Debt-Free Forever (20 page)

Most whole life policies have a “reserve,” which can be refunded if you cancel the policy before your death. This reserve is referred to as the cash value of the plan. You can also borrow against this cash value at an interest rate set in the policy. However, if you haven’t paid it back, the money owed will be deducted from the death benefit.

As we saw in an earlier example, term insurance premiums are much lower than those for permanent insurance, so if you
need a whack of coverage and just don’t have the cash flow to support permanent insurance premiums, you may have to default to term insurance to protect your family in the short-and medium-term.

There is a reasonably simple formula for figuring out how much insurance you should buy. Yes, it’s more math. Yes, you’ll need a calculator. Here goes:

Your Insurance Needs = (B + C + D + E) - A

A
: Your family’s Assets and income, including existing insurance, a spouse’s income, government benefits, pension income, income from investments (e.g., GICs, CSBs, mutual funds), income that could be realized from the sale of assets.

B
: Your family’s monthly Budget needs, including shelter, food, and household supplies, clothing, utilities, car maintenance, insurance (home and car), child care, entertainment. If you have a young family, many more years of expenses have to be covered. With a family that’s almost launched into independence, less insurance may be needed.

C
: Costs associated with your death, including funeral expenses, accounting and legal fees, probate costs, estate taxes.

D
: Debts to be paid off, including credit card balances, mortgages, loans, and lines of credit.

E
: Exceptional expenses, including educational costs, vacations, major purchases (e.g., new car, medical equipment), and the like.

Begin by calculating the income your family would have based on the existing income (from pension, spouse’s employment, etc.). Add the income generated from existing assets. Once you know how much income your family will have, you must calculate the expenses they will face.

Some expenses will be one-time costs, such as your funeral or the payoff of existing debt; others are ongoing, such as monthly expenses and educational costs.

The difference between what your family has and what it will need must be covered in some way if you wish to minimize the financial impact of your death. And that’s how much insurance you’ll need to buy. Good insurance representatives will take you through this process, and may even have software to make the whole thing easier. It’s important that you deal with someone who knows what they’re doing. Insurance is a highly technical financial product, and having someone on your side who knows the ins and outs is one way to ease the whole process.

The best place to start is with the amount of coverage you need. Let’s say you’ll need $125,000 to pay off your mortgage, $5,000 to cover your funeral expenses, $15,000 to cover legal and accounting bills, and an additional $100,000 to cover the capital gains your estate will be hit with. All told, you’ll need about $245,000. Buying a policy with a lower payout clearly won’t serve your needs.

The next thing to look at is how long you’ll need the coverage. Some of your needs may be short-term. Declining term
insurance is often the most cost-effective way to cover mortgage debt. On the other hand, the need to meet your funeral expenses and minimize the tax hit on your estate is permanent and will likely go up over time. So permanent insurance will be your best bet here.

GAIL’S TIPS

Since the premium on permanent insurance will remain the same over the life of the policy, while the premium on term insurance will rise each time the policy is renewed, the cost of term insurance will appear far less expensive in the early years of a policy. If you’re holding your policy for a long time—30 years or more—compare the lifetime cost of both types of policies (remember to compare similar features and benefits—apples and apples), and then make your decision.

Some policies let you buy the right to convert your term policy to a whole life policy at a later date. So if you decide to start off with term insurance to protect your young family and then decide to convert to a whole life policy when your needs change and you have more money, your health won’t be a factor in setting the premiums. However, your age will be and the older you are the more your insurance will cost.

Shop around when looking for life insurance. Get several quotes, make sure you’re comparing apples with apples, and buy the policy that best meets your needs. Resist the urge to overbuy, but don’t sell yourself and your family short either. Evaluate your future earning potential and your family’s ongoing needs realistically, take inflation into account, and then buy enough insurance to meet your needs.

Here’s an exercise I like to do with the people who come to see me speak. Think about four of your friends who are all about the same age as you. Write their names on pieces of paper and drop ‘em in a hat. Now write your own name and drop it in the hat. Pick out one name. There’s a 92% to 98% chance that person will become disabled. How sure are you that it won’t be you?

Imagine the horror of being diagnosed with a progressively debilitating disease. Imagine the relief of knowing that while you have to stop working, you have a group disability plan that will help to make ends meet. Imagine your disbelief when your claim is declined by the insurance company because you
just aren’t disabled enough in their eyes. It happened to a girlfriend of mine, and it could happen to you. If you want to avoid a nasty surprise just when you can least afford it financially and emotionally, take these questions below to your benefits administrator at work and make sure you understand the answers you’re given.

1. What’s the policy’s definition of “disabled,” and how long will benefits be paid?
If you can’t do the job you were hired to do, will you be paid regardless of what other work you may be able to find? Will partial benefits be paid if you can only work for a few hours a day? A weak definition of disabled can be one of the biggest holes in a plan. Carol had a disability plan that covered her for her “own occupation” for two years, after which it reverted to “any occupation,” which is pretty typical of a group plan. The only way Carol could continue to collect after two years is if she were unable to do any work at all. If the insurance company deemed she could be a parking lot attendant, they wouldn’t pay.

