Why do I need Life Insurance?

Why do I need Life Insurance?

There are only 2 things in life that you know for certain: you will pay taxes and you will die (at least for now).

Life Insurance is an insurance contract designed to protect your family and other people who depend on you for financial support (your dependents). It does this by paying a tax free lump sum to the beneficiary(s) you’ve named on your policy when you die.

But why is this necessary? Because you’re a walking ATM and when you die, your paycheque dies too. How would your family get on without your income?

Let’s use a hypothetical example to illustrate the issue. This is the story of Sue and Chris.

Sue and Chris are both 40 years old. Sue earns $75,000 a year and Chris earns $45,000. They have 2 children together ages 7 and 4. Let’s start by painting a picture of their current financial situation.

Savings:

$50,000 in cash, RRSP’s and some GIC’s

Monthly Expenses:

• $1100/month – Mortgage
• $250/month – Property Tax
• $500/month – Groceries
• $250/month – Cable/Internet/Cellphone
• $200/month – Gas
• $200/month – Car Payment
• $250/month – Utilities
• $500/month – Miscellaneous Expenses (Entertainment, Haircuts, Healthcare, etc.)
• $1000/month – Childcare
• Total = $4,500/month

Sue and Chris’ combined after-tax monthly income is about $7,400. They’re covering their expenses just fine for now but they’re cutting it close. They’re really relying on Sue’s income at the moment.

One fateful night, Sue doesn’t make it home from work; she was killed in a car accident. Chris and his children are devastated. A few days later, Chris starts to sort out his life…

Scenario A) Sue has enough life insurance

Sue was insured for $750,000 (about 10 times her yearly pre-tax income). With the life insurance proceeds, Chris decides to pay off the mortgage, the car and set money aside for his children’s education. With the house, car and his children’s college fund taken care of, the extra cash left over also gives Chris and his family options. He can take time off work to spend with the kids, invest it to try to generate extra income to make up for the short fall, use it to pursue a new career, or pay for someone to help look after the kids while he’s at work.

Scenario B) Sue has some insurance, but not enough

In this scenario, Sue hadn’t purchase her own life insurance but she does have a group benefits plan from work. Chris gets $75,000 (her pre-tax annual salary).

It’s not enough money. After paying $10,000 for the funeral, he doesn’t have enough money left to replace Sue’s income. He will either have to cut some expenses or make more money. Even though Chris and his kids are still grieving, he doesn’t have time to fully process his emotions. He’s worried about money and his family’s future.

After looking at his finances, he decides to do both. To cut expenses, Chris sells the car and starts taking transit, cancels cable (they never watch it anyways) and scales back his cellphone plan. He won’t be able to take the kids out for their weekly family dinner anymore.

He also starts to put out his resume trying to find a higher paying job. His family’s future is uncertain but this will do for now.

Scenario C) Sue has no insurance

The situation is dire. Chris has to dip into their savings to pay for the funeral. With $40,000 in savings left, he knows he doesn’t have enough money – even if he sells the car and slashes other expenses.

He doesn’t want to uproot his kids but he has no choice; it’s only a matter of time before he has to sell the house.

Who Needs Life Insurance and When Should You Buy It?

If you have dependants like children, disabled family members or a spouse who relies on your income, you should consider life insurance. Usually the decision to purchase life insurance is triggered when a new dependant enters your life.

If you don’t have any dependants, you probably won’t need life insurance unless it’s part of a larger financial plan. But carrying some life insurance could still be useful simply for paying your own funeral expenses, estate taxes or to tide them over until your assets clear probate. This helps to reduce the burden put on your surviving family members.

You can see the advantages of being prepared – don’t leave your family in Scenario B or C. Life insurance ensures, that your family will still get the money you make, even if you’re not around to make it anymore.