The difference between term and whole life insurance is an important one to understand. Without understanding the difference between term and whole life insurance, you won’t be able to tell whether you are properly insured, under insured or over insured.

Temporary needs

The key to understanding the difference between term and whole life insurance comes down to temporary versus permanent coverage. Term insurance is in place for a specific period of time, or term. You can get term insurance ranging from five years to 30 years in some cases. Once the specified term expires, your coverage goes out the window.

Now, there are several riders you can add to your term insurance contract that will modify your coverage, but each rider usually makes your coverage a bit more expensive. One beneficial rider is the guaranteed renewal rider. With this kind of rider when your term expires, your insurance contract will automatically renew itself. This type of insurance coverage can be beneficial if you have a temporary insurance need, but aren’t exactly sure how temporary.

The most common use for term or temporary insurance is to replace the “mortgage insurance” your bank tries to sell you (and often succeeds). Term insurance is an excellent replacement for the bank’s mortgage insurance because when you use term insurance your coverage never decreases and you have control over how to spend the payout.

Permanent needs

Whole life insurance is often recommended for permanent needs, such as final expenses and income replacement at death. Usually, whole life insurance will come with a premium and death benefit that remains level for the entirety of the contract. Also, the insurance policy will build up a cash value that operates as a reserve. The cash value of the policy will usually end up equalling the death benefit if the insured individual lives to 100.

The two most common types of whole life insurance are participating and non-participating. With participating (or par) whole life insurance, any profits derived from the policy are refunded to the policy holder in the form of dividends. Non-participating whole life insurance does not offer this kind of refund. While insurance companies often argue this cash value is a benefit, others consider it a form a forced payment.

Whole life insurance isn’t the only form of permanent coverage. There is also universal life insurance, but it is often expensive and complicated. The most affordable form of permanent insurance coverage is term to 100. Term to 100 coverage often blurs the difference between term and whole life insurance.

Term to 100 (T100) coverage is a stripped down version of whole life insurance. It does not build up a cash value and this means the premium will be cheaper.

Most properly insured people have term insurance to coverage any mortgage that exists and a form of whole life insurance. I’ve been progressing through the various stages of financial well-being. When you are trying to get your finances in order, first you need to develop a small emergency fund. Then you need to start your debt snowball.  Once you’ve paid off your high-interest debt you need to increase your emergency fund so that it can cover a few months worth of expenses. These are the basics, the very bottom level of your financial pyramid. Included at the most basic level is proper life insurance. Once you are properly insured, have enough savings and reduced your debt, you can move on to the next level in the financial planning pyramid – saving for retirement.

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I’ve already touched on how to use high interest savings accounts to keep your emergency fund safe. I also mentioned that if you have debt, you need to establish a small emergency fund first and then worry about paying off your debt. As mentioned, your small emergency fund should be $1,000 if you make over $20,000 per year and $500 if you make less than $20,000 per year.

Once you have your baby emergency fund established and tucked away in a high interest savings account you need to get your debt snowball rolling. (I discussed the debt snowball solution here.) While some people have some criticisms of the debt snowball solution, it is still an effective way to start reducing your debt.

When you’ve used the debt snowball solution to reduce your high interest debt to zero, you can start to increase your emergency fund so that eventually it will be able to cover three to six months worth of expenses. I know having enough money to cover three to six months worth of expenses can seem like a daunting task, but it’s not. Here’s how to figure out how much money you’ll need to stash away in a high interest savings account.

Calculating a month’s worth of expenses

Here is how to calculate how much an emergency fund you’ll need:

The first thing you need to do is to look through your budget and bank account records and develop a list of all your monthly expenses. Once you have the list, cross off any non-essential items that you can go without. For example, cell phone plan extras like voicemail, caller ID or data plans. This new trimmed down list of monthly expenses is what you will use in the rest of your calculations.

