Term insurance

Term insurance is a form of life insurance, i.e. a contract that pays a sum upon the death of the life insured. Term insurance gets its name because the contract is in effect only for a specified length of time, typically from one to 30 years. As long as premiums continue to be paid during the contract term, the contract will pay off should the covered person or persons die before the term expires (cf. permanent life insurance). At the end of the term, the contract is typically renewable for a further term, usually for a higher premium because the life insured is now older, but without proof of continued good health. Life insurance proceeds, including those from term insurance, are generally received free of tax by beneficiaries.

The most common term insurance policies are employment benefits and are typically one year renewable. If an employer pays some or all of the premium on such policies, a taxable benefit arises for the employee.

Those with term insurance needs over and above employer-provided coverage should contact an insurance agent. Costs for term insurance can be approximated using an online service such as Term4Sale.

How much insurance and for how long?
The death benefit should ideally be such that if you die before retirement, your family can maintain the same standard of living. What you are insuring is your human capital, the value of your future earnings. If you are no longer around, your paycheque can be replaced by income earned on investing the death benefit.

The primary purpose of life insurance is income replacement for dependents. When you fully retire from paid work, you are no longer converting your human capital into a paycheque. On the other hand, you probably have accumulated significant financial assets in preparation for retirement. So the need for life insurance is either much less, or nil, at retirement, assuming your assets can be transferred to your surviving spouse.

In summary, you generally need term life insurance when you have dependents, until you retire. The amount of coverage should be enough to replace your future employment earnings. You can estimate this amount using rules of thumb, or calculators such as Barney's Life Insurance Calculator and Milevsky's Human capital calculator. This will probably be a much larger number than you anticipated. Note that if you use the human capital calculator to estimate life insurance needs, you could use your net (i.e., after-tax) salary, because the death benefits are not taxable, although if the death benefit is invested in a non-registered account, interest, dividends and capital gains will be taxable.

Group products
Many employers offer group life insurance as part of their employee benefits package. These packages typically break down the offerings into employee term insurance, dependent term insurance, and optional term insurance. The terms of the plan also may provide for group life conversion, within specific time limits, if their group insurance ends, say through job loss. There are tax implications for group insurance, depending on who is paying the premiums. If an employer pays some or all of the premium on such policies, a taxable benefit arises for the employee.

The terms and conditions of group products vary by provider and by employer. You should review and understand the terms and conditions that apply for your specific plan.

Employee term insurance
Coverage is for the plan member only and various benefit levels are available, typically a multiplier of annual salary.

Dependent term insurance
Plan members’ spouses and dependent children are covered and the coverage amount is usually fixed to an amount designed to pay for the insured's last illness and funeral expenses, not to replace the deceased's future lost income.

Optional term insurance
This coverage provides additional coverage options for the plan member and possibly spouse. You have the opportunity to increase existing insurance coverage, at low group rates, to reflect their individual needs. As part of prudent planning, you should be aware your insurance coverage is now tied to your employment, although most group products do allow conversion, within specific time limits, to an individual policy without providing medical evidence of insurability.

Before you sign up for optional term insurance through work, you may want to compare what is being offered by the group plan with a quote from an online service. Purchasing a term policy independently could be cheaper, depending on your age, health, etc.

Individual term policies
If you don't have life insurance coverage through your employer, or if the coverage is insufficient, consider adding an individual term insurance policy. This will involve contacting a life insurance agent or broker. You will have to answer numerous medical questions, and probably submit a blood or urine sample. In exchange for this minor unpleasantness, you will get protection for your dependents, and healthy people get better pricing.

Selecting the term of the policy
If you are insuring your future earnings, a common guideline is that the term of the policy should stretch from now to an estimated retirement age, for example 65. For example, a 35 year old person would purchase a 30 year term policy, of a term to 65 policy.

Of course, the same person could buy a 10 year term policy, which will originally be much cheaper, then renew it twice, for a total coverage period of 30 years. The problem with this strategy is that upon renewal, your renewal premiums will be much higher if you choose not to pass the medical exam again: the lifeco assumes you are now in bad health. If you take a new 10 year policy with a new medical exam, your premiums will still increase, because you are now older (greater mortality risk), and perhaps not as healthy, as you were 10 years ago. If you have developed a serious illness, you may not be insurable anymore, forcing you to accept the very high renewal premiums.

So when you are young and in good health, it makes sense to buy a term policy that covers the entire period during which you will need life insurance.

Declining needs?
If you need more life insurance coverage in the next 10 years than in the subsequent 10 years, you can combine a 10 year term policy with a 20 year term policy.

Price inflation will also reduce the purchasing power of a constant death benefit anyway: $100k won't buy as much in 20 years as it does now.

Mortgage life insurance
When taking out a mortgage, your lender may offer mortgage life insurance. If you already have enough life insurance to replace your paycheque, you don't need extra insurance to cover your mortgage. If you have dependents, a mortgage, and no (or not enough) life insurance, consider an individual term policy, which has many advantages over mortgage life insurance.