We recommend straight-term life insurance. But beyond that, here are five insurance purchases we advise against.
My view is that you should only buy insurance to protect yourself against catastrophic, unforeseeable losses. That’s why it’s essential to have fire and liability insurance on your house, plus liability and possibly collision on your car. To stretch a point, you might want to add kidnapping/ransom insurance, depending on your travel plans.
For life insurance, I only recommend straight term insurance. This type of life insurance has no investment component. It simply provides a cash payment if you die. The premiums go up on a pre-planned schedule, and you may only be able to maintain coverage to age 65. (Note that if you and your spouse both work to support the family, or even if one works and the other is a full-time homemaker, it’s a good idea to look into joint term insurance policies that pay off if either one of you dies.)
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Meanwhile, here are some insurance purchases I’ve advised against:
1, Buying life insurance on the parents’ lives, paid for by the children, to pay the capital-gains taxes that will be due on the family cottage when the parents die.
You must remember that life insurance is priced to reflect the insured’s actuarial risk of death. So, it costs more to insure old people than young people.
Life insurance only produces an attractive financial return (beyond its cost, that is) if the insured dies sooner than average. However, in that case, he or she will leave a larger estate than expected. The extra funds in the estate can go to pay the capital-gains taxes on the property. So, you didn’t need the insurance.
If the insured lives longer than average, premiums are paid for a longer period, which cuts any net financial return on those premiums, or converts it to a loss. But in that case, if the kids skipped the insurance, they’d that much longer to save and invest, so they can afford to pay the capital-gains tax bill when it comes due.
Meanwhile, they can invest the money they would otherwise have spent to buy life insurance for their parents. So, you didn’t need the insurance.
If the insured has no other assets, he or she cannot afford the property and should sell it. It’s best to do so before a major expense or a season of bad weather comes along and cuts the value of the property.
The children can, of course, buy the property from the parents at a mutually agreeable price. This sale would trigger the capital-gains tax. But the gain would be taxed at half the parents’ marginal tax rate, which will be low if the parents have no income-generating assets.
2, Buying life insurance for young children.
Parents generally have no need to insure their children’s lives. If anything, the reverse is true. That’s because children are a financial drain until they get old enough to support themselves. But some parents believe their children will need life insurance one day, and the earlier you buy the policy, the lower the premiums.
However, some children never go on to marry or start a family. That means they will never need life insurance, at least from a financial point of view. Buying these kids a life policy is a bad use of funds earmarked for their benefit since they need to die to get anything out of it.
You’d be better off to put the cost of the policy into an RESP, or an in-trust account with the child as the beneficiary. That way, the child can benefit from the money during his or her own lifetime.
3, Buying a life-insurance policy to fund a charitable donation.
Why not just save and invest the money, and leave it to the charity in your will? That way, if you live a normal lifespan, the charity, rather than the insurance company, will benefit from the compound returns that build up over a period of decades.
4, Buying disability insurance for an adult child “who’s not good with money.”
This kind of insurance may simply reduce the public assistance, including medical assistance, that the child might one day wind up collecting.
It’s better to set up a trust fund with a friend or relative as trustee, so you retain some flexibility as to when the money goes to the adult child.
5, Buying an annuity to pay the premiums on a life insurance policy.
This is a favourite of some insurance agents, since it generates two sales commissions—one on the insurance policy, the other on the annuity.
A particular insurance policy may or may not be a wise buy for the client. But now is generally a bad time to buy any annuity. That’s because annuity rates are related to interest rates at the time you buy the annuity. That makes periods of unusually low interest rates, like today (even with the recently announced increase in the Central Bank’s benchmark rate), an especially poor time for buying annuities.
However, if you want to buy annuities, you could buy one annuity each year for the next five years. That way, your returns will increase if interest rates continue to rise.
In the end, you can think of an annuity as a long-term bond with a variable maturity date and no liquidity. Interest rates are low, so now is a bad time to buy any long-term bond, especially one with those drawbacks. An insurance policy is, above all, a financial product. You pay for the privilege of possibly receiving money in the future, under certain conditions. You should assess it as a financial product.
Can you think of other reasons not to buy life insurance?