Let's say you want to save for a big vacation. You can do that. You should do that. There is no reason to go into debt for a vacation. Save the money in an account where you can get a reasonable return and a guarantee that the money will be there when you need it.
You could use a money market account or a savings account, but if you are saving for a big vacation like a trip to Hawaii or Europe, you'll want more interest and you'll probably have to save for a longer period of time. A great rate in a money market account is less than 1% right now. If you have a little more time to save, why not combine your savings and purchase a whole life contract. What are the downsides and upsides of this strategy.
A downside is that you'll need to save for at least six or seven years before you'll want to take money out of your life insurance policy.
An upside is that you'll get a little bit of life insurance along with your savings. Since most people are inadequately insured, you'll get that benefit as well.
In addition, you'll already have the policy set up to begin saving for your next vacation as well.
The rate of return on a good life insurance policy will be between 3% and 4% tax free. This is equivalent to about a 6% return on a taxable investment. Over time, this will provide a much greater rate of return on your "savings" account that a money market or other savings account.
Another downside is that you'll actually be loaning yourself money from your policy in order to pay for your trip. However, there is no specific payback period and you can simply ensure you continue to pay your annual premiums.
Another upside is that you can use your policy to save for everything you want to buy over time. So, let's say that you want to save for a new car, a big vacation, and a new motorcycle. You can plan out how much you need to save each year, then you can put all of that money into your life insurance policy. Consolidating your money into the policy provides you with more insurance, and a better return.
A downside of this strategy is that you have to be disciplined and wait until you've really saved the money before using it. This could be seen as an upside because most people who save and invest say that building wealth is largely done by consistent saving and investing over time and not using sophisticated investments. Developing a habit of disciplined saving is a great character trait that will benefit you in all aspects of your life.
Again, a savings account can be a great vehicle for basic savings, but a whole life insurance policy is the only vehicle that will guarantee you a decent minimum return, potential dividends, and a life benefit on the side, just in case. The younger you are when you being this process, the more insurance you can buy and the more you can have the benefit of the long term returns.
Tuesday, May 6, 2014
Monday, May 5, 2014
Disability Insurance: Do you need it?
Disability insurance may be the least understood and lease owned insurance, especially when compared to its common counterpart--life insurance.
Few people think about disability insurance, even though a person is about 3 times more likely to become disabled than to die (this depends on age and occupation). Only a very small percentage of people have in individual disability policy, even though only about 40% of Americans have disability insurance at work.
While few people have disability insurance, disability claims continue to rise. Many people believe that Social Security disability insurance will cover them, but do not realize how long the waiting period is and how many people are rejected.
Increasing disability claims are related to a number of factors. Medical technology saves people who might have died in the past, but instead they live with a disability. Cancer rates are up. Obesity rates are up. In addition, the number of disabilities classified as diseases or syndromes is on the rise.
While disability insurance may not be cheap, it may be necessary. Some financial advisors believe that disability insurance is a key part of a personal financial plan, yet few people have a policy.
Contact me, and I can give you more information about disability policies, how they work and the options available.
Few people think about disability insurance, even though a person is about 3 times more likely to become disabled than to die (this depends on age and occupation). Only a very small percentage of people have in individual disability policy, even though only about 40% of Americans have disability insurance at work.
While few people have disability insurance, disability claims continue to rise. Many people believe that Social Security disability insurance will cover them, but do not realize how long the waiting period is and how many people are rejected.
Increasing disability claims are related to a number of factors. Medical technology saves people who might have died in the past, but instead they live with a disability. Cancer rates are up. Obesity rates are up. In addition, the number of disabilities classified as diseases or syndromes is on the rise.
While disability insurance may not be cheap, it may be necessary. Some financial advisors believe that disability insurance is a key part of a personal financial plan, yet few people have a policy.
Contact me, and I can give you more information about disability policies, how they work and the options available.
Wednesday, April 30, 2014
Why buy life insurance?
Over the past few weeks, I've promoted the value of whole life insurance when used appropriately and the risks of the "Buy term. Invest the difference" strategy.
In this post, I'm going to avoid that issue and simply say, "BUY LIFE INSURANCE!" I know it's impolite to yell, but given that about 70% of people either have no life insurance or do not have enough life insurance, I wanted to be bold.
So, why buy life insurance or buy more life insurance?