Don had a good group policy that paid out when he became disabled with a severe joint disorder. When his insurance benefits stopped coming two years later, Don wasn’t prepared for the interruption in his income; he wasn’t familiar with his policy and how his benefits would be paid out. Had he been familiar with the fact that the initial coverage was only for two years and further documentation would be needed to prove ongoing disability, he could have started his doctor on his documentation before his coverage
ran out. Instead, his credit took a big hit because with no money coming in, he had no other option.

2. How much am I covered for, and how will it be taxed?
Most group policies cover employees for a certain percentage of their salaries—often somewhere between 60% and 75%. Some also have a cumulative maximum. But many people have no idea how much they’re covered for or even if their disability income will be taxed. This happened to my girlfriend Kathryn, who thought she’d be facing a tax bill on her disability income. Kathryn is a teacher, and I was pretty sure her benefits were tax-free. So we called and asked and, sure enough, she was in the clear. Many group policies paid for by an employer generate income that is taxed. If you pay the premiums directly from your after-tax income, or if your premium is a taxable benefit, then the money you receive on a claim can be considered tax-free. If you find that the income you receive from your disability coverage is taxed, the next question is: will the money be enough once tax is taken?

3. Does my policy have a residual disability feature?
In the case of a slow recovery or a slow deterioration from a progressive disease, this feature becomes very important. Without it, years may pass before your claim can begin because you must meet the insurance company’s definition of “totally disabled.” That was the humbug in my girlfriend Cookie’s case. While she couldn’t work, the insurance company refused to accept that she was 60% disabled and wouldn’t pay up. Not until she got herself a lawyer, anyway.
Since most group plans have limited benefits for residual disabilities, the seams of your safety net may not be as strong as you think they are.

4. What are the exclusions on my policy?
An exclusion is something you aren’t covered for, and typical exclusions include travel outside Canada, pre-existing conditions, mental or nervous disclosure, and alcoholism. The list can be wide and varied. And if your malady falls within the list, you’ve got a hole in your safety net.

People often don’t carry individual disability insurance because they believe their group coverage is fine. Smart people who want to make sure that they and their families are well protected don’t rely on the off-the-shelf version. They look to an individual policy to supplement it. The other important point in favour of an individual policy is that you may not always have your group plan. A change in jobs, the decision to stay home to raise a family, or self-employment could all leave you with no coverage.

Buying disability coverage is complicated. There are rigorous health criteria, and you must also show proof of income relative to the coverage you’re applying for. That often excludes new entrepreneurs from coverage at least until they have a two-year earnings history. And as you get older, not only does coverage get more expensive, it becomes more difficult to qualify.

You
absotively, posolutely
need the help of a qualified insurance adviser when you go shopping for disability insurance. With so many sizes and styles out there, it’s very easy to buy
one that looks good on the hanger but just doesn’t fit. Using a generalist will get you in trouble. The good fit comes with a fine tailor who can custom-make a disability plan just for you. When you’re shopping for an individual plan, look for the following:

• A policy that it is non-cancellable and guaranteed renewable so that the contract cannot be changed or cancelled just when you may not qualify for another plan.
  
• An inflation rider or a cost-of-living rider, which is a good way to increase your monthly benefits. While expensive, it is critical when you look at the impact of inflation on your purchasing power.
  
• A future insurability rider that will allow you to increase your benefits by quite large sums without additional health questions. If you anticipate significant increases in your future income, make sure you have this feature.
  

So, you’ve been out shopping like a mad fiend, trying to lay your hands on disability insurance coverage. It’s expensive. It’s tough to get. You give up. You’re never going to qualify! Or, worse, because you’re currently not employed (maybe you’re a mom or dad at home, or maybe you’re between careers), you can’t even apply.

While you may not be able to qualify for that disability plan I’ve convinced you that you need, I have another suggestion that might be at least a partial solution: critical illness (CI)
insurance. With this insurance, you buy a policy to cover specific types of diseases and if you’re subsequently diagnosed, you’ll receive the payout of the amount of coverage you bought.

CI originated in South Africa in the early 1980s, the brainchild of a cardiologist who watched as the financial stress exacerbated his patients’ health problems.

According to the Heart and Stroke Foundation of Canada, one in four Canadians will contract a critical illness by the age of 65. But with the tremendous strides in medical technology, you’re far less likely to die. You might even make a full recovery. Thirty percent of cancer victims are completely cured, while 75% of stroke victims and 95% of heart attack victims survive the initial occurrence. The problem most people face is that lengthy and expensive treatments often mean people don’t have the money to get them through the crunch until they can get back on their feet and start earning a living again. And that is where CI insurance steps in to fill the gap.

Critical illness insurance pays a lump sum on either diagnosis of the conditions you’ve bought coverage on or their progress to an agreed state. While a heart attack is a heart attack and requires no further definition, multiple sclerosis might not actually impair your lifestyle for many years.