Being truly self-insured means a client’s financial plan should hold up even when one spouse passes away.shapecharge/iStockPhoto / Getty Images
Many clients choose to cancel insurance policies once their mortgages and other debts are paid off, opting to self-insure with other assets.
But advisors say clients – especially couples – should consider other factors before letting policies lapse.
“They need to look at other unforeseen liabilities,” says Steve Meldrum, founder and corporate insurance specialist at Swell Private Wealth Ltd. in Medicine Hat, Alta.
In Mr. Meldrum’s view, being truly self-insured means a client’s financial plan should hold up even when one spouse passes away. And insurance can play a role in keeping the financial plan intact.
“The financial plan should work where the family isn’t forced to sell its assets, significantly change their lifestyle or absorb taxes that could have been avoided,” he says.
Mr. Meldrum says the death of a spouse can throw finances into disarray. For example, many retired couples split their pension income to reduce the amount of taxes they pay. But when one spouse dies, income splitting is no longer an option for the surviving spouse.
Assets rolling over to the surviving spouse may also mean a higher tax rate, as more assets mean larger withdrawals from registered retirement income funds, he says.
“We have one spouse taking on all that income stream versus two,” Mr. Meldrum says. “So, now they’ve increased their overall tax liability.”
Justine Zavitz, vice-president of life and living benefits at Hub International in London, Ont., says she rarely advises clients to drop their term insurance policies when they’re debt-free. She emphasizes that when a client dies, their income dies with them, and many families still rely on the deceased spouse’s income.
In terms of estate planning, Ms. Zavitz points to the cash crunch that can come immediately after a loved one dies.
“Don’t underestimate the chaos of being an executor of a loved one’s estate and how much life insurance can help with that,” she says.
The benefit of insurance is that the beneficiary receives the tax-free payout immediately after death, she says.
Without insurance in place, she adds, executors may opt to sell investments or property and use those proceeds to pay final taxes. But that could mean selling a house in a sluggish real estate market, for example.
“There’s a need for liquidity, so the estate can pay those taxes,” Ms. Zavitz says. “Owning something that can’t be sold on the spot can create problems. Properties can sit on the market for quite some time, or else you are taking a fire sale price on it.”
Cameron Smith, certified financial planner (CFP) with Clarify Wealth at IPC Securities Corp. in Mississauga, says the death of the second spouse triggers the most taxes, as all investments are deemed sold, triggering capital gains taxes and disposition of registered accounts.
Still, he says that doesn’t necessarily translate into an insurance need if the estate has enough assets to pay the taxes and leaving an inheritance isn’t a priority.
Some parents will let insurance policies lapse as their adult kids become financially independent, he says.
“The discussion [of whether to self insure] has to revolve around the clients and their view of the world. Find what works best given their context,” he says. “The result is a conversation of what life will be like if certain scenarios happen and always make sure the numbers make sense.”
Letting an insurance policy lapse may make sense for clients who don’t have any desire to leave inheritances, says William Chan, CFP and principal and owner at Modern Vision Planning in Mississauga. He notes many child-free couples may not have significant beneficiaries in mind for their estates.
“Their main concern is often maintaining their quality of life through retirement rather than leaving a substantial inheritance,” he says.