If you are on a budget, and you just want a minimal amount of life insurance, then it's cheap. If you are a young couple and both spouses work, then both of you should have coverage. You might have $25,000 or $50,000 of life insurance from your employer, but it's almost never enough. Let's look at a very simple example.
Even if you only make $25,000 each per year, then that means your spouse would have to find a way to double his or her income to make due. If you have a family income of $50,000 per year and two kids, you probably aren't saving a lot to begin with. Some of this depends on your region, but you probably have to be very disciplined to make your budget work.
It is unlikely that either person would die, if you are in good health, but if you do, what would your spouse do? Even $50,000 of life insurance through your employer would, at best, cover your funeral and perhaps two years of living expenses. If you have young children, what happens in year 3? Even if your spouse was able to cut expenses 20%, the life insurance money would still run out in about three years.
In such a case, a 25 year old would probably want between $250,000 to $500,000 for at least ten years. Such a policy would be relatively reasonably priced, but would require some tightening of the budget. One strategy would be to get a ten year policy and a twenty year policy so that the total would come out to amount required. It would give the couple the ability to postpone a decision about how much insurance would be needed in the future.
The risk with buying any life insurance is that you could become uninsurable at any point in time. This is again not likely, but worth thinking about in any insurance decision, especially for young people buying short term policies. If a 25 year old relies on a 10 year policy, what would happen if he or she became uninsurable within that period. Would you really want to be without life insurance from age 35 and up?
The other factor for those underinsured is that the reason is often that they have a policy through their employer, so they don't think they need life insurance. What if you leave your employer? You have nothing and it's possible that your next employer won't have life insurance for you. So, even if you are willing to take the risk and do not think you need insurance, you could find yourself without any insurance. Buying your own policy, even a small one, eliminates that risk.
Another reason often given for not having life insurance is a lack of understanding about life insurance and a lack of trust in the insurance agent. Some people won't buy online, but they won't contact an agent. This is a difficult hurdle for many buyers. The truth is that often a good agent can get rates equal to or competitive with those available through internet search engines. The key is to find a trustworthy agent that works with reasonably priced insurance companies. This can be difficult. Asking friends may be the best way to get this information. The other factor to consider is that buying through a traditional auto and home insurance company is almost always 30% to 60% more expensive than buying through a dedicated life insurance company. Because most people are price conscious when it comes to buying life insurance, they should buy through a life insurance agent, not their auto and home agent.
Life insurance is not something that anyone likes to talk about, but it's important for securing your family as well as your assets. Life insurance proceeds may be the only way that a surviving spouse can stay in a house or keep other assets. Given the inexpensive rates for term life insurance, almost anyone can afford some insurance. For those who have more money to save and put away, a well structured whole life policy or a combination of whole life and term life may be the answer.
In this post, I'm going to avoid that issue and simply say, "BUY LIFE INSURANCE!" I know it's impolite to yell, but given that about 70% of people either have no life insurance or do not have enough life insurance, I wanted to be bold.
So, why buy life insurance or buy more life insurance?
If you are on a budget, and you just want a minimal amount of life insurance, then it's cheap. If you are a young couple and both spouses work, then both of you should have coverage. You might have $25,000 or $50,000 of life insurance from your employer, but it's almost never enough. Let's look at a very simple example.
Even if you only make $25,000 each per year, then that means your spouse would have to find a way to double his or her income to make due. If you have a family income of $50,000 per year and two kids, you probably aren't saving a lot to begin with. Some of this depends on your region, but you probably have to be very disciplined to make your budget work.
It is unlikely that either person would die, if you are in good health, but if you do, what would your spouse do? Even $50,000 of life insurance through your employer would, at best, cover your funeral and perhaps two years of living expenses. If you have young children, what happens in year 3? Even if your spouse was able to cut expenses 20%, the life insurance money would still run out in about three years.
In such a case, a 25 year old would probably want between $250,000 to $500,000 for at least ten years. Such a policy would be relatively reasonably priced, but would require some tightening of the budget. One strategy would be to get a ten year policy and a twenty year policy so that the total would come out to amount required. It would give the couple the ability to postpone a decision about how much insurance would be needed in the future.
