(As published in LifeStyles55+ September 2012)
You don’t want insurance, but you have to buy it for your car, as MPIC requires it. Your bank likely requires it for your home mortgage coverage. Your most important asset, the one that provides you a car and a home, is your income. The risks to your income need to be managed. An unexpected job loss (or just telling your boss to “stuff it”) may interrupt your cash flow, making car and mortgage payments, not to mention buying groceries, difficult. This risk is best managed by having three months worth of net income in liquid savings to help you over such a hump. TFSAs are a good choice for this “emergency fund”. Employment Insurance is another mandatory insurance product that can replace employment income for a short period. But with all its exceptions and conditions, you really need to have your own nest egg to manage any unexpected interruptions in or demands on your income. Longer term risks to your ability to maintain your income, such as a disabling injury or illness, can be insured against, often on a group basis through your employer.
Besides the risk of taxes to be managed in your planning, your income is going to cease when you die. Financial planning can provide for loved ones who were depending on your continued income. Unless you are already independently wealthy, life insurance is the most cost effective way to manage the risk of premature death.
Assuming you do not plan to die, the next risk to your income will be when you stop working, whether forced to retire by age or health or by your own choice. This risk is managed by having a pension plan, supplemented by an RRSP. Additional investments and savings will replace some of your pay cheque so that you can maintain your lifestyle. Risks can occur that put additional demands on your income. We all know people battling cancer or other debilitating disease. As we are still alive, life insurance doesn’t help so insurance companies offer critical illness coverage; most advisors recommend having two years of net income available to provide the capital to get through a period of care-giving, interrupted income, or for health care across the border that medicare doesn’t cover.
We plan financially in order to have a happy retirement, travelling, enjoying grand kids and other pursuits that we never had time for during our working years. But active as you may be in your sixties and even seventies, you will age. The other expense that we rarely think about is long term care. Depending on our needs, the cost of that care can exceed our pension and savings. The risk of living too long so that you outlive your savings is best managed by continuing to keep your plan up to date, with investment products such as annuities that are guaranteed for however long you live.
Sitting down with a financial planner and thinking about all of these risks to your income, and hence your quality of life, can be a downer. We can insure ourselves for most of these risks, but that uses cash flow that can detract from all the demands on our incomes right now. If we really do not want insurance, or at least not any more than we have to buy, whether due to legislation or guilt, what is our alternative? The best alternative to buying life insurance to manage these risks is to accumulate sufficient wealth that we can cope with life’s events ourselves, that is, we self-insure these risks. That is what we do when you build up a nest egg to cope with short term interruptions or unexpected demands on income; an emergency fund is the first step in planning financial independence.
Buying lottery tickets can be another independence strategy as a jackpot could provide our future income stream. As an indirect government taxing schemes, the odds on 6-49 or Lotto Max are so poor, you will be depending on God to win – and so far God seems to prefer me poor. So we are left with savings, to divert some of today’s cash flow from the latest “must have” or the newest model car into investments. But while our investments grow to be enough to self-insure our risks, we have the challenge that most of our risks are now. For the 20 to 30 years it will take to accumulate financial independence, we manage these risks by insuring the gap.
The insurance industry has created a clever product called Universal Life that does wealth accumulation while insuring the gap. Traditional permanent insurance products combined savings with insurance cost, with the implication that building the base of savings would reduce the cost of insuring the difference to make up the face value of the contract. Universal Life unbundles these components, while still offering tax-deferred growth and the insurance benefits of bypassing probate. UL provides you more choices in financial planning. Insurance cost options include level term or yearly renewable term. As the investment portion grows, the insurance cost declines as the gap is a decreasing amount of insurance that is needed to make up the face value. The UL contract automatically reduces your insurance coverage as your investment for self-insurance grows. You can choose from a wide range of investment choices: fixed income, bond funds, asset allocation, balanced, or growth funds, and choices can be varied through the years. By retirement, the UL contract has an investment value that you can stop making deposits but it will continue to grow. Like the short term nest egg, this asset will be there after you retire to self-insure the on-going risks to your income, whether to supplement your pension, to meet the crisis of a critical illness or for long term care costs. And if you are so fortunate as to not need your self-insurance account for any of these risks, it can serve as your legacy, in a family trust to help your great grandchildren’s futures!