Insurance 101: Who Are You Protecting?
At its core, life insurance is about protecting someone. When you die – and let’s be clear on this, it’s not “if you die” – you almost always leave something behind. You hit the big wall of death. You pass through, and all the stuff we had stays on the other side.
A lot of that “stuff” has tax and debt implications.
If we owe money on anything (a house, for example), that debt could become due when we die. RRSPs that haven’t yet been taxed could be taxed as income. If we have a rental property or vacation property, there could be huge capital gains – especially if we’ve had them for a long time.
This creates financial risk – for your family, for your creditors, etc. And insurance is all about making risk someone else’s problem (specifically the insurance company’s problem). With insurance, you’re protecting them from that risk. The question is, who are you protecting?
Well, it depends on the strategy you use:
Let’s go into a little more detail:
Individual Insurance is built to protect your spouse. If one of you dies, money goes to the survivor – to pay off your mortgage, clear your debts, help with the costs for raising kids, cover funeral costs, etc. Joint First to Die insurance is like that too – when one person dies, the other gets money.
Joint Second to Die Insurance, which we’ll sometimes refer to as a Legacy Fund, isn’t built to support the surviving spouse. When you die, the things you own pass to your spouse tax-free (not debt-free though, which is why we need the Individual Insurance). But when it gets passed down to heirs, that’s when all the taxes we talked about earlier come due. Joint Second to Die can help take care of these tax problems. Without it, in the case of a family cabin, for example, the kids could have to sell the cabin just to have enough money for the tax. Why does it say, “maybe society”? Because you can also use this for charitable giving – creating a donation that offsets your taxes. A large donation goes to the charity of your choice (funded by life insurance); your heirs get your estate and it knocks off some or all of your tax burden.
Bank / Creditor Insurance is what most banks will suggest you purchase when you sign up for your mortgage. It’s pretty simple: you pay for it, and the bank owns it. If there’s a claim, the bank gets the money. Sounds like a good deal right? Well, it’s a good deal for the bank. If you take out this insurance instead of the Individual Insurance mentioned above, you’re protecting the bank – they’ll get the full value of the insurance you’re paying for. If your house is worth $300K at the start and you’ve paid off $290K, you don’t get the rest back after the bank takes the $10K remaining.
No Insurance is a great way to protect the government. You’re doing your part to make sure that they still get taxes from you, even after you die. Let’s say that you have $150K left in RRSPs when you die. In Alberta, this would put you into a 41% marginal tax rate. Your estate would owe about $42,208 in taxes on your RRSPs. That’s money that’s not going to your heirs or to charity. But you are doing your part to keep the money flowing to Ottawa! That is very responsible of you, citizen!
So, what’s your situation? Who are you hoping to protect?
This issue of the Capital Newswire has been brought to you by our very own Rick Harcourt, the Manager of Group and Voluntary Benefits for Capital Estate Planning. He helps protect Capital’s clients from the last two options; businesses from excessive Group Benefit renewals; community children from errant soccer balls and practice pucks; and neighbours from his overly enthusiastic puppy.
Questions? Comments? Start the conversation with us!
Capital Newswire - Volume 1, Issue 06.26