The risk with buying any life insurance is that you could become uninsurable at any point in time. This is again not likely, but worth thinking about in any insurance decision, especially for young people buying short term policies. If a 25 year old relies on a 10 year policy, what would happen if he or she became uninsurable within that period. Would you really want to be without life insurance from age 35 and up?
The other factor for those underinsured is that the reason is often that they have a policy through their employer, so they don't think they need life insurance. What if you leave your employer? You have nothing and it's possible that your next employer won't have life insurance for you. So, even if you are willing to take the risk and do not think you need insurance, you could find yourself without any insurance. Buying your own policy, even a small one, eliminates that risk.
Another reason often given for not having life insurance is a lack of understanding about life insurance and a lack of trust in the insurance agent. Some people won't buy online, but they won't contact an agent. This is a difficult hurdle for many buyers. The truth is that often a good agent can get rates equal to or competitive with those available through internet search engines. The key is to find a trustworthy agent that works with reasonably priced insurance companies. This can be difficult. Asking friends may be the best way to get this information. The other factor to consider is that buying through a traditional auto and home insurance company is almost always 30% to 60% more expensive than buying through a dedicated life insurance company. Because most people are price conscious when it comes to buying life insurance, they should buy through a life insurance agent, not their auto and home agent.
Life insurance is not something that anyone likes to talk about, but it's important for securing your family as well as your assets. Life insurance proceeds may be the only way that a surviving spouse can stay in a house or keep other assets. Given the inexpensive rates for term life insurance, almost anyone can afford some insurance. For those who have more money to save and put away, a well structured whole life policy or a combination of whole life and term life may be the answer.
Thursday, April 24, 2014
The hidden cost of level term insurance
I'm sure you've heard that you should "Buy term and invest the difference." Another phrase I've heard is that I want to buy my insurance as insurance, as if whole life insurance is something else.
There are many reasons given in favor of term insurance.
1. Lower commissions
2. It's cheaper
3. It keeps my savings/investing separate from my purchase of insurance.
4. I don't need insurance for my entire life.
Let's look at these reasons and some of the hidden costs of choosing term insurance.
Commissions. No one wants to pay more than they should for something, but people pay commissions every day. Whole life insurance commissions are generally higher than term life commissions, but there are ways to reduce them. This reason is not entirely invalid, but it is a bit of a smokescreen if the other reasons to purchase whole life insurance are good ones.
Cheaper. This is deceptive. It is cheaper, but it's not the same product. It's like saying I'm purchasing a Kia instead of a Mercedes and then pretending as if you got the same thing. Cheaper is not always better.
Keeping savings separate from insurance. Buying term definitely does this, but it's not obvious what the advantage is. What if there is an advantage to combining the two?
I don't need insurance for my entire life. Really? And you know that how? No one knows what will happen? That's why there is insurance. The argument usually is that investments will grow so great that I won't need insurance once I reach age XX. You fill in the XX. The problem is that there are no guarantees, which brings us to the hidden costs of term insurance.
Hidden cost #1 - what if your investments don't attain the value you assumed? So, you reach age 60 and you can't retire or your investments are worth 20% less than you had projected. What then? You die at age 61 with no insurance. Your spouse has to sell the house, get a higher paying job, or ...? This is not impossible. Look at the past fifteen years of the stock market. And are you willing to bet, which is what you are doing, that the next fifteen to twenty years of the stock market will be like the past twenty or the twenty before that?
Hidden cost #2 - what if you can't get insured again once your current term policy runs out? Here is an example. You are 25 years old and you and your spouse have just bought a house and had a child. You need live insurance, so you are really smart and you lock in a 30 year term policy. You think you'll need insurance until age 65. When do you purchase your overlapping policy? Do you wait till age 55? What will the premiums be then? What if you develop a heart condition or cancer or any other disease that would either cause you to be uninsurable or to have extremely high rates? Do you really want to risk not being able to be insured from age 55 until age 65 when you are much more likely to die?
Hidden cost #3 - you will almost certainly not receive anything from your term insurance policy. This is simply a fact. If it were not, then how could insurance companies sell term insurance so inexpensively?
In many cases, especially for young people, the answer is probably a mix of investments and savings options that includes stock market based investing, a whole life insurance policy that will last forever and a term life policy to provide bonus protection and an inexpensive rate for those years when spouse and kids are relying heavily upon you.
There are many reasons given in favor of term insurance.
