Basic Questions on Life Insurance Basics: Part 2

photo credit: Mike Thoma

Welcome to our two part series on life insurance. As indicated in part one, my purpose is not to give an all inclusive explanation of life insurance but a primer which should help you better understand what you have and what you need.

In our previous post we covered the following topics:

• What are the different types of life insurance?
• What is the purpose of life insurance?
• Does everyone need life insurance?
• How much insurance is enough to buy?

Now…on to part two:

What is the best kind of Life Insurance?

In order to address this question, I am going to compare Whole Life vs Term Life, assuming the insured is a 30 year old male in good health. Dave Ramsey’s organization solicited actual Whole Life quotes from the five largest insurance companies for this fictional 30 year old. Averaging the quotes (which were very close), they discovered that a $125,000 policy would require a premium of $145 a month. A 30 year Term Life Insurance policy for $125,000 would cost $15 a month premium.

But, remembering that $125,000 is not nearly enough insurance to replace the lost income, let us assume a $50,000 annual salary and thus a $500,000 Term policy. The premium now becomes $35 a month. So what happens to the difference in premium? Remember that the Whole Life policy builds a cash value. In this case, the cash value will be $27,000 after 20 years and $66,000 after 40 years.

Sounds pretty good until you figure what a conservative investment would bring if this 30 year old bought the term and invested his savings in premium through an investment brokerage. If he only averaged an 8% return on this $110 a month ($145 – $35), he would have a nest egg of $65,000 after 20 years and $384,000 after 40 years. The following table shows this comparison:

*based on earning an 8% return by investing the difference in premium.

These numbers convincingly tell us that Term Life is a better buy for the money than Whole Life. One more detail about the Whole Life: when the insured person dies, the payoff from the insurance company is the face value of the policy only ($125,000 in the above example). What happens to the “cash value”? The insurance company keeps it.

What if you purchased a term policy but, because of health reasons, do not qualify to renew the policy after it expires?

Yes, it is possible that after the 30 year term, the insured person may have health difficulties that would make it very difficult to buy more life insurance. This contingency should motivate this person to work hard during these 30 years to be self insured. He should strive to be debt free and have a paid for house at this point in his life, and will not likely have dependent children. Besides, he will have the peace of mind during those 30 years of knowing that he has provided enough coverage to serve his family if needed.

What about Universal and Variable Life?

Universal and Variable are forms of permanent life insurance that correct some of the shortcomings of Whole life by offering options that allows for better investment returns and can include the cash value with the face value in the death benefit. Because the investment options are tied to money markets (Universal) or to stocks, bonds or mutual funds (Variable), the returns are not guaranteed. And inclusion of the cash value benefit will cost more in higher premiums. This being said, if permanent insurance is important to you, the Universal or Variable should be considered, making the same comparisons with Term as in the chart above.

What life insurance do you have?

That is a fair question. I cashed out my Whole Life Policy over 20 years ago and used the payout to purchase IRA’s for myself and my wife. We have used Term life ever since and have never regretted it. At 63 years old, I am three years from the end of a 10 year $500,000 term policy with a $78/month premium. We have no debt, a paid for house, an untapped IRA and three monthly pension checks for life. One of these has a 100% survivor benefit; the other two have 50% survivor benefits. We are close to being self insured, but we will weigh our options (whether to renew our policy and for how much) in three years when our current term policy expires.

Conclusion

My conclusion is that, with the affordable rates of term life insurance, there is absolutely no excuse for anyone who needs life insurance to not have it. By buying a cheap term life insurance policy, you will be buying your insurance from an insurance agency while making your investments through an investment brokerage; this is a clean and healthy distinction.  While it doesn’t make as much sense for 50-59 year old’s to have life insurance, in some cases it is warranted.   Meet with your financial planner to see what’s best for you and get the best term life insurance quote.