Can you have too much life insurance?

Life insurance provides a financial safety net for your dependents when you die. As with many other things in life, too little or too much life insurance can be a bad thing.

On one hand, you don’t want your loved ones to worry about money on top of dealing with the pain of your loss. On the other, if you go overboard with your life insurance benefit amount, you may end up paying much higher premiums than you can logically afford.

This article will explore how you can avoid purchasing too much life insurance.

Why do people buy life insurance?

Two of life’s certainties, death and taxes, can both take from your family if you (as an income-earner) pass on. Buying life insurance helps to protect your surviving family financially.

The benefit from a life insurance policy makes it easier for your family to deal with your funeral expenses, house payments, debts, future education, and so much more.

In Canada, the lump sum death benefit is not subject to income tax, so your beneficiaries will receive the total amount of the benefit, tax-free. Therefore, buying life insurance ensures your dependents are well taken care of in your absence.

Calculating how much insurance you need

Insurance needs differ from person to person. While a huge lump sum looks appealing, it may be too much (or too little) for your needs.

The exact amount of insurance you need depends on several factors like:

• Number and age of dependents
• Debt profile
• Mortgage loan size and amortization schedule
• Age
• Marital status
• Total household income

A thorough analysis of your financial and personal circumstances is the first step to determining the amount of insurance you need.

For example, if you are the sole breadwinner with several dependents and a new mortgage, you will likely need more coverage. In contrast, if you have a single dependent and your spouse has a substantial income, a large life policy may not be necessary.

If you determine that your dependents’ needs outweigh the coverage you can get on one policy, you may need to take out a second or third life policy. Canadian laws don’t prohibit holding multiple life insurance policies.

Multiple policies are advantageous for a number of reasons: they can increase the size of the death benefit you are leaving behind, or can be structured in ways that cover your riskiest years with a higher benefit and taper off as you get older and pay down more debt (more on that later). However, you also have to pay multiple premiums, which can hit your pocket a little harder than a single policy.

Calculating how much insurance you and your family need can be complicated given the interplay of so many variables. Use a life insurance calculator to simplify the process. It helps determine the coverage you need based on your current financial circumstances.

Why too much life insurance can be a bad thing

You may think a larger death benefit (or multiple death benefits) is better since it may meet or even improve your family’s financial needs. However, too much coverage can be a negative, especially if it takes away from the present.

The financial reality

The expense of larger or multi-policy premiums can set you back financially. Inflated insurance premiums can take income and funds from the present day that you could have spent enjoying while you’re still here with your loved ones. Preparing for the inevitable is essential and a thoughtful gift for those that depend on you, but you need some balance.

The type of coverage

Having too much of one type of insurance may not be the best coverage for your financial situation. Term insurance is cheaper, but it will only be valid for a specified period. In contrast, whole life coverage lasts indefinitely, but comes with higher premiums.

For instance, if you’re older and your children have grown up, finished college, and left the house, and you are close to paying off your mortgage a 20 to 30-year term insurance policy may mean paying for coverage you don’t need. At that point in your life, whole life insurance coverage may be more appropriate.

If you want the most comprehensive coverage you can get, using a life insurance ladder strategy can help you find the right balance of coverage that protects you in the long term.

The risk of your coverage lapsing

Lastly, if you struggle with your payments and eventually miss a few, your policy will lapse. You will have wasted the money you invested in your protection in the first place. Even worse? Requalifying for the coverage may be more expensive if you do right the ship financially and decide to take on coverage again. Stick with a policy that you know you can afford to prevent a lapse in your coverage.

How can you tell if you have too much life insurance?

The goal when purchasing life insurance is to take care of your loved ones when you’re no longer there to do so. Taking out more insurance than you need, while thoughtful, is an unnecessary expense that you may not always have the luxury of affording.

But how do you know when you have too much? Watch out for these tell-tale signs.

Difficulties paying for insurance

One of the biggest signals that you have too much life insurance coverage is struggling to pay your premiums. Generally, an insurance policy that suits your needs should fit easily into your budget. If you find yourself questioning the expense of every insurance payment, it may mean you are overinsured.

Payout / Asset mismatch

Life insurance policy coverage is typically higher than the value of your assets. However, if your coverage substantially surpasses your assets, it’s a sign that your policy (or policies) outweighs your needs.

Cost of care

Life insurance meets a critical need in your absence. The proceeds should still be able to take care of your family in the unfortunate event of your passing. However, if the coverage from your policy exceeds the amount you would be contributing if you were still there, then it may be a larger amount than your dependents require.

An appropriate coverage should match – not exceed – the continued costs of caring for your dependents if you were alive.

What to do if you have too much life insurance

After you determine your insurance needs and if you realize you are overinsured, what’s the next step?

First, you need to compare rates to see if you can change your policy. Talk to an insurance advisor so you don’t inadvertently create gaps in your life insurance coverage.

An insurance advisor can give you the best recommendation for realigning the structure of your life insurance policies. They can help with suggestions like:

• Moving to a different policy or carrier for a better price or better policy structure through life insurance riders.
• Alternative coverage arrangements like insurance laddering. As mentioned earlier, life insurance laddering can help you match several different life insurance policies to the appropriate years of risk while providing an extended coverage time frame.
• Replacing expensive, existing insurance coverage (like creditor or mortgage insurance, or a guaranteed or simplified policy) with a fully underwritten term life insurance policy.

Purchasing too much life insurance can mean tying up your hard-earned cash when you can better enjoy it while you are still here with your loved ones. That said, it’s still important to prepare for the uncertainty of the future. Taking a critical look at the amount of coverage you have, determining it’s sufficient for your future financial goals of your loved ones, and adjusting if required can help you find the coverage balance you need to live life to the fullest.