Life insurance is not for everyone
What if someone told you there was one solution that could fix all of your financial problems at once? Initially, you’d be intrigued. After a few minutes of explanation, maybe skeptical. By the end of the presentation, downright confused. This is the emotional rollercoaster clients go through when they’re sold permanent life insurance. And, I’m not surprised - it’s a product that is intentionally complex, so you can’t see through to what is actually happening… the insurance company and agent selling you are making TONS of money (off you). Let’s take a closer look at life insurance in general to see when it makes sense to incorporate it into your Plan and what alternative product is fair for all parties involved.
Do you even need life insurance?
If you scroll past an insurance advocate (nice way of putting it) online and start listening to their pitch, STOP and zoom out. Insurance is a for profit business and purchasing a policy is a losing proposition for most people, in the long run. With that being said, there is a time and place for life insurance. This is when you should consider coverage…
Someone depends on YOU to cover their living expenses
In other words, you have a dependent who could not survive on their own if you passed away. Most commonly, this is a child - though, it could also be a spouse, elderly parent or other family member. Taking this a step further, it also means you produce some sort of income, which will play into how much coverage you need (more on that below).
What are the different types of policies available?
So, the cost of life insurance is justified since you need it to protect a loved one. How do you minimize this new expense?
It all boils down to the type of policy you choose to purchase - there are 2 types:
Permanent - also known as whole life, cash value, variable life, universal life and any other name marketing can come up with to try and reinvent themselves (due to prior bad rap).
What is it?
Coverage that never ends. You have the policy forever (until you die) and typically continue paying into it up until that point. One of the “selling points” is the policy accumulates cash value, so it doubles as an investment while providing coverage when you pass away.
Why it doesn’t work?
Kind of like restaurants with menus that are 10 pages long, permanent policies try to do too much - life insurance coverage, cash value that is invested, the ability to take a loan from the cash value, etc. Behind the scenes are astronomical fees, sometimes north of 3% per year. Ultimately, this cuts into the growth of the invested portion of the policy over time and really impairs the effects of compounding interest.
Term - surprisingly (sarcasm) there are no other names for this type of policy.
What is it?
Pure insurance coverage. You pay a premium while you need the coverage and when you don’t, it stops. As a result, it is much cheaper than permanent policies - both on a yearly premium basis and due to the limited time you’re paying into it.
Why it’s better than above?
Going back to the restaurant analogy, term policies are only trying to do one thing and they do it really well. Think of your favorite food truck - there are only a few items on the menu and the whole process runs efficiently, at a low cost.
How much coverage is right for you?
Now that you know what type of policy to purchase, there is only one question remaining. How much do you need? This is where the fun starts, at least for your Financial Planner, since they can pull out their fancy scientific calculator and run the numbers. Don’t worry, the thought process of how much coverage you need is easy to understand.
First, calculate the current value of your future income (up until the point you stop working aka retire). Then, add any outstanding debt (like a mortgage or student loans). Finally, consider if you want to incorporate the future cost of college (if you have kids). The final number tells you the total amount of coverage.
Other considerations:
The term (amount of time you have the policy) is the same as the number of years until you plan to retire (you can use age 65 if you’re not sure about this right now). You do not need coverage for longer since your income stops at that point. In other words, risk goes away and you can self insure with other assets/savings.
You may want to ask the insurance company if they offer the option to reduce your coverage at some point in the future. The idea here is the amount of life insurance coverage you need is higher when you are younger (more income potential since there is more time to retirement). Therefore, you can reduce your coverage (and therefore the cost) as you get older. It is always nice if the insurance company gives you this option without needing to apply for a whole new policy.
Life insurance is not for everyone
Don’t get sucked into the life insurance pitch that is overly complicated with empty promises of future returns, access to tax free income and protection for your family. There is no free lunch - these products are secretly expensive with high long term fees. First, consider if you actually need coverage - you may not. Next, go for a term policy that strictly provides life insurance for a specified period - you will pay a fraction of the cost when compared to a permanent policy. Lastly, take the cost savings and invest it in a low cost, diversified index fund that will grow uninterrupted by high fees.