Do You Need Permanent Life Insurance?
The necessity of life insurance today is based around the idea of a family with one or both spouses working outside of the home, and that if one of them dies, the other will be left with financial obligations that will not be able to be met. Most advisers agree that life insurance is supposed to fill that gap.
However, financial professionals often disagree about how much and what type of insurance one should carry. The perception is that term insurance is always the easiest and most cost effective. To this end, many advisers and financial "gurus" like Suze Orman and Dave Ramsey often suggest that their audience forget about cash value insurance and instead focus on good-sounding investments. In short...they hate whole life insurance.
Life insurance agents of course love cash value insurance. The investment industry does a pretty good job of putting down the insurance industry. So...who's right?
It's surprising that the financial industry is supposed to be the educator. I say that only because many of the financial advisors in my industry seem to be more concerned about what the next "hot" mutual fund is...or manipulating interest rate returns, eliminating or disguising fees and disregarding suitability with respect to their clients.
I say that in light of the fact that on both sides of the debate, neither is doing a very good job of defending their position. Many financial professionals are simply leaving out critical information, or appear to not have a very good grasp of how life insurance really works.
Their reasons for lying can be many. Now, there's nothing wrong with pointing out the shortcomings in a financial product. In the case of life insurance; however, the attacks being made are completely baseless. This is especially disheartening because most, if not all, of these attacks are originating from well known financial "gurus". Here are a few of the lies being spread around:
Lie Number One:
Cash value life insurance is one of the worst financial products available, and it is definitely the worst type of insurance you can buy to insure your life. The BEST kind of insurance is term insurance because it's cheap and I'm not paying all those extra fees to the evil and greedy insurance company. Besides, don't insurance companies have a record of being reckless, cheating their policyholders, and systematically going out of business.
Fact: About 1% of all term policies pay a claim. So, your family has (roughly) a 1% chance that they will benefit from that term policy. Term insurance is cheap - IF you are only considering the cost per thousand dollars of insurance. It is guaranteed to get more expensive as time goes on (and you will see this if your policy gets repriced). Life insurance companies are not dumb. They know they can collect premiums from term life and make a killing because the turnover rate is high (people drop their policies before the term is up) or the policy owner simply doesn't die before the term is up. Life insurance companies are in the business to make money and provide a product. You have to understand how they position their products and how they make money.
You may have heard of the "law of averages". Well, insurance uses something called the Law of Large Numbers. The larger the group of people you are insuring, the more certain you can be about the number of losses.
If I started a life insurance company and I only had one customer, I would be taking on an incredible risk because of the nature of life insurance, if that one person dies, I could be out of business very quickly. If, however, I have thousands or millions of customers, then I can manage the risk. Since no one can predict when a specific individual will die (i.e. no one can predict when I will die), I need a large number of people to study to formulate a statistic. With a large enough number of people, I can make surprisingly accurate predictions about the number of individuals within a particular group that will die in any given year. So...what do the statistics say?
They tell us that term insurance just doesn't pay...well not for policy owners anyway. Most people live until age 65. After that premium costs spike dramatically. This is why I say that, on most accounts, permanent is cheaper, even though there are probably a few critics saying "no Dave, it's cheaper on all accounts". Oh yeah? Watch this:
A male (let's use Jim again), age 25 and in good health with a wife and a child finds that he needs life insurance. Jim is looking for $250,000 in coverage. A typical 30-year term policy - a policy that has level premium payments for 30 years - should cost Jim around $370 per year until he reaches age fifty-five. At that point, the premiums jump up significantly (as all term insurance premiums do) to a tad over $4,700 per year.
After 65, will have spent $58,780 in premiums. That's a lot! Also, remember that this is money that the insurance company collects and never has to give back. Since there's no cash value associated with term insurance, the insurance contract pays off only when he dies.
What would have happened if he had purchased the same amount of death benefit but used a universal life insurance policy? His annual premiums would have been higher - $1739. By his 65th birthday, Jim has a total premium outlay of $69,560 ($1739 x 40). Wow! But, he will have built up $157,000 of cash value inside the policy.
That money can be used on a tax-free basis to supplement his retirement or left alone to continue growing. This is an example of one of many living benefits that permanent insurance has (didn't your adviser tell you about that?). Some permanent policies also offer an option to spend down up to 100% of the death benefit for any reason in the event of a critical, chronic, or terminal illness. This can be especially useful if you haven't been able to accumulate a lot of money and something tragic happens to you...and you live!
Lie number two:
Cash value life insurance is overpriced. You can never tell how much money you are spending on death benefit and how much money is actually going into the cash value of the policy. With term insurance, the costs are clear.
Fact: Whole life insurance carries a stigma in that it is often difficult to determine how much the death benefit is costing you. However, universal life insurance is, in actuality, a term policy with a separate savings account - often called 'the pot of money'. The costs are broken down and the policy is very transparent. Cash value insurance can seem expensive in comparison to term insurance because of the front loaded nature of the contract and the fact that you are forced to save money in a cash account. Sadly, the fees charged by the insurance company are being stressed (I guess they don't know that all financial products carry similar fees).