Next you need to determine how many months worth of expenses you are going to tuck away. The minimum you should stash away inside a high interest savings account is three months worth of expenses and the most you would need to save is six months. The exact number of months you need to save depends on you and the type of job you have. For example, if you work in a volatile industry where there are regular layoffs you should save the maximum, six months. If, on the other hand, you live in a two income home or have a lot of job security you would only need to save three or four months worth of expenses. Other things to think about are the job market in your area and industry, security of your spouse has at their job or if there will be new financial commitments coming up.

Finally, this is the easy part, once you know your monthly expenses and how many months you want to store away, just multiply the two numbers. Personally, I work in a volatile industry and in a commission-based job so my aim is to save six months worth of expenses and my monthly expenses are $2,000. This means I need to save $12,000 to create an adequate emergency fund.

Revisit, review and revise

An emergency fund will cover you and your family when unavoidable tragedy strikes. To make sure that you are adequately covered, you need to:

• Revisit your emergency fund calculations every year
• Review your list of monthly expenses
• Revise your emergency fund where necessary. If you ever review your emergency fund and see that you have more saved than necessary, you should move it to a registered retirement account to shelter it from tax. But I’ll go into this in more detail at a later date.

As I mentioned in my previous post, high interest rate savings accounts are the best place to keep your emergency fund because it is a further step removed from the rest of your money. This means that when you have a moment of weakness, it will be harder to get at the money you have saved for emergencies.

Emergency funds, high interest savings accounts, debt reduction and life insurance are the very basics of personal finance. By making sure you reduce your debt, save enough and have proper insurance coverage you lay a healthy foundation for the rest of your financial life.

How do your determine how large your emergency fund should be? Are you comfortable will how much you have saved? Let me know what you think, comment below.

I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.

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The debt snowball is a popular solution to start working on debt reduction. The debt snowball solution is something made famous by personal finance guru Dave Ramsey. After establishing a baby emergency fund and placing it in one of the available high interest rates savings accounts, your next action should be starting your debt snowball rolling down hill.

The debt snowball solution is based more around behaviour and psychology than pure mathematics. Mathematics would suggest that you start by paying off your debt with the highest interest rate. Most people don’t look at things so objectively and rationally.

A lot of people will start trying to pay off their debt and then give up because it looks like they aren’t making any progress. But the debt snowball solution targets the lowest balance first. This way you can pay off one of your debts completely in a short period of time and this progress will motivate you to continue down the path of debt reduction.

Where to start

The best way to get started on debt reduction with the debt snowball solution is to make a list of all of your debts (Fiscal Geek has a great image of how he set up a debt snowball spread sheet in this post. Vertex 42 has a downloadable spreadsheet.) Once you have the list, sort them from lowest balance to highest.

Once you have a list of all of your debts from lowest to highest, you need to concentrate on the debt with the lowest balance. Your aim from here on out is to focus all of your effort and extra cash on getting rid of your smallest balance.

To make sure your focus is concentrated enough, you need to pay only making the minimum monthly amount on all of your other debts. If you don’t, your efforts will be diluted and you debt snowball will fail to grow. Once you reduce your monthly payments to the minimum amount, then you must focus all of the monthly income you can on paying off the smallest debt.

When your smallest debt is paid off you must make sure the debt snowball keeps growing.

Continue using the debt snowball for debt reduction

After your smallest debt is paid off, take the total monthly amount you were paying on your smallest debt and add the minimum monthly payment of your next debt. Take this new monthly total and put all of it towards the next item on your list.

Keep repeating this process as you pay off your debts and with each payment you will see another item removed from the list. Even better, as you are paying off your debts place the statements with a zero balance somewhere you can see. This will give you even more motivation to keep the debt snowball rolling down the path of debt reduction.

Debt free!

Eventually, you will work down your list from lowest balance to highest balance. As you progress, the amount of money you put towards any one debt will increase. This is the debt snowball solution to reduce your debt to zero.

Once you hit this point, the debt snowball solution has succeeded and you can move on. Where do you go from here? Subscribe to my RSS feed to make sure you catch the next post in this series.

