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I received a call the other day from someone who wanted to know if I “believe” in insurance. People typically pick one side of the money debate and hold tight to it: there are people who think debt repayment should come before investing, and others who think just the opposite. And there are people who think that permanent insurance trumps term, and other who think just the opposite. Me, I don’t much care what you do, as long as what you do is WORKING for YOU! You know my basic rules:

• Don’t spend more money than you make,
• Save something
• Get that consumer debt paid off, and
• Offset your risks wherever you can.

So when it comes to the insurance debate I actually don’t have a “side”, but I completely believe in the validity of having insurance as a part of a well-balanced financial plan. Here are some questions I’ve received recently:

Roxanne & Robert wrote:

My husband and I have death and disability insurance on our mortgage. The insurance was purchased through the same bank that holds our mortgage. We read a recent article that warned about buying this kind of insurance from a bank. The article referred to problems with “post-claims underwriting”, and listed some horror stories that have occurred with this type of insurance. One such horror story was chronicled in the Toronto Star on March 21. Gail, what are your thoughts about this sort of insurance? Should we consider different insurance coverage?

I’m not a big fan of the insurance that comes with loans. I have always found that personally purchased life and disability insurance are not only less expensive, but offer more flexibility. However, if you have a whopping debt and cannot qualify for individual insurance, then creditor insurance may be the only option. As for the horror stories, you must make sure that whomever you buy this insurance from is prepared to deal with the insurer too… if they’re selling the policy to cover their own product, they should be willing to go to bat to get the claim paid.

D wrote:

Hi Gail I am married for year and a half, my wife is dental hygenist and she is paying for disability insurence $120 mnt for about 5 years already. I am wondering she is 27 y.o. is it better to stop paying insurance and to contribute this money into RRSP where we can get some returne or just continue to pay insurance? If she stops paying she wont get any money back.

Absolutely NOT. She needs to keep her private disability insurance in place since that’s all that standing between her and poverty if she becomes disabled.

C wrote:

Is insurance that important if I’m single, no kids, etc…? I’m 30 years old and my mortgage is only $700 a month. All other monthly charges total around $400. I’ve been saving around $10000 a year in a regular savings account for the past 3 years, $5000 a year in RRSPs and now hav $5000 in a TFSA. I think i’m “safe” should anything happen, and don’t see the benefits of insurance.

C, the only reason life insurance is important for the young, single person is because if they think they’ll need it when they are older, buying it at a younger age does two things:

1. It ensures you are insurable… you get the insurance approved while you’re still young and healthy, and
2. It locks in a lower price, particularly on permanent insurance.

Disability insurance is important for everyone. Critical illness insurance is particularly important for people who can’t get disability insurance.

If you don’t think you’ll ever need life insurance because you won’t have dependents counting on your income or an estate to protect from taxes, don’t buy life insurance.

…

And now for something totally off-topic. I received this email recently and wanted to pass it on to y’all.

Love your show and your blog. I just wanted to correct you on one little point regarding taxes and student loans. In a couple of your answers I’ve seen you suggest that interest paid on student loans can be deducted or written-off. That isn’t quite right. You can claim a tax-credit for interest paid on government student loans, but that’s only a 15% credit (against federal taxes, and typically another 5-6% against provincial taxes). That’s typically a lot less than ones top marginal tax rate, so it’s far less valuable than a deduction.  Moreover, as I noted, that’s only available for government student loans (OSAP, etc.), you can’t claim it in respect of a student line of credit or a bank student loan. That said, depending on what interest rates you can get from the bank (and I was able to get a very reasonable student line of credit when I was in law school), it may make sense to pay off the government loans first and forego the tax credit rather than pay higher interest just to claimb the tax credit. Anyhow, love your show, but I just wanted to clarify that point. Cheers, Carl

Thanks Carl!

From The Wealthy Barber:

“Disability insurance is the most neglected of all forms of insurance, yet for many people, it’s the most critical insurance need…. A thirty year old has a one in four chance of becoming disabled for one year or more at some point in his or her life…When people are disabled, they don’t just cease to be an asset to their families…they become a liability.”

When I review benefit handbooks, many of my clients are surprised to learn the details of the actual coverage that they carry. Most disability benefits only cover 60% of the employee’s salary and exclude bonuses. Many plans will only cover the first five years of disability and most plans are not indexed to inflation. Many clients are unaware that their disability benefits are not portable and a move to a new company results in a different benefit plan.

