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.
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.
Some financial advisors love cash value insurance, others hate it. Who's right? Who's wrong?
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.
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:
Don't waste your money on cash value insurance. It is a complete waste of money because the insurance company collects premiums from you for 20 years and then when you die you only get the death benefit. They keep all of your cash and your family gets ripped off. Besides, you could make more money by buying term and investing the difference.
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.
Insurance uses something called the Law of Large Numbers. Basically this is how it works: the larger the group of people you are insuring, the more certain you can be about the number of losses you will sustain.
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 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.
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, say, purchased the same amount of death benefit but used a universal life insurance policy with slightly higher but level annual premiums of $1739 every year to age 100? By his 65th birthday, 'ole Jimbo would have had a total premium outlay of $69,560 ($1739 x 40). But, he would 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 for what you get. Also, 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: You may not need life insurance in 30 years to protect your children from financial ruin when you die. But you may need it to protect your beneficiaries (whoever they may be) from taxes. And, even if you are "smart" with your money, you can't predict the investment returns in a mutual fund (or a stock for that matter) inside of a 401(k) or IRA unless you are very good at researching stocks (hint: 99% of the general population is not). It takes years of practice, and even some of the best stock brokers and financial 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 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 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.
So, should you buy term or cash value life insurance? That depends. What are you really looking for? If you are looking for an investment, then learn how to invest in stocks, bonds, no load mutual funds, options, and other financial derivatives. If you want a savings, then a properly structured permanent life insurance policy can fill 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.
Some financial advisors love cash value insurance, others hate it. Who's right? Who's wrong?
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.
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:
Don't waste your money on cash value insurance. It is a complete waste of money because the insurance company collects premiums from you for 20 years and then when you die you only get the death benefit. They keep all of your cash and your family gets ripped off. Besides, you could make more money by buying term and investing the difference.
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.
Insurance uses something called the Law of Large Numbers. Basically this is how it works: the larger the group of people you are insuring, the more certain you can be about the number of losses you will sustain.
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 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.
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, say, purchased the same amount of death benefit but used a universal life insurance policy with slightly higher but level annual premiums of $1739 every year to age 100? By his 65th birthday, 'ole Jimbo would have had a total premium outlay of $69,560 ($1739 x 40). But, he would 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 for what you get. Also, 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: You may not need life insurance in 30 years to protect your children from financial ruin when you die. But you may need it to protect your beneficiaries (whoever they may be) from taxes. And, even if you are "smart" with your money, you can't predict the investment returns in a mutual fund (or a stock for that matter) inside of a 401(k) or IRA unless you are very good at researching stocks (hint: 99% of the general population is not). It takes years of practice, and even some of the best stock brokers and financial 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 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 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.
So, should you buy term or cash value life insurance? That depends. What are you really looking for? If you are looking for an investment, then learn how to invest in stocks, bonds, no load mutual funds, options, and other financial derivatives. If you want a savings, then a properly structured permanent life insurance policy can fill 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 want more information about any aspect of financial planning, please visit David's website.
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