3 Uses for Life Insurance
Life insurance makes a lump sum payment to the beneficiary upon the insured person’s death.
In working with clients on their planning, occasionally there is use for life insurance.
We have found there to be three applications.
First is the most traditional purpose: to provide financial protection for a family. Picture a husband and wife with children. They are paying down a mortgage or building up savings for the future and working at their respective careers. If one of the spouses passes away, whether through sickness or tragic accident, there is not only a huge emotional loss, but a financial one. Therefore, the couple will typically buy insurance on each other to protect against that financial loss. Since the need for this insurance is temporary, one will often buy term insurance, which allows a large amount of coverage to be acquired for a low annual cost.
Reason number one, life insurance is acquired to provide financial protection for a surviving spouse and children.
The second reason life insurance is purchased is in a business context. Business partners will purchase life insurance on each other to ensure there is cash in the company to buy out the deceased partner, spouse, or family. A shareholder agreement will often assume that if a partner dies, his or her shares will be bought out by their surviving shareholders. Receiving a one-time payment reduces the financial strain on the company in coming up with the funds for a buyout. It also benefits the deceased partner’s spouse to have the buyout occur more quickly. Since most business relationships are not permanent in nature, the most cost-effective way to provide adequate coverage is through term insurance.
Reason number two life insurance is acquired to facilitate the buyout of a deceased business partner.
This brings us to the third reason life insurance is recommended, and that is for estate planning. As many of our clients reach their fifties and sixties, it becomes apparent that there are more assets than they will need for their lifetime. So, they consider effective ways to transfer the surplus upon their passing. They don’t necessarily need life insurance in its traditional sense, but instead will use it as a tool to guarantee cash in their estate. They might do this for various reasons. First, to ensure there is cash to pay CRA. Often there are assets that will be taxed such as an RRSP but could also include shares of a private corporation. It is common for there to be real estate assets that have been held by the family long term and have appreciated significantly in value. Even if these assets aren’t sold during the owner’s lifetime, there will eventually be a sale or a deed disposition that will result in tax being triggered. Sometimes our client’s estate plan will direct a significant charitable gift to be made upon their passing. And since this is typically going to be a cash gift, life insurance ensures that the cash will be there. Permanent insurance is also used as an estate equalization tool. If one child is going to inherit a large asset such as a business or family farm, parents may allocate a portion of their wealth to insurance as a way of equalizing the value that each child inherits. Since the objective is to hold this policy for life, we recommend using permanent life insurance.
Reason number three for acquiring life insurance is to facilitate estate planning objectives.
If you wonder whether life insurance is a useful tool for your situation, consider the three applications:
- Financial protection for your family
- Facilitation of a buyout between business partners
- Efficient transfer of wealth in your estate
At Covenant, discussions about life insurance always occur in the context of an overall financial plan. While there are similar themes, everyone’s situation is different and will require specific recommendations. For more information, email me at mark@covenant.ca.