As the working population ages and companies are more cognizant of expenses, there is a growing trend for employers to offer “flex dollars” benefits. With this plan the employee is given an allotted sum of dollars from which he must choose from a shopping list of benefits (health, dental, life, short term disability, long term disability, critical illness insurance). While the employee can top up each element of coverage, in general, as the employee gets older, the same dollar allotment buys fewer benefit

The Disability Contract
When you pay for the premium out of pocket there is no tax-deduction, but you receive the benefits tax free. This compares to a company paid policy where you are taxed on the benefits.

A personally owned non-cancellable disability insurance policy is a contract between the individual and the insurance company. As long as the premiums are paid, the policy cannot be cancelled or altered in any way without the individual’s consent.

There are three common clauses used to determine the criteria and length of time for which an insurance company is obliged to pay a claim if you become disabled. This determines whether you can be forced to work, even in some other field at a reduced level of income. These clauses are known as:

• “Any occupation” requires that you must be unable to work in any occupation, regardless of the change in duties or income.
• “Regular Occupation” clause states you must be unable to perform the important duties of your own occupation and not working in any other gainful occupation.
• “Own Occupation” is the most complete yet most expensive clause as it permits you to receive full benefits if you are totally disabled not working in your field but choose to work in another field.

Ask yourself “How likely is it that I could be totally disabled out of my specialty and still be able to work in another?”

Additional contract terms to know
Elimination Period (waiting period) – This is the length of time that must elapse after the onset of the accident or sickness before the insured becomes eligible to receive disability benefits. The typical elimination period for private coverage is 90 days.

Non-Cancelable Contract – Under the provisions of this contract, as long as the premiums are paid, the insurance carrier cannot:

• Cancel the policy
• Change any provisions or add restrictions
• Increase the premiums or add any changes to the existing policies

Features of Disability Insurance
Waiver of Premium: It is important to continue premium payments even after you become disabled especially since you may not receive benefits for 90 days. Many insurers take over paying future premiums while the insured is receiving a disability benefit and some will refund the premiums that were paid during the elimination period.

Future Increase Option: This benefit allows one to increase the benefit by a certain amount at specified intervals without providing evidence of health. You only need to prove earnings. This may be of interest to those who want a robust policy now but to keep premiums low, they take the lowest coverage and enhance the coverage at later time. A chartered accountant, who buys disability insurance and later becomes a roofer, would be an extreme example.

Cost-of-Living Benefit: This benefit ensures that while on claim, the purchasing power of your benefit dollar is increased at specific periods (every 6 or 12 months). There are two formulas which can generally be utilized when applying for coverage:

• CPI index (with or without minimums and maximums)
• Simple interest

Portability: As a general rule, you want the plan to remain as unrestrictive as possible so that future changes in your status or location can be accommodated. An example would be an oil engineer who moves to Saudi Arabia but owns disability insurance purchased 10 years before. Only private plans offer this feature without restriction.

Like all insurance, disability insurance is not well understood by most people. The old adage is true “you get what you pay for”, so do your research.

Level of Benefit

Residual Benefit: A residual benefit is payable if the person is able to work on a limited or reduced basis. For example, an individual with back pain may only be able to tolerate sitting at a desk for 2 hours per day. The level of payout is based on the proportion of lost income relative to the time lost. This provision is essential since most individuals make claims for partial rather than full disability.

Partial Benefit: A partial benefit is also payable if you are working at a reduce level. However, the payout is based on the amount of lost time and duties and there is no requirement to show a loss of income. This is an attractive clause for those who are newly employed and show limited prior earnings (e.g. a new graduate doctor).

Paying for the policy
Why should I pay for a policy when I can just contribute to my RRSPs or savings and hope that I will have enough money should I become disabled? Consider this: If you are forced to withdraw from your RRSPs you will have to pay taxes. A withdrawal of $5,000 could be as little as $2,600 in the end depending on your tax bracket. Additionally, if you are forced to withdraw during a bear market, such as we are currently experiencing, you will be forced to withdraw more units from your mutual funds and potentially at a loss.

If you own an individual disability insurance policy paid from your cash, any claims payment come to you tax free once you have satisfied the waiting period or other contract requirements. This will apply even if you are currently unemployed.

