Do You Need Permanent Life Insurance?
Life insurance is necessary. However, most individuals do not carry enough of it. The idea behind life insurance is that we all die. If your spouse dies prematurely, a life insurance policy will make sure that there is enough income to make your family whole for the financial loss you've suffered. Pretty much every adviser agrees having life insurance is a good thing.
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.
In truth, neither the insurance industry nor the investment industry is doing a very good job of defending their respective positions. Point Blank: Financial "gurus" are leaving out critical information. Either they do not have a very good grasp of how life insurance really works, or they are outright lying. Either scenario is totally unacceptable.
The motivation for lying can be as simple as "money". There is a lot of money floating around in the financial industry, and everyone is competing for it. So, while isn't anything wrong with demonstrating flaws in a financial product, it has to be done objectively. In regards to life insurance, it's not. The attacks are baseless and unsound, and most, if not all, of them are coming from very well known financial professionals. Here are a few of the misconceptions being passed around. Many of them have been repeated so many times, that most people think they are true (they aren't):
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.
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.
For example, if we were to start an insurance company and we only had one customer, we would be taking on an incredible risk because of the nature of life insurance, if that one person dies, we could be out of business very quickly (imagine that one customer giving you $20 for a $250,000 death benefit and then dying the very next day). If, however, we have a million customers, then we can better control the risks we are taking by insuring other people's lives. No one can predict when an individual will die, but if we study a large enough group of people, we can make surprisingly accurate predictions about the number of individuals within that group that will die in any given year. Given that insurance companies have an excellent record of predicting deaths every year, what do all of the statistics say?
They say that that term insurance doesn't pay, since most individuals live until age 65. This is why I say permanent is a better deal. In the long-run, it's cheaper. I know, I know...there are probably a few of you saying "no way, it is always cheaper to buy term insurance". Oh yeah? Watch this:
Let's reuse our example, Jim. Let's assume Jim is 25 and in good health with a wife and a Kiddo. He needs life insurance, and he is looking at $250,000 in coverage. A 30-year level term policy would cost Jim around $370 per year until age 55. At that point, Jim's premiums spike to over $4,700 per year.
By the time he is 65, he will have spent $58,780 on premiums. Keep in mind that the insurance company collected this money but never has to give it back. There's no cash value in term insurance, so the contract only pays when he dies.
What would have happened if Jim had just purchased the same amount of death benefit but used a universal life insurance policy instead? His premiums would have been higher - about $145 per month or $1739 per year. At age 65, Jim has paid $69,560 ($1739 x 40) in premiums. That's a little more than the term insurance, but he also has $157,000 of cash value inside the policy.
This money is part of the policy's living benefits, and can be used on a tax-free basis to supplement his retirement or left alone to continue growing. Some life insurance companies also offer an option to spend down up to 100% of the death benefit if you become chronically or terminally ill. If you haven't been able to accumulate a lot of money, this can be very helpful.
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?
In the long run, you will usually get all of your money back that you put into a cash value policy and then some. You can even structure the policy so that it provides substantial cashflow in retirement. The only exceptions to this are variable life insurance contracts. There really aren't any guarantees on them.
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: You might need insurance to protect your children from a big tax burden. Even if you are "smart" with your money, you can't predict the future with absolute certainty. Some people alive today are experiencing a 40% loss in their retirement accounts 5 years before retirement. This is money that was supposed to be there for them and it isn't. If your investments take a hit right before YOU are ready to retire, it doesn't matter how "smart" you were with your money.
Still don't think life insurance is necessary as you get older? Consider that dying isn't free. What does the average funeral cost in your home town? Ask a funeral director how quickly the costs double over any given time period. You will be shocked...shocked I tell you. Also, ask any child whose parents left them a sizable IRA 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.
In truth, neither the insurance industry nor the investment industry is doing a very good job of defending their respective positions. Point Blank: Financial "gurus" are leaving out critical information. Either they do not have a very good grasp of how life insurance really works, or they are outright lying. Either scenario is totally unacceptable.
The motivation for lying can be as simple as "money". There is a lot of money floating around in the financial industry, and everyone is competing for it. So, while isn't anything wrong with demonstrating flaws in a financial product, it has to be done objectively. In regards to life insurance, it's not. The attacks are baseless and unsound, and most, if not all, of them are coming from very well known financial professionals. Here are a few of the misconceptions being passed around. Many of them have been repeated so many times, that most people think they are true (they aren't):
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.
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.
For example, if we were to start an insurance company and we only had one customer, we would be taking on an incredible risk because of the nature of life insurance, if that one person dies, we could be out of business very quickly (imagine that one customer giving you $20 for a $250,000 death benefit and then dying the very next day). If, however, we have a million customers, then we can better control the risks we are taking by insuring other people's lives. No one can predict when an individual will die, but if we study a large enough group of people, we can make surprisingly accurate predictions about the number of individuals within that group that will die in any given year. Given that insurance companies have an excellent record of predicting deaths every year, what do all of the statistics say?
They say that that term insurance doesn't pay, since most individuals live until age 65. This is why I say permanent is a better deal. In the long-run, it's cheaper. I know, I know...there are probably a few of you saying "no way, it is always cheaper to buy term insurance". Oh yeah? Watch this:
Let's reuse our example, Jim. Let's assume Jim is 25 and in good health with a wife and a Kiddo. He needs life insurance, and he is looking at $250,000 in coverage. A 30-year level term policy would cost Jim around $370 per year until age 55. At that point, Jim's premiums spike to over $4,700 per year.
By the time he is 65, he will have spent $58,780 on premiums. Keep in mind that the insurance company collected this money but never has to give it back. There's no cash value in term insurance, so the contract only pays when he dies.
What would have happened if Jim had just purchased the same amount of death benefit but used a universal life insurance policy instead? His premiums would have been higher - about $145 per month or $1739 per year. At age 65, Jim has paid $69,560 ($1739 x 40) in premiums. That's a little more than the term insurance, but he also has $157,000 of cash value inside the policy.
This money is part of the policy's living benefits, and can be used on a tax-free basis to supplement his retirement or left alone to continue growing. Some life insurance companies also offer an option to spend down up to 100% of the death benefit if you become chronically or terminally ill. If you haven't been able to accumulate a lot of money, this can be very helpful.
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?
In the long run, you will usually get all of your money back that you put into a cash value policy and then some. You can even structure the policy so that it provides substantial cashflow in retirement. The only exceptions to this are variable life insurance contracts. There really aren't any guarantees on them.
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: You might need insurance to protect your children from a big tax burden. Even if you are "smart" with your money, you can't predict the future with absolute certainty. Some people alive today are experiencing a 40% loss in their retirement accounts 5 years before retirement. This is money that was supposed to be there for them and it isn't. If your investments take a hit right before YOU are ready to retire, it doesn't matter how "smart" you were with your money.
Still don't think life insurance is necessary as you get older? Consider that dying isn't free. What does the average funeral cost in your home town? Ask a funeral director how quickly the costs double over any given time period. You will be shocked...shocked I tell you. Also, ask any child whose parents left them a sizable IRA 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: Only so much information can be covered in one article. If you would like more detailed information about any aspect of personal financial planning, please visit David's website.
posted by Credit Counseling at
9:59 AM
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