Estate planning is crafting the legacy you'll leave behind. A will is an important part of that legacy, but picking the right life insurance can be just as important when it comes to being there for loved ones after you’re gone.
Why? For most of us, a big reason we create an estate plan is to make sure our family is financially cared for. Life insurance can be a big part of providing that support by replacing our income, paying off any debts we leave behind, and covering taxes and end-of-life expenses.
In this article we’ll go over how life insurance can be used as an estate planning tool, who should buy it, what type to buy, and other common questions. If you come across any terms you’re not familiar with, be sure to consult our glossary to help you along.
How is life insurance used in estate planning in Canada?
There are several ways life insurance can help provide security to loved ones in the event that you pass away. These benefits all help make sure they’re cared for while also alleviating some stress during what can already be a very difficult time.
1. Quickly cover end-of-life expenses
Probate fees, capital gains tax, funeral expenses, and outstanding debts can affect your estate's value. Life insurance can help cover these costs and pay off debt so your beneficiaries receive a larger share of your estate after it goes through probate.
Life insurance ensures your loved ones quickly receive the necessary funds to handle expenses resulting from your death. When the appropriate steps are taken, insurance policies can be paid out in as little as two weeks. However, it may take months or years for an inheritance to reach beneficiaries. That means insurance can save your loved ones from paying these end-of-life costs out of pocket, even if they eventually get reimbursed.
2. Asset and tax protection
Your estate may include valuable assets like a family home, cottage, or investments. Life insurance can protect these assets from being sold off to cover debts or taxes. When you die, your estate is subject to a capital gains tax on the value of everything you owned (though this can vary by province). Life insurance can be used to pay these taxes and make sure your estate is untouched and inherited by your beneficiaries.
This can be especially valuable to your beneficiaries when dealing with real estate and other assets with prices that may have risen significantly since they were first purchased.
3. Income replacement
Your family may rely on your income to survive or to sustain their lifestyle. Life insurance provides a death benefit which is a financial safety net, replacing lost income and ensuring your loved ones' financial stability.
You can think of this as providing the paycheques you would bring home for years – or even decades – to come. Not only can a life insurance policy cover basic expenses like groceries and rent, it can also be a legacy to give your children and other loved ones to spend on homes of their own, college, and other investments.
4. Charitable giving
If you're passionate about supporting charities, life insurance can allow you to leave a significant charitable contribution (sometimes called legacy gifts) to the causes you care about, even if your estate's assets are primarily tied up elsewhere. It’s relatively easy to designate a portion of your life insurance to a charity or cause that’s important to you. Willful’s online will platform includes a step to allocate funds or a percentage of your estate to causes that you care about.
5. Discreet money dispersal
In many provinces, wills are public records that anybody can pull and view, whereas insurance is private. A life insurance policy allows you to leave money to people or causes discreetly, helping prevent beneficiaries from legally disputing how funds are dispersed after your death.
That means a life insurance policy can help make sure your estate planning wishes aren’t disrupted.
Do you need life insurance for estate planning?
Yes, it’s almost always a good idea. Life insurance is a crucial component of estate planning. It can help protect assets, provide income to your family, cover end-of-life expenses, and leave a financial legacy for your loved ones or charities you support.
Types of life insurance for estate planning
This subject warrants its own dedicated article, but in this piece, we’ll provide a concise overview of the two fundamental types of insurance policies offered by insurance companies to help you become more familiar with the topic.
If you have life insurance as a benefit through your employer, it’s a great start, but it’s important to review the policy to make sure it has adequate coverage. Many employer benefits plans cover only a percentage of income replacement, so it’s common for people to purchase additional life insurance on top of their employer policy. You may also want to consider reviewing your life insurance after major life milestones.
Term life insurance
Term life insurance can work for estate planning in certain cases. It provides coverage for a specified time period (usually 10, 20, or 30 years, but sometimes more) at a fixed price. The life insurance premiums (the regular payments you make to the insurance company) with this type of insurance are usually more affordable and can be good for temporary financial situations, such as paying off a mortgage or putting your kids through college.
As an example, if you just got a 25-year mortgage, you might want to get a life insurance policy on a 30-year term so your family can easily cover payments in the event something happens to you.
Most term life insurance policies in Canada are renewable and convertible. That means that after the term is up, you can renew it for another term or convert it into a permanent policy. Always review the contract with your insurance company to make sure your term policy is convertible and renewable.
Permanent life insurance
This type of insurance, which includes whole life and universal life, offers lifelong coverage. The key difference between permanent insurance and term is that once you’re done paying a permanent policy, all the benefits will still be permanently available to you and your beneficiaries. It’s comparable to buying a house: if you get a permanent life insurance policy that you pay premiums into for 20 years, you own it after that term is up. That means it will be paid out in the event of your death no matter what.
It can also be used as an investment in some cases, but that’s usually only beneficial for people who have already maxed out other investments like tax free savings accounts, and registered retirement savings plans. You should consult a trustworthy expert if you’re considering life insurance as an investment.
Permanent life insurance is a great choice for covering end-of-life expenses, taxes, and debts, while also making sure your beneficiaries and any dependents are taken care of after you're gone. The downside is that premiums are usually more expensive than term life insurance.
What are survivorship life insurance policies?
Both types of policies can also be purchased as a survivorship. Survivorship life insurance policies cover two individuals, typically spouses, under a single policy. These policies usually pay out upon the second individual's death.
How are survivorship policies helpful? They’re often more affordable than individual policies but can still help provide children or other beneficiaries with a death benefit payout.
If needed, one person can make arrangements to have certain assets or money go into probate for designated beneficiaries even though their life insurance is in a survivorship.
How to pick the life insurance type for your estate plan
So, what type of life insurance is best for estate planning? It depends on how much debt you have and if you have dependents. Generally, permanent life insurance is a better choice, but with most providers you can start with term life insurance and convert it to permanent. It’s best to consult a specialist to help you pick the best type for your needs.
Things to consider include life insurance premium prices, how much debt you have, if you have dependents, and the amount of life insurance you need.
How to calculate life insurance needs
How do you know how much insurance you need? Basically, you’ll want to get a policy that can cover all your debts plus the costs that people depend on you for. This includes any monthly living expenses for dependents (like groceries, clothing, medicine, and so on) plus enough money to pay your mortgage, debts, taxes, and death expenses.
You can start calculating this by adding up the following items:
- Your outstanding debts
- Your outstanding mortgage
- Living expenses your income provides for children and dependents
- The future education expenses for your children
- The potential tax liabilities your estate might face
You will likely need help from an expert with that last item, but doing the first four is a great place to start. An insurance advisor or financial planner can help you determine the precise coverage for your unique estate planning needs.
Start preparing your estate plan with Willful
While life insurance is a pivotal part of estate planning, it's just one piece of the puzzle. For a comprehensive estate plan, it's always a good idea to consult with financial advisors and insurance experts who can provide personalized guidance.
To kickstart your estate planning journey, platforms like Willful provide a user-friendly way to create a legally valid will in Canada. It’s a fully guided process that helps you make sure your wishes are not only documented but also upheld. It’s also easy to update online and offers options to specify your funeral wishes, power of attorney, and more.
Your will, alongside your chosen life insurance policy, forms a powerful duo in safeguarding your loved ones and easing the burdens that often accompany unfortunate and unforeseen circumstances. We hope this article has provided you with some guidance to help you make the best decision for you and your loved ones.