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How Does Life Insurance Work in Canada?

Feb 2, 2023 | Insurance, Life Insurance

Life is uncertain, and your death could impact your loved ones financially as well as emotionally. One way to give your family a sense of security is to purchase a life insurance policy. Life insurance will provide your loved ones with financial support, alleviating some of the burdens your death may leave behind. 

So, how does life insurance work? Though many Canadians have life insurance, not everyone understands how it works, who would benefit from it, or how beneficiaries receive payment. This guide will teach you everything you should know about getting life insurance in Canada. 

What Is Life Insurance and What Is It For?

Life insurance is an agreement between a person and an insurance company that states the insurance company will deliver a tax-free payout to the person’s beneficiaries upon their death. The life insurance policyholder will pay monthly premiums in exchange for the payout. 

The definition is relatively straightforward, but you may still ask, “How does life insurance work, and why is it necessary?” People get life insurance because a family member’s death can have long-lasting consequences for loved ones. In many cases, the deceased’s relatives are responsible for expensive funeral or burial costs, mortgages, loan payments, credit cards, and other debts. 

With life insurance, you can ensure that your loved ones have enough money to settle your debts and provide a funeral or memorial service without the burden of unexpected debt. The policy may also provide enough funds to cover years’ worth of everyday expenses that your income would otherwise cover for dependents, like a spouse and children. 

When policyholders pass away, insurance companies will pay the contingent beneficiary the sum outlined in the life insurance policy through various means. However, agencies may deny claims if the policyholder died due to suicide or risky behaviour, such as skydiving, racing cars, scuba diving, or mountain climbing, especially if didn’t invest in what is called high-risk insurance.

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Common Terms in Life Insurance Policies

Learning about life insurance in Canada can be daunting. The terminology may be confusing or difficult to understand. If you’re unsure about insurance jargon, you might purchase the wrong life insurance coverage unintentionally. 

Here are the most common terms you’ll see regarding life insurance:

  • Insured Person: Whoever holds a life insurance policy is both the policyholder and insured person. 
  • Insurer: An insurer is the insurance company that provides life insurance coverage.
  • Premium Payment: Premium payments are the monthly payments the insured gives the insurance company for coverage.
  • Beneficiary: The insured person will name one or more people to receive the life insurance payout when they die. The persons listed are beneficiaries. 
  • Death Benefit: Death benefits are the tax-free payouts insurance companies give beneficiaries with the policyholder passes away. 
  • Cash Value: Some life insurance policies offer death benefits and a savings account called cash value. A portion of the monthly payments will go into the policy’s cash value and become a source of withdrawable funds through a policy loan.

Types of Life Insurance in Canada

As you learn the answer to “how does life insurance work,” you’ll see that different types of insurance have varying purposes, timelines, and requirements. In Canada, most life insurance policies are either term or permanent. Let’s discuss the differences:

Term Life Insurance 

Term life insurance is temporary coverage that only lasts for a predetermined period. You can purchase a policy for 5, 10, 15, 20, 25, or 30 years or until you reach a specific age. If the term policy ends before you die, you could renew it or purchase a new policy. 

People often get term life insurance when they are young to cover temporary financial obligations, like education fees for children or outstanding debt. Premiums for the term life insurance benefit are usually the most affordable options. You should consider purchasing this type of policy if you:

  • Want to ensure that your children have enough money for their education if you pass away
  • Don’t want your family to be responsible for your debt
  • Can’t afford a permanent policy

Your beneficiaries will receive a payout if you pass away while the policy is active. However, they will receive nothing if you outlive the policy without another one to back it up. Unfortunately, term life insurance renewals are more expensive than the original contract because life insurance premiums increase as you age. 

Should you outlive your original policy, you might have the option to renew it without taking a medical exam, which is a common requirement for life insurance. However, a downside to term life insurance is the lack of cash value. 

Permanent Life Insurance

Permanent coverage has no end date. The policy will remain in effect until you pass away or cancel the policy. 

Many Canadians choose permanent life insurance coverage as part of their estate-planning efforts. With this policy, your beneficiaries can receive a lump sum upon your death. You can also take advantage of your policy’s cash value before you pass away.

Since this type of insurance doesn’t require a renewal, premium rates are more expensive than premiums for a term policy. However, these monthly or yearly premiums will not increase. The longer you have the policy, the more money will accrue in cash value.

Permanent life insurance has several subtypes: 

Whole Life Insurance 

When most people refer to permanent life insurance, they mean whole life insurance. Whole life insurance is a policy that usually includes a cash value that builds with interest and continuous premium payments. If you cancel the policy, you could receive some of the funds back. 

You can borrow from your whole life insurance to pay for major life purchases or settle outstanding debt. You must repay what you borrow if you don’t want your beneficiaries to receive less than they are entitled to when you pass away. Your policy’s cash value can be collateral if you need a loan. 

Universal Life Insurance

This comprehensive policy combines life insurance with investment accounts and includes a cash value. You can make investments through the account, which will affect the policy’s overall value. If your investment choices work out well, your loved ones will receive a higher payout than your policy states. 