What do you think of the debt snowball solution to debt reduction? Leave a comment below.

I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.

Related posts:

1. Use high interest savings accounts to store your full-blown emergency fund I’ve already touched on how to use high interest...
2. The difference between term and whole life insurance The difference between term and whole life insurance is...

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High interest savings accounts are the best place for people to keep their emergency funds. Better still; pick from the best internet savings accounts available, such as the Orange Savings Account from ING Direct.

Internet savings accounts are the best place to park your emergency fund because it keeps you funds beyond arms reach. In other words, having your emergency fund in one of the many high interest savings accounts available means that there will be a few more steps involved to tap into the funds you have set aside. This will shelter your emergency fund from any weak-willed moments you may suffer.

Why are emergency funds so important? They are important because when people don’t have emergency funds in place, they fall back on credit and fall into debt when an emergency happens. Recent data released in the media is a prime example of this.

The need

New information was released last week that showed the number of Canadian’s defaulting on credit card payments is increasing. The number of credit card accounts that are more than 30 days past due sits at 2.82 per cent, an almost 25 per cent increase from this time last year. The reason behind the increasing rate of credit card default is that credit card balances are ballooning.

Credit card balances are ballooning because people are losing their jobs and losing income. To replace the lost income and pay the bills people are falling back on credit. With increased balances come increased minimum payments and eventually they get to the point where people can no longer make the payment. When it comes to the point where people can no longer make their monthly payments a bad situation becomes much worse.

When you default on a credit card account you are penalized in two ways. First, your credit rating suffers and it will be harder to get a mortgage, line of credit or a car loan in the future. Second, the credit card company may slam you with increased interest rates and extra fees for being late with a payment.

The sad thing is that situations like these are increasing and the financial health of more people is suffering. It is even more tragic when we realize it can easily be avoided. It can be avoided by setting up an emergency fund when times are good.

An emergency fund is when you set aside extra cash in a safe place to pay for the unexpected, but unavoidable, things life throws at you. Murphy was right: eventually whatever can go wrong, will go wrong. Since these emergency situations are assured you need to have something other than credit to fall back on when they happen. Here is how to set up your own emergency fund.

How much?

How much you put aside for emergencies depends on if you have high interest credit card debt sitting around. If you do, then you need to set up a temporary emergency fund while you pay off your debt. This baby emergency fund should be $1,000 or $500 if you make less than $20,000 per year.

If you are out of debt it’s time for your small emergency fund to grow up. A full-blown emergency fund should be large enough to cover three to six months worth of expenses. I say three to six months because the actual amount will depend on you. If you have a job in a volatile market and you only have one income coming in then you should have a six month cushion. If you live in a dual income household then you may be able to get by with a smaller emergency fund.

Where you should keep it

Like I mentioned in the introduction above, you need to keep your emergency fund in one of the high interest rate savings accounts available. Your current bank probably has a high interest rate savings account, but the fees with these are typically rather high and require that you maintain a minimum balance. These fees and restrictions can make it expensive to keep a savings account at your everyday bank. If you are comfortable with online banking there are other and less expensive options available to you.

At the time of writing this some of the best internet savings accounts with the highest savings account interest rates are:

• Ally Bank 1.75%
• People’s Trust 2.10%
• Maxa Financial 2.00%
• Canadian Tire Bank 1.20%
• Outlook Financial 1.50%
• ING Direct Orange Savings Account 1.30%

You can set up an account and make regular monthly deposits at any of these banks. Once you have your emergency fund established you won’t have to worry about going into default and relying on credit when the unexpected happens.

I have decided to start this blog with a series of posts that deal with the basics of personal finance. This is the first post in this series. To make sure you catch the rest of the series and future posts subscribe to our feed and follow Savings Chronicle on Twitter.

Related posts:

1. Use high interest savings accounts to store your full-blown emergency fund I’ve already touched on how to use high interest...

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