Do You Need Permanent Life Insurance?
Today, life insurance is based around the idea that if you or your spouse dies, that your family will be made whole by replacing your spouse's income. This essential foundation for effective financial planning is often overlooked by many individuals. Most advisers agree that life insurance is necessary.
But, this is where the consensus ends (sadly). Most every financial professional recognizes the importance of life insurance. However, "gurus" like Dave Ramsey and Suze Orman have done a good job of painting the picture that whole life insurance is "evil". There is opposition though, and quite a debate over the issue.
The life insurance industry, and all of it's agents, of course love it. For the most part, the investment industry discounts its importance. So, who wins the debate?
It is shocking that the financial industry is responsible for informing and educating the rest of society about saving and investing. I say shocking because many of the advisors that represent the industry seem to be less concerned with the truth, and more concerned about pitching products.
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: Less that 2% of all term policies ever sold ever pay a claim. Which means: there is a 98% chance that your family will never benefit from a term policy. Term insurance may be the best type of insurance if all you are considering is the cost per thousand dollars of insurance. It is generally the worst type of insurance you can buy to insure your life if you are expecting your family to benefit from it (statistically speaking). You need to understand how life insurance companies 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?
Term insurance just doesn't pay, at least not for policy owners. That's because most people live to age 65. Term is expensive long-term. Permanent is a good deal long-term. A few critics will still say "no Dave, term is cheaper - always cheaper". Oh yeah? Watch this:
Let's look at a male, age 25 and in good health with a wife and a child. In fact, let's call him Jim (again *cheesy grin*) finds that he needs life insurance He needs $250,000 in life insurance. A 30-year term policy should cost Jim about $370 per year until he reaches age fifty-five. After that, the premiums become unaffordable (as is the case with all term insurance) at $4,700 per year.
At age 65, he will have spent $58,780 on policy premiums. Keep in mind that this is money that the insurance company collected but never had to pay back. Since there's no cash value in a pure insurance (term) plan, the insurance contract pays off only when Jim 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's $87,000 more than his premium payments for those 40 years. That's also money that can be used on a tax-free basis to help supplement retirement. This is called a living benefit, and a feature that term just doesn't offer. Some of the more competitive permanent policies also offer an option to spend down the death benefit if you become terminally ill. This can be helpful if you haven't accumulated a lot of money and something tragic happens to you and you don't die...or you don't want to spend down your savings.
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: With whole life insurance it is often difficult to determine how much the death benefit is costing you. If that bothers you, then don't buy whole life insurance. However, universal life insurance is, in actuality, a term policy with a separate savings account - often called 'the pot of money'. As such, you can easily determine the cost per thousand dollars of insurance, how much is going to pay the death benefit, and how much is going into the cash value of the policy. Cash value insurance can seem expensive in comparison to term insurance because of the front load (commissions and administrative fees) nature of the contract and the fact that you are forced to save money in a cash account. This is a point that is really driven home by the anti-cash value life insurance crowd.
Be thankful that you pay some of the fees that you do. It makes saving and investing money a lot easier. In regard to life insurance, you have a choice: the contract can be set up to maximize the death benefit (maximizing the cost of the contract), or it can be set up to focus on cash accumulation (minimizing expense charges). All of the expenses associated with permanent life insurance can be made just as efficient and in some cases more efficient than an investment product. But why compare insurance to an investment?
You will usually get all of your money back that you put into a permanent policy plus interest (depending on how you structured the contract). Additionally, the policy can give you a substantial tax-free income at retirement. The only exception to this is variable life, which typically has no guarantee on cash values
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.
The cash value life insurance that your financial guru told you was evil and that you didn't need could have prevented all of this by bypassing probate, providing an income tax free death benefit and, inside of a life insurance trust, completely avoided the estate tax thereby giving your heirs, your favorite charity, or your church 100% of the money you wanted to give them.
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.
But, this is where the consensus ends (sadly). Most every financial professional recognizes the importance of life insurance. However, "gurus" like Dave Ramsey and Suze Orman have done a good job of painting the picture that whole life insurance is "evil". There is opposition though, and quite a debate over the issue.
The life insurance industry, and all of it's agents, of course love it. For the most part, the investment industry discounts its importance. So, who wins the debate?
It is shocking that the financial industry is responsible for informing and educating the rest of society about saving and investing. I say shocking because many of the advisors that represent the industry seem to be less concerned with the truth, and more concerned about pitching products.
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: Less that 2% of all term policies ever sold ever pay a claim. Which means: there is a 98% chance that your family will never benefit from a term policy. Term insurance may be the best type of insurance if all you are considering is the cost per thousand dollars of insurance. It is generally the worst type of insurance you can buy to insure your life if you are expecting your family to benefit from it (statistically speaking). You need to understand how life insurance companies 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?
Term insurance just doesn't pay, at least not for policy owners. That's because most people live to age 65. Term is expensive long-term. Permanent is a good deal long-term. A few critics will still say "no Dave, term is cheaper - always cheaper". Oh yeah? Watch this:
Let's look at a male, age 25 and in good health with a wife and a child. In fact, let's call him Jim (again *cheesy grin*) finds that he needs life insurance He needs $250,000 in life insurance. A 30-year term policy should cost Jim about $370 per year until he reaches age fifty-five. After that, the premiums become unaffordable (as is the case with all term insurance) at $4,700 per year.
At age 65, he will have spent $58,780 on policy premiums. Keep in mind that this is money that the insurance company collected but never had to pay back. Since there's no cash value in a pure insurance (term) plan, the insurance contract pays off only when Jim 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's $87,000 more than his premium payments for those 40 years. That's also money that can be used on a tax-free basis to help supplement retirement. This is called a living benefit, and a feature that term just doesn't offer. Some of the more competitive permanent policies also offer an option to spend down the death benefit if you become terminally ill. This can be helpful if you haven't accumulated a lot of money and something tragic happens to you and you don't die...or you don't want to spend down your savings.
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: With whole life insurance it is often difficult to determine how much the death benefit is costing you. If that bothers you, then don't buy whole life insurance. However, universal life insurance is, in actuality, a term policy with a separate savings account - often called 'the pot of money'. As such, you can easily determine the cost per thousand dollars of insurance, how much is going to pay the death benefit, and how much is going into the cash value of the policy. Cash value insurance can seem expensive in comparison to term insurance because of the front load (commissions and administrative fees) nature of the contract and the fact that you are forced to save money in a cash account. This is a point that is really driven home by the anti-cash value life insurance crowd.
Be thankful that you pay some of the fees that you do. It makes saving and investing money a lot easier. In regard to life insurance, you have a choice: the contract can be set up to maximize the death benefit (maximizing the cost of the contract), or it can be set up to focus on cash accumulation (minimizing expense charges). All of the expenses associated with permanent life insurance can be made just as efficient and in some cases more efficient than an investment product. But why compare insurance to an investment?
You will usually get all of your money back that you put into a permanent policy plus interest (depending on how you structured the contract). Additionally, the policy can give you a substantial tax-free income at retirement. The only exception to this is variable life, which typically has no guarantee on cash values
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.
The cash value life insurance that your financial guru told you was evil and that you didn't need could have prevented all of this by bypassing probate, providing an income tax free death benefit and, inside of a life insurance trust, completely avoided the estate tax thereby giving your heirs, your favorite charity, or your church 100% of the money you wanted to give them.
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:
Author information: There is only so much information that can be covered in one article. If you want more information about any aspect of personal finance, please visit David's website.
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