Is Your Adviser Lying To You About 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.
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 sometimes surprising that the financial industry is charged with the responsibility of informing and educating the rest of society about saving and investing principles, and yet many of the advisors that represent the industry seem to be less concerned about truth and honesty, and more concerned about injecting their own personal agenda.
On both sides of the debate, neither is doing a very good job of defending their respective position. It amazes me to see so many financial professionals leave out important information about not only their products but about the nature of insurance contracts. I wonder sometimes if they even have any idea of how life insurance really works.
Their motives for deception can be numerous, and diverse. Now, there isn't anything wrong with pointing out the flaws in a financial product, as long as it can be done objectively. However, in the case of life insurance, the attacks being made are baseless and unsound. This is especially shocking because most, if not all, of these attacks are coming from high profile, well known financial professionals. Here are a few common lies, attacks, & misconceptions:
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: Term insurance can be the best type of insurance if all you are considering is the cost. But it is generally the worst type of insurance you can buy to insure your life if you want it to pay off, at least statistically speaking. To understand this, we need to understand how life insurance companies position their product line, 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.
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 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 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'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. 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.
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.
Your financial guru told you cash value insurance was evil, but it could have really helped out of a jam when the tax man cometh. You could also bypassing probate, providing an income tax free death benefit and, inside of a life insurance trust, completely avoid the estate tax.
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 any decision on whether to buy term or cash value life insurance, think about what you are trying to accomplish. If you want to invest your money, then learn about investing. Learn how to value corporations and buy stocks, bonds, no load mutual funds. If you want a long-term savings, then find an adviser that can maximize your savings through cash value life insurance.
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 sometimes surprising that the financial industry is charged with the responsibility of informing and educating the rest of society about saving and investing principles, and yet many of the advisors that represent the industry seem to be less concerned about truth and honesty, and more concerned about injecting their own personal agenda.
On both sides of the debate, neither is doing a very good job of defending their respective position. It amazes me to see so many financial professionals leave out important information about not only their products but about the nature of insurance contracts. I wonder sometimes if they even have any idea of how life insurance really works.
Their motives for deception can be numerous, and diverse. Now, there isn't anything wrong with pointing out the flaws in a financial product, as long as it can be done objectively. However, in the case of life insurance, the attacks being made are baseless and unsound. This is especially shocking because most, if not all, of these attacks are coming from high profile, well known financial professionals. Here are a few common lies, attacks, & misconceptions:
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: Term insurance can be the best type of insurance if all you are considering is the cost. But it is generally the worst type of insurance you can buy to insure your life if you want it to pay off, at least statistically speaking. To understand this, we need to understand how life insurance companies position their product line, 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.
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 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 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'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. 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.
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.
Your financial guru told you cash value insurance was evil, but it could have really helped out of a jam when the tax man cometh. You could also bypassing probate, providing an income tax free death benefit and, inside of a life insurance trust, completely avoid the estate tax.
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 any decision on whether to buy term or cash value life insurance, think about what you are trying to accomplish. If you want to invest your money, then learn about investing. Learn how to value corporations and buy stocks, bonds, no load mutual funds. If you want a long-term savings, then find an adviser that can maximize your savings through cash value life insurance.
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.
posted by Credit Counseling at
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