-case scenario, they’d have that extra money for other needs.

In addition to providing affordable protection, term insurance also gives you some future flexibility. Most term insurance plans let you convert your term coverage to permanent insurance without having to answer any health-related questions. As long as your premiums are paid, your life insurance protection will stay in place for the rest of your life.

Use our life insurance calculator to get an idea of how much you might need to protect your loved ones.

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