A comprehensive financial plan will incorporate cash flow analysis, investment management, estate analysis, but also risk management.
From a purely holistic perspective, a life plan would look at all aspects of risk management, including health, fitness and mental wellbeing; however in the financial arena, risk management is insurance. Just like we will tend to spend more time researching the purchase of a new vehicle than we do examining our investments or even constructing a plan, life insurance policies are often entered into and forgotten.
Worse still, memories of the rationale behind said policies may have lapsed.
It is ironic that something which became so commoditized -- to the extent that insurance salespersons are treated like those peddling vacuums and encyclopedias -- has led people to have a hard time identifying the real purpose of insurance. In the spectrum of Canadians, ranging from those with no life insurance to those with properly constructed insurance strategies, is an unfortunately large group consisting of individuals with inadequate, overly expensive or excessive insurance.
The first segment is easy to understand and most of us get how insurance costs will generally raise with age, but how can one have too much insurance? Simply, because insurance was purchased (usually from friends or family members "just getting started" in the industry) without thought to the cumulative insurance coverage or burden, if we're thinking cost.
For all the above reasons, individuals should do a regular audit of their insurance policies as part of a financial plan review.
Indeed, it is extremely difficult to get a handle on how much insurance coverage is needed without a comprehensive plan. From an analysis of assets and liabilities and cash flow, an individual will figure out where the need for insurance will come from. If we think in terms of a hierarchical structure of needs, the pure need for insurance is to simply replace income and support a lifestyle for those who survive us when we die.
For those with adequate assets, this need will be minimal or non-existent, leading to the two other main drivers for insurance -- tax efficiency and estate protection. Where sizable assets have been built up in a taxable environment (personal investment or corporate accounts), the income generated from investments could cause major tax headaches, requiring sheltering.
Permanent insurance strategies lend themselves to this problem, effectively becoming large tax-free savings accounts. When we do pass, final personal and estate taxes can be a massive burden on survivors and beneficiaries. For example, if the last spouse to die or a single individual leaves with a large RRSP or RRIF, that account value is treated as income in the final tax return, resulting in hefty cheques to Ottawa. Likewise, capital gains taxes can also create a significant drag on final estate value. In both cases, a well-constructed insurance strategy will accomplish the objective of eliminating or mitigating the final tax hit.
Of course, there are many more considerations to take into account when reviewing insurance coverage, including the decision to hold insurance inside a corporation or outside. With the summer doldrums approaching, Canadians would be well advised to dig into their drawers and find all the assorted policies they have accumulated, or discover that there is no insurance, and spend a few days thinking about what they can purge, what they should keep and what they don't have.