Life insurance is among the most misunderstood financial concepts out there. But when you break it down to its components, it’s not that complicated at all: Life insurance just replaces the future income of the people in the risk pool who don’t make it to life expectancy. They do that by taking their premiums and saving it on their behalf – paying claims and investing the difference.
- Term insurance is cheaper than cash value insurance.
Can you get a larger amount of term for the same premium you would pay on a cash value policy? Sure. That doesn’t mean it’s cheaper – any more than buying a clunker every year for ten years is cheaper than buying one good car and taking care of it. For shorter time horizons, where you know you don’t need insurance after a certain period of time, term is cheaper. For longer term applications, term gets expensive very quickly. Live out to life expectancy, and you will probably pay more in premiums than your heirs ever receive in life insurance.
- You should lock in the longest level term you can.
Not necessarily. Locking in long level terms requires you to pay higher premiums up front. That means you’re foregoing investing in your own portfolio or current consumption. That has value, too. Meanwhile, as mortality statistics improve and the competitive environment changes, term insurance premiums continue to fall precipitously. If you are still in good health, chances are very good you can get a better deal in a few years. Consider using an annually renewable term policy that increases each year-or if your agent doesn’t sell those, a five year term policy. Once you get out to 20 year terms, cash value policies start to make more sense.
- I have life insurance at work.
A lot of people reflexively assume their workplace policy is sufficient. “I already have life insurance,” they say. But most workplace plans only provide for $50,000 in death benefit. That’s all the life insurance the law allows the boss to deduct. In reality, most families need a lot more than $50,000 in life insurance. So if you have a family, unless you’re planning on only being dead for a year or so, you need to get some more coverage.
- Whole life insurance is a lousy investment.
Let’s be clear: Whole life insurance is a permanent policy that stays in force no matter how long you live. Well, until age 121, anyway. Premiums are guaranteed level, and you have cash value that grows at a conservative rate, guaranteed every year. It’s guaranteed never to go down, unless you withdraw it (as long as the insurance company remains solvent). As such, it doesn’t make sense to compare whole life to, say, the stock market. Any allocation to whole life is more akin to money in a CD or money market. When compared on that basis, whole life cash value is an excellent place to keep conservative, safe money – especially on an after tax basis, since interest in CDs, money markets and treasuries is taxable. Life insurance cash value grows tax free. And meanwhile, you have the life insurance, which is the whole point.
Don’t leave your family with less death benefit than they need because you’re going overboard with the whole life. But definitely consider it as your needs evolve, if you need a place for safe money and an emergency fund, and/or you need or want a permanent end-of-life death benefit for whatever reason.
- I need to buy a big permanent policy with an expensive premium.
That’s not true by a long shot. The best kind of life insurance to buy is the kind that will be in force when you need it. Which leads us to the corollary – the amount of life insurance you need is an amount you can easily afford. After all, policies you can’t afford are policies that eventually lapse. That doesn’t do you any good.
- Why can’t I get a level term policy for life?
You can. Ask your agent to show you an illustration for a universal life policy with a lifetime no-lapse guarantee. It’s the same thing. The policy will remain in force, for as long as you live, provided you keep up on the premiums. You’ll see the policy build up a cash value for a while, then spend it down to zero – the cash value is just a camel’s hump: A reserve that helps supplement your premiums, so your out of pocket premiums don’t go up as you get older.
You won’t be able to rely on the policy for cash value, and the death benefit won’t go up with inflation, but from the consumer’s point of view, it will work the same way as a level-term policy for life.
- My wife doesn’t work. I don’t need life insurance on her.
Life insurance isn’t there for you to profit from someone else’s death. But if something happened to your spouse, you may need to take time off work to spend with the children. You may even need to be a full-time dad for an extended period of time. If not, you may need to spend money on all the things your spouse did for the household during her life. Expenses like day care, laundry, cleaning and meals out that used to be cooked at home add up fast. A small policy even on a non-working spouse until the kids are grown can give you a lot of freedom of action.
- I don’t need life insurance on my children.
Probably not. It depends what kind of funeral expenses and final medical bills you may incur. The latter is something you can’t really control. We look at that risk, though, and how it interfaces with your medical insurance coverage. We also know that a lot of parents want to take an extended amount of time off of work after losing a child. Life insurance on children is so inexpensive that it often makes sense to get enough coverage to figure out the worst-case scenario and just get that amount. If you use a cash value policy, and you fund it adequately, they can make a very good college funding vehicle, down payment assistance fund, wedding fund, dowry, or graduation gift. Over 17-23 years, you should have far more in cash value than you ever put into it, so the life insurance works out to be free in the long run.
Furthermore, you lock in your child’s insurability. If your baby girl wants to start a family, she can have coverage, no matter what her medical condition or history. If she beat cancer as a child, or screws up once or twice and gets a drug-related conviction as a teenager, or discovers a passion for helicopter skiing and motorcycle racing, that could prevent her from getting coverage. Having coverage in place ahead of time can hedge that risk, and protect her options. (Otherwise, guess who gets to bring up your grandchild if something happens to her? That’s going to come out of your pocket!)
Nobody likes contemplating the death of a child. It’s unpleasant. And some cultures frown on it for other reasons. We like to confront the risk head on, though, and help our clients make a big picture decision.
- I can deduct premiums.
Generally, the only time you can deduct life insurance premiums is on the first $50,000 of coverage in a group workplace policy. Otherwise, life insurance premiums are a non-deductible expense. It’s actually better that way. Otherwise, the death benefit would be taxable. It’s much better to have a tax-free death benefit, in the long run, than a tax deduction on premiums.
- I’m single with no kids. I can get life insurance later.
Don’t count on it. There are a lot of medical conditions that kick in in early adulthood – like schizophrenia, multiple sclerosis, Lou Gehrig’s disease, ovarian cancer, and many others that can make it expensive or impossible to get coverage. One DUI on your record can put a damper on your ability to get coverage. If you’re in good health, lock in your good rating now. As long as you keep the policy in force, you can keep that preferred rating for life. That’s a valuable asset. Since the best coverage to get is the coverage you can easily afford, do it now. Don’t wait ‘til the baby’s on the way to get turned down.
If it seems like I’m very pro-life insurance, it’s because I am. Think about it… if you’re a client, and something happened to you tomorrow, who is going to be trying to help your family solve their financial problems when you’re gone?
Every financial planner or life agent who’s been in practice long enough sooner or later gets that teary phone call from someone. Planners get it during working hours. Life agents get it from the hospital at 3 AM. When something happens, your spouse is going to ask one question, and it’s always the same: “Am I going to be ok?”
Please, make sure that when that call comes from your loved ones someday, I get to answer “Yes.”