When you’re up at those pearly gates noting really matters except that you get in and you hope your family is making it without you. Your family is where the use of life insurance comes in. Most people will agree that it is important to buy some type of life insurance to protect your family in the event you are no longer there to provide for them. The kicker though, is what type of insurance you should purchase. There are many versions of life insurance but let’s discuss the 2 basic policies most people will see.
Term Life Insurance
Term life insurance is a temporary policy that will typically cover you for 20 or 30 years. The yearly premiums are often set for the time period you’ve chosen which means no increase in premiums. If you were to die during this period then the death benefit would be paid to your beneficiaries.
Think of term insurance as health insurance or auto insurance in that it is there to merely protect you in case something happens. Typically, the younger you are the more immediate need for coverage. The reason being is there are debts to cover (mortgage, car loans, student loans, etc.) as well as future earning years. Term insurance supplements this gap until those debts are paid off and as your future earning years dwindles down. Essentially, the idea is when you retire you have hopefully saved enough that you don’t need anymore life insurance.
Permanent Life Insurance – Whole Life Insurance
There are a few different type of permanent policies but let’s just focus on whole life. This is a permanent policy that will last as long as you are in good standing by paying the premium on time. The premiums will be significantly higher than term policy because this will cover your entire life. It will also provide a dividend each year, if the insurance company approves one. Dividends can be used to buy more death benefit, allow it to build up or utilize it to reduce the premium. Any cash left at your death will be taxed as ordinary income.
These policies are often sold as a guaranteed retirement vehicle because it will earn a certain dividend each year without the dependence of the market. However, the guarantee will depend on the insurance company and their willingness to pay out. The idea behind this product is to protect against an early death and then have a nest egg at retirement.
So what policy is right for you? Well there are many things to consider. We believe that markets work and that you will be rewarded for the risk you take. A tough pill to swallow after 2008 but there is something to be said about paying for a “guaranteed” return. Whole life policies carry very high fees which make premiums very high. Often times, it takes years before the value of the policy begins to breakeven. The policy is also illiquid which means you cannot take your money out without very high surrender charges. Policies often return 2-6% annual dividend return but when the historical inflation rate is around 4% the return doesn’t seem that attractive. There are many catches like these that make whole life unattractive and we believe there are better options on the table.
If you decide to choose term, can you commit to saving for other goals like college savings and retirement? Over a long period in time if you can commit to a savings and investing plan we believe you can have a better chance of achieving your goals. You will also have more flexibility than just investing in a whole life policy.
For those that have a hard time saving and must purchase a whole life policy keep in mind that these policies can be negotiable. The insurance salesman makes most of his/her money during the first year so you want to look at the first years surrender value and premium. The first years surrender value should be at least half of the first years premium. If not, go back to the agent and tell him to work on it. They can make changes to the policy.
So what kind of insurance do you have?