A downside to universal life insurance involves premiums. If you make too many poor investment choices, your life insurance premiums may increase. 

Term-to-100 Life Insurance

One exception to permanent life insurance offering cash values is term-to-100 life insurance. This type of coverage blends term and permanent coverage without the benefit of a cash value. As a policyholder, you will pay lower premiums than other permanent life insurance policies until you reach 100 years old. 

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Who Should Purchase Life Insurance in Canada?

Life insurance is a worthy investment for anyone with loved ones who rely on the insured’s income. For instance, you might consider life insurance for your spouse, partner, or children to financially protect them and ensure they have support for housing, education, daily living expenses, and your funeral costs. 

Your death could cause a financial setback for your loved ones if it occurs, especially if it happens unexpectedly. Instead of leaving your family to deal with your financial obligations and post-death expenses without financial support, you could purchase a life insurance policy and have a safety net.

With life insurance, your policy payout delegates some funds for your funeral expenses and debts. You can ensure that your loved ones won’t be financially overwhelmed by your absence.

Not everyone has a spouse or dependents, but they can still benefit from life insurance. If you’re unmarried and childless at the moment, you don’t have to purchase life insurance. However, the future is unpredictable, and if your death will financially impact someone now or later, it’s best to get coverage. 

How to Name a Contingent Beneficiary to Your Life Insurance Policy

When you set up your life insurance policy, you can arrange for specific loved ones to receive death benefits. Your options include:

  • A spouse
  • Children
  • A close friend
  • An extended family member

People sometimes assume that they cannot have life insurance because they have no one to name as a beneficiary within their immediate family. However, you can give your death benefit to a charitable organization, a distant relative, or anyone you have a relationship with or deem worthy.

You can also arrange for specific beneficiaries to receive a predetermined percentage of your policy’s overall payout. For instance, you could leave 50% to your spouse and spread the remaining funds evenly among your children. 

Another option is to name your estate as your contingent beneficiary. In that situation, money from your insurance policy will become part of your estate upon death. Monetary disbursements of the death benefit will go to individuals according to your will, but debtors can claim the funds from your estate if you die with outstanding debt. 

As a life insurance policyholder, you can change who your beneficiary is without notifying them as long as they are a revocable beneficiary. However, you must seek written permission to change an irrevocable beneficiary.

If you designate your children as the recipients of your death benefits, they can’t receive payment until they reach the age of majority. You must create a trust for underaged beneficiaries and name an administrator to handle their money until they come of age. A closer look at deciding who should be your life insurance beneficiary, and the process in which to possibly divide them can be found here.

Life Insurance Payout Options in Canada

If you’ve asked yourself, “how does life insurance work,” you might also be curious about death benefit payouts. When you pass away, your beneficiaries must file a claim and submit it to the insurance company with a copy of your death certificate. After a brief review period, the agency will release a payout in one of the following ways:

  • Lump-Sum Payment: Your death benefit recipients may get the entire amount at once as a tax-free amount. This option provides the most flexibility over how the beneficiaries can use the money. 
  • Lifetime Income: You may prefer the total benefit payout to be an annuity that guarantees smaller payments to beneficiaries until they pass away. The payment amount will depend on your age and the total amount of the death benefit. 
  • Fixed Amount: Your beneficiaries can receive a specific amount of money monthly or annually until the death benefit amount reaches zero. 
  • Interest Income: Your life insurance policy may allow you to put the death benefit amount in an interest-bearing account, where the insurer will pay interest earnings to a beneficiary. The remaining payments will go to a secondary beneficiary when that person dies. 
  • Semi-Permanent Life Income: Beneficiaries may receive annual or monthly payments for a specific period or until they die, whichever is longer. 

What Happens If You Pass Away Without a Renewed Insurance Policy

If you determine term life insurance is most suitable for your lifestyle, family, and budget, you should know what will happen if you die after the policy runs out and you don’t renew the policy. An expired policy is a voided contract, regardless of how much you paid into it. If you die without coverage, your family or estate will be responsible for financial obligations without financial support from insurance companies. 

You can cancel a permanent life insurance policy if you want different coverage or intend to make other arrangements for your loved ones after you pass away. Some policies will reimburse you a portion or the entirety of your life insurance’s cash value if you cancel early. You may also receive some or all of the investment payments if your coverage permits it. 

Find Your Life Insurance Policy Today

Taking the initiative to get sufficient life insurance coverage for your loved ones is a big step, and the process can be overwhelming. Now that you know the answer to “how does life insurance work,” allow Alliance Income Services Corp to help you find the most suitable insurance policy for your needs. 

Alliance Income makes it easy to find various types of Canadian insurance online, including life insurance, seniors life insurance, mortgage life insurance, disability insurance, and group insurance. With our site, you can quickly compare quotes and apply for coverage from leading Canadian insurance providers. Our insurance agents are available to assist you, so complete our convenient online form to start comparing quotes.


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