In summary, disability insurance is only one element in the “Risk Management Strategy”. Is it worth spending less than 3% of your gross income to protect your greatest asset, the ability to earn a steady income? Other coverage’s to consider include Life insurance, Critical Illness insurance and Long Term Care insurance.

I recently received a mighty big question from  NM and thought I’d share it and my answer here since she is asking a lot of the same things many other people are asking and I can kill many birds with this one stone.  NM writes:

I recently bought your book and in it, you suggest Disability Insurance, Critical Illness Insurance and Life Insurance. I’ve made a spending plan and am trying to figure out how/when/where these insurance products would fit in. Now that you’ve convinced me insurance isn’t evil, I’m wondering… I’m 24 (about to turn 25), single, and I just started a new job in June grossing $33,000/year. I have about $6,500 owing on a line of credit at 8.5% interest and $2,000 on a credit card at 19.97% interest. My question is: do I need all three types of insurance? Should I get them now or wait until I pay off my debt? And how do I figure out how much disability or critical insurance I would need? I’m assuming that once I move out on my own or collect any assets I would need to look in to getting Critical Illness or Disability insurance?

NM, since you are single and young, you’re most important insurance step is to get disability insurance. Not any old disability insurance, but the very best disability insurance you can afford. (Tomorrow I will post a guest blog on disability insurance from a Guy In The Know, so read it.)  Life insurance is important when you have assets and dependants, and since you have neither, and are still very young, this doesn’t have to be a priority. Critical Illness insurance is also useful, but I often recommend it for those who can’t get disability insurance because they are old, and that’s not you. So, the best DI you can find, m’girl, that’s what you’re after.

NM went on to say:

Speaking of debt, I plan to pay off the 19.97% interest credit card debt and then start an emergency fund (meaning I will have a very small emergency fund until I pay off that high interest credit card). I was then going to put away about $300 per month for emergencies. 5% of my income goes in to my company’s pension plan; I was also thinking about increasing those contributions once I pay off the credit card. Should I save less and continue making huge debt repayments? Or should I work on boosting my savings even though it would take me longer to get out of debt?

Also, my company’s pension plan acts like an RRSP in that my income is taxed after the contributions are deducted. My company also matches my contributions. The plan is locked, meaning I can’t get to the money until I retire. Is there any downside to having this type of a pension plan (for ex. I can’t borrow against it to get a house, etc.)? I want to contribute the maximum to this plan, but I’m wondering if I should also get an RRSP?

Thank you for this book–I can hear your voice talking to me through the pages! I plan to use it to guide me in to being a Woman of Independent Means.

Good questions all, NM. Focusing on getting your debt repaid is the right thing to do, particularly since you are not ignoring either your long-term or emergency savings. When I work with my fams, I often start them off saving only $100 a month for each, just to get the habit established. You’re already doing this so go nuts on the debt repayment.

Since 5% of your income goes toward your company pension plan (which is fine, by the way) and they match your contributions, that means you’re saving 10% long term. Perfect. And $300 a month for emergencies until you get to the months’ worth of Essential Emergency Expenses is terrific. As for not being able to borrow against your retirement savings for a home, I’m not a huge fan of this strategy. Once you have all your consumer debt paid off, take the money you were using for debt repayment and start building a Home Downpayment Fund.

I’m glad you’re enjoying A Woman of Independent Means.  It’s always good to hear when people are using the book to make more sense of their money. I’m working on an outline for a new book, but if you stay this course you’re on, you won’t need it! Ha!

This is my final blog of the year, so I want to wish you all a very healthy and happy 2009. Last year I made a resolution that kept me sane through all my ups and downs. Being the stone in the river was one of the things that got me through the tough changes at the end of the year. (All your hugs and my emergency fund were the other two.)

We have been in our new home now for almost a month and things are settling down and developing a rhythm. I want to thank you all from the bottom of my heart for all your good wishes and kind words. I believe that it was being wrapped in your positive energy that made the last couple of months bearable. Now I can hardly wait to see what 2009 has in store for me!

The best to you all. I am so proud of so many of you for seeing the light and taking control of your money and your lives.

Hey, I’m almost out of success posts, so if any of you want to share your stories, please send them along so everyone else can be inspired by you, or can share their wisdom with you to help you along.

One more thing: Since we’ve covered a lot of ground in the past year, is there anything in particular you’d like more information about? I already know you want more on investing, so I’m going to work up some stuff on that. Anything else?

Cheers, with heaps of love, and great big hugs.