The fees aren't so bad. I'm serious. Think about how much more difficult it would be if every time you wanted to save or invest money, you had to call a lawyer to draft a contract for you? With respect to life insurance, you have a few choices: you can structure the contract for maximum cash (minimizing the fees) or maximum death benefit (maximizing the fees, but getting more death benefit as a result). All of the expenses associated with permanent life insurance can be made very reasonable if cost is the concern. But why compare insurance to an investment?
Over the long-term, you should get all of your money back that you put into a cash value policy with interest (note: the exception to this is variable life insurance which doesn't guarantee cash values). If the policy is structured properly, you can also be left with a sizable amount that can be drawn on in retirement.
Lie number three:
If you are smart with the money you have today and you get rid of your mortgage, car loans and credit card debt and put money into retirement plans you don't need insurance 30 years from now to protect your family when you die.
Fact: I'm not exactly sure what being "smart" with your money means, but advisers like Ric Edelman have done at least one thing right by demonstrating that debt can be leveraged and paying off your home early is rarely a good idea. But beyond that, you may need life insurance to protect your beneficiaries (whoever they may be) from taxes. As for retirement, you can't predict the investment returns in a mutual fund inside of a 401(k) or IRA unless you are very good at researching stocks - which most people are terrible at. Even professional stock analysts don't always get it right. The stock market ebbs and flows, and goes through cycles of boom and bust. If your investments take a hit right before you are ready to retire, it just doesn't matter how "smart" you were with your money.
Also, consider that dying isn't free. Ask a funeral director in your home town how much a funeral costs...and then ask him or her how much it should be in 10 years...20 years...when you expect to die. You will be amazed...and not in a good way. Also, ask any child whose parents left them any amount of money what they paid in taxes and if it was financially disruptive.
That cash value life insurance policy that your financial guru told you to ditch could have bypassed probate, provided an income tax free death benefit and, inside of a life insurance trust, completely avoided the estate tax thereby giving your heirs what they deserve.
Although many financial gurus try to draw a connection between insurance and investing in the process of telling you what a lousy investment cash value life insurance is, comparing this type of insurance to investing is nonsensical. It's like asking "how many vinyl records does it take to equal a DVD?"...we're talking about two different products that, while somewhat related, work in two very different ways - each with their own different objectives.
Before you make a final decision on whether to buy term or cash value life insurance, consider what you are really looking for. If you are looking for an investment, then be prepared to look for stocks, bonds, no load mutual funds, options, and other various financial derivatives (and learn how to research them). If you're looking for a long-term savings tool, then cash value life insurance can fit that need very well.
However, financial professionals often disagree about how much and what type of insurance one should carry. The perception is that term insurance is always the easiest and most cost effective. To this end, many advisers and financial "gurus" like Suze Orman and Dave Ramsey often suggest that their audience forget about cash value insurance and instead focus on good-sounding investments. In short...they hate whole life insurance.
Life insurance agents of course love cash value insurance. The investment industry does a pretty good job of putting down the insurance industry. So...who's right?
It's surprising that the financial industry is supposed to be the educator. I say that only because many of the financial advisors in my industry seem to be more concerned about what the next "hot" mutual fund is...or manipulating interest rate returns, eliminating or disguising fees and disregarding suitability with respect to their clients.
I say that in light of the fact that on both sides of the debate, neither is doing a very good job of defending their position. Many financial professionals are simply leaving out critical information, or appear to not have a very good grasp of how life insurance really works.
Their reasons for lying can be many. Now, there's nothing wrong with pointing out the shortcomings in a financial product. In the case of life insurance; however, the attacks being made are completely baseless. This is especially disheartening because most, if not all, of these attacks are originating from well known financial "gurus". Here are a few of the lies being spread around:
Lie Number One:
Cash value life insurance is one of the worst financial products available, and it is definitely the worst type of insurance you can buy to insure your life. The BEST kind of insurance is term insurance because it's cheap and I'm not paying all those extra fees to the evil and greedy insurance company. Besides, don't insurance companies have a record of being reckless, cheating their policyholders, and systematically going out of business.
Fact: About 1% of all term policies pay a claim. So, your family has (roughly) a 1% chance that they will benefit from that term policy. Term insurance is cheap - IF you are only considering the cost per thousand dollars of insurance. It is guaranteed to get more expensive as time goes on (and you will see this if your policy gets repriced). Life insurance companies are not dumb. They know they can collect premiums from term life and make a killing because the turnover rate is high (people drop their policies before the term is up) or the policy owner simply doesn't die before the term is up. Life insurance companies are in the business to make money and provide a product. You have to understand how they position their products and how they make money.
You may have heard of the "law of averages". Well, insurance uses something called the Law of Large Numbers. The larger the group of people you are insuring, the more certain you can be about the number of losses.
If I started a life insurance company and I only had one customer, I would be taking on an incredible risk because of the nature of life insurance, if that one person dies, I could be out of business very quickly. If, however, I have thousands or millions of customers, then I can manage the risk. Since no one can predict when a specific individual will die (i.e. no one can predict when I will die), I need a large number of people to study to formulate a statistic. With a large enough number of people, I can make surprisingly accurate predictions about the number of individuals within a particular group that will die in any given year. So...what do the statistics say?
They tell us that term insurance just doesn't pay...well not for policy owners anyway. Most people live until age 65. After that premium costs spike dramatically. This is why I say that, on most accounts, permanent is cheaper, even though there are probably a few critics saying "no Dave, it's cheaper on all accounts". Oh yeah? Watch this:
A male (let's use Jim again), age 25 and in good health with a wife and a child finds that he needs life insurance. Jim is looking for $250,000 in coverage. A typical 30-year term policy - a policy that has level premium payments for 30 years - should cost Jim around $370 per year until he reaches age fifty-five. At that point, the premiums jump up significantly (as all term insurance premiums do) to a tad over $4,700 per year.
After 65, will have spent $58,780 in premiums. That's a lot! Also, remember that this is money that the insurance company collects and never has to give back. Since there's no cash value associated with term insurance, the insurance contract pays off only when he dies.
What would have happened if he had purchased the same amount of death benefit but used a universal life insurance policy? His annual premiums would have been higher - $1739. By his 65th birthday, Jim has a total premium outlay of $69,560 ($1739 x 40). Wow! But, he will have built up $157,000 of cash value inside the policy.
That money can be used on a tax-free basis to supplement his retirement or left alone to continue growing. This is an example of one of many living benefits that permanent insurance has (didn't your adviser tell you about that?). Some permanent policies also offer an option to spend down up to 100% of the death benefit for any reason in the event of a critical, chronic, or terminal illness. This can be especially useful if you haven't been able to accumulate a lot of money and something tragic happens to you...and you live!
Lie number two:
Cash value life insurance is overpriced. You can never tell how much money you are spending on death benefit and how much money is actually going into the cash value of the policy. With term insurance, the costs are clear.
Fact: Whole life insurance carries a stigma in that it is often difficult to determine how much the death benefit is costing you. However, universal life insurance is, in actuality, a term policy with a separate savings account - often called 'the pot of money'. The costs are broken down and the policy is very transparent. Cash value insurance can seem expensive in comparison to term insurance because of the front loaded nature of the contract and the fact that you are forced to save money in a cash account. Sadly, the fees charged by the insurance company are being stressed (I guess they don't know that all financial products carry similar fees).
The fees aren't so bad. I'm serious. Think about how much more difficult it would be if every time you wanted to save or invest money, you had to call a lawyer to draft a contract for you? With respect to life insurance, you have a few choices: you can structure the contract for maximum cash (minimizing the fees) or maximum death benefit (maximizing the fees, but getting more death benefit as a result). All of the expenses associated with permanent life insurance can be made very reasonable if cost is the concern. But why compare insurance to an investment?
Over the long-term, you should get all of your money back that you put into a cash value policy with interest (note: the exception to this is variable life insurance which doesn't guarantee cash values). If the policy is structured properly, you can also be left with a sizable amount that can be drawn on in retirement.
Lie number three:
If you are smart with the money you have today and you get rid of your mortgage, car loans and credit card debt and put money into retirement plans you don't need insurance 30 years from now to protect your family when you die.
Fact: I'm not exactly sure what being "smart" with your money means, but advisers like Ric Edelman have done at least one thing right by demonstrating that debt can be leveraged and paying off your home early is rarely a good idea. But beyond that, you may need life insurance to protect your beneficiaries (whoever they may be) from taxes. As for retirement, you can't predict the investment returns in a mutual fund inside of a 401(k) or IRA unless you are very good at researching stocks - which most people are terrible at. Even professional stock analysts don't always get it right. The stock market ebbs and flows, and goes through cycles of boom and bust. If your investments take a hit right before you are ready to retire, it just doesn't matter how "smart" you were with your money.
Also, consider that dying isn't free. Ask a funeral director in your home town how much a funeral costs...and then ask him or her how much it should be in 10 years...20 years...when you expect to die. You will be amazed...and not in a good way. Also, ask any child whose parents left them any amount of money what they paid in taxes and if it was financially disruptive.
That cash value life insurance policy that your financial guru told you to ditch could have bypassed probate, provided an income tax free death benefit and, inside of a life insurance trust, completely avoided the estate tax thereby giving your heirs what they deserve.
Although many financial gurus try to draw a connection between insurance and investing in the process of telling you what a lousy investment cash value life insurance is, comparing this type of insurance to investing is nonsensical. It's like asking "how many vinyl records does it take to equal a DVD?"...we're talking about two different products that, while somewhat related, work in two very different ways - each with their own different objectives.
Before you make a final decision on whether to buy term or cash value life insurance, consider what you are really looking for. If you are looking for an investment, then be prepared to look for stocks, bonds, no load mutual funds, options, and other various financial derivatives (and learn how to research them). If you're looking for a long-term savings tool, then cash value life insurance can fit that need very well.
About the Author:
About the author: There is only so much information that can be covered in one article. If you would like more detailed information about any aspect of financial planning, please visit David's website.
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