1. Lower commissions
2. It's cheaper
3. It keeps my savings/investing separate from my purchase of insurance.
4. I don't need insurance for my entire life.
Let's look at these reasons and some of the hidden costs of choosing term insurance.
Commissions. No one wants to pay more than they should for something, but people pay commissions every day. Whole life insurance commissions are generally higher than term life commissions, but there are ways to reduce them. This reason is not entirely invalid, but it is a bit of a smokescreen if the other reasons to purchase whole life insurance are good ones.
Cheaper. This is deceptive. It is cheaper, but it's not the same product. It's like saying I'm purchasing a Kia instead of a Mercedes and then pretending as if you got the same thing. Cheaper is not always better.
Keeping savings separate from insurance. Buying term definitely does this, but it's not obvious what the advantage is. What if there is an advantage to combining the two?
I don't need insurance for my entire life. Really? And you know that how? No one knows what will happen? That's why there is insurance. The argument usually is that investments will grow so great that I won't need insurance once I reach age XX. You fill in the XX. The problem is that there are no guarantees, which brings us to the hidden costs of term insurance.
Hidden cost #1 - what if your investments don't attain the value you assumed? So, you reach age 60 and you can't retire or your investments are worth 20% less than you had projected. What then? You die at age 61 with no insurance. Your spouse has to sell the house, get a higher paying job, or ...? This is not impossible. Look at the past fifteen years of the stock market. And are you willing to bet, which is what you are doing, that the next fifteen to twenty years of the stock market will be like the past twenty or the twenty before that?
Hidden cost #2 - what if you can't get insured again once your current term policy runs out? Here is an example. You are 25 years old and you and your spouse have just bought a house and had a child. You need live insurance, so you are really smart and you lock in a 30 year term policy. You think you'll need insurance until age 65. When do you purchase your overlapping policy? Do you wait till age 55? What will the premiums be then? What if you develop a heart condition or cancer or any other disease that would either cause you to be uninsurable or to have extremely high rates? Do you really want to risk not being able to be insured from age 55 until age 65 when you are much more likely to die?
Hidden cost #3 - you will almost certainly not receive anything from your term insurance policy. This is simply a fact. If it were not, then how could insurance companies sell term insurance so inexpensively?
In many cases, especially for young people, the answer is probably a mix of investments and savings options that includes stock market based investing, a whole life insurance policy that will last forever and a term life policy to provide bonus protection and an inexpensive rate for those years when spouse and kids are relying heavily upon you.
Comparing rates of return on a whole life policy
Whole life policies are not all built the same. They do not return the same dividends and they do not all have the same expenses. Building a policy through a top dividend paying mutually owned insurance company is the only way to go. The other only way to go is to fund the policy through a structure that uses a lower base premium and a large amount of paid up additions.
Using this method, you can get a policy with close to a 4% tax free return with a guarantee of about a 2.75% to 3% guaranteed tax free return.
Of course, if you compare this to a stock mutual funds return of somewhere around 10%, it's tough to call this a good return. However, if you remember that the 10% is taxable and not guaranteed, then there isn't such a huge difference. That 10% could be as low as 6% over time, depending on market conditions. The two don't stand alone though because with the whole life insurance policy, you are guaranteed the death benefit at some point, which will likely give you a return much higher than the 4% tax free.
Most people also do not invest 100% in stock mutual funds over time. A target allocation fund might make more like 7.5% over time. Again, this will vary with the market. That return could be as low as 5% or so and it's a taxable rate.
A taxable bond fund will make between 4% and 7% over time, and now we see that a whole life insurance contract, properly structured does return about the same (after tax) as this category of investment, but remember we still have our lifetime death benefit in the whole life contract, which depending on the age at death, could increase the return by 30% or so. This would make the policy's rate of return closer to a 5.2% to 5.5% tax free rate of return or equivalent to a 7.5% after tax return, depending on your tax bracket.
While some may still not like the whole life policy because they would rather risk the chance of making more money, those same people are also risking the chance of making less money.
This is where the matter of preference comes in. Risk preferences make a big difference in who is attracted to a whole life policy. A whole life policy used as a personal bank or line of credit can also increase the internal rate of return on the policy because by using the cash in the policy to invest in other activities or to reduce interest expense paid to banks, a person can leverage his or her own whole life policy to either increase total return or else decrease other living expenses. These savings have to be factored