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.
This is where the agreement between financial professionals ends abruptly, because the next question that arises is: OK, so what kind of life insurance should people buy? The debate between which is better - term or cash value/permanent life insurance - is seemingly a "never ending battle". For many various reasons, many investment houses, stock brokers, mutual fund managers (and the agents who sell their funds), as well as many popular financial "gurus" like Suze Orman, Ric Edleman, and Dave Ramsey presumably (according to their many published books and comments on national radio and television) 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 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 a waste of money. It is the worst type of insurance you can buy. The BEST kind of insurance is term insurance because it's cheap. Insurance companies are shady and always try to take advantage of policyholders and cash value insurance is proof of that.
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.
Insurance companies use the Law of Large Numbers. They sample a group of people (similar age, height, weight, etc.). The larger the group of people they insure, the more accurate they are about the number of losses they will see.
Let's suppose you were to start an insurance company and you only had one customer - let's call him "Jim". You would be taking on an incredible risk by insuring just Jim. If Jim kicks the bucket, then you're on the hook for a lot of money that you may not have. You would be business very quickly (imagine: Jim gives you $20 for a $500,000 death benefit and then they die the very next day...where do you come up with $500K for Jim's family?). However, if you have thousands of customers just like Jim, then you have the unique ability to better control the risk you take by insuring Jim's life. No one can predict when Jim will die, but if you study a large enough group of people just like Jim, then you can begin to make very, very accurate predictions about the number of people just like Jim that will die in any given year. Given the accuracy of insurance companies in predicting deaths every year, what do their statistics tell us?
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 for what you get. You never know how much money you are spending on the death benefit, how much money is actually going into the cash value of the policy, and how much interest you are really earning. Term insurance is so much simpler.
Fact: Whole life insurance is not very transparent. So it is difficult to determine how much the death benefit is costing you. That bothers some people. That's OK. Just don't buy whole life insurance. Universal life insurance, on the other hand, is very transparent. That's because UL policies are a term policy with a separate savings account. 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 seems expensive in comparison to term insurance (at least initially) because insurance contracts are front loaded as far as fees are concerned. That's a good thing...because the contract becomes cheaper over time. Unfortunately, the initial cost is really driven home by the anti-cash value life insurance crowd.
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?
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:
Be smart with the money you have today and pay off your mortgage, car loans and other debt. Put enough 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.
Is life insurance is necessary as you get older? You will be shocked at the costs of even a modest funeral these days. What does the average funeral cost in your home town? Ask a funeral director. What is the inflation effect in the funeral industry. If it costs $12,000 today, what will it cost in 10 years? 20 years? 30 years? Ask any beneficiary who has been left any amount of money what they paid in taxes and if it was financially disruptive to them personally.
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 so-called experts try to compare life insurance to an investment, don't be fooled. Yes, life insurance, if properly structured, can build very strong cash values that rival investment products (my guess as to why the investment folks are upset). They try to tell you what a lousy investment cash value life insurance is. But comparing this type of insurance to investing is nonsensical. It's like asking "how many walkmans does it take to equal an Ipod?"...cash value insurance serves a different purpose from an investment. Each has 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.
This is where the agreement between financial professionals ends abruptly, because the next question that arises is: OK, so what kind of life insurance should people buy? The debate between which is better - term or cash value/permanent life insurance - is seemingly a "never ending battle". For many various reasons, many investment houses, stock brokers, mutual fund managers (and the agents who sell their funds), as well as many popular financial "gurus" like Suze Orman, Ric Edleman, and Dave Ramsey presumably (according to their many published books and comments on national radio and television) 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 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 a waste of money. It is the worst type of insurance you can buy. The BEST kind of insurance is term insurance because it's cheap. Insurance companies are shady and always try to take advantage of policyholders and cash value insurance is proof of that.
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.
Insurance companies use the Law of Large Numbers. They sample a group of people (similar age, height, weight, etc.). The larger the group of people they insure, the more accurate they are about the number of losses they will see.
Let's suppose you were to start an insurance company and you only had one customer - let's call him "Jim". You would be taking on an incredible risk by insuring just Jim. If Jim kicks the bucket, then you're on the hook for a lot of money that you may not have. You would be business very quickly (imagine: Jim gives you $20 for a $500,000 death benefit and then they die the very next day...where do you come up with $500K for Jim's family?). However, if you have thousands of customers just like Jim, then you have the unique ability to better control the risk you take by insuring Jim's life. No one can predict when Jim will die, but if you study a large enough group of people just like Jim, then you can begin to make very, very accurate predictions about the number of people just like Jim that will die in any given year. Given the accuracy of insurance companies in predicting deaths every year, what do their statistics tell us?
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 for what you get. You never know how much money you are spending on the death benefit, how much money is actually going into the cash value of the policy, and how much interest you are really earning. Term insurance is so much simpler.
Fact: Whole life insurance is not very transparent. So it is difficult to determine how much the death benefit is costing you. That bothers some people. That's OK. Just don't buy whole life insurance. Universal life insurance, on the other hand, is very transparent. That's because UL policies are a term policy with a separate savings account. 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 seems expensive in comparison to term insurance (at least initially) because insurance contracts are front loaded as far as fees are concerned. That's a good thing...because the contract becomes cheaper over time. Unfortunately, the initial cost is really driven home by the anti-cash value life insurance crowd.
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?
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:
Be smart with the money you have today and pay off your mortgage, car loans and other debt. Put enough 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.
Is life insurance is necessary as you get older? You will be shocked at the costs of even a modest funeral these days. What does the average funeral cost in your home town? Ask a funeral director. What is the inflation effect in the funeral industry. If it costs $12,000 today, what will it cost in 10 years? 20 years? 30 years? Ask any beneficiary who has been left any amount of money what they paid in taxes and if it was financially disruptive to them personally.
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 so-called experts try to compare life insurance to an investment, don't be fooled. Yes, life insurance, if properly structured, can build very strong cash values that rival investment products (my guess as to why the investment folks are upset). They try to tell you what a lousy investment cash value life insurance is. But comparing this type of insurance to investing is nonsensical. It's like asking "how many walkmans does it take to equal an Ipod?"...cash value insurance serves a different purpose from an investment. Each has 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: Only so much information can be covered in one article. If you want more information about any aspect of personal financial planning, please visit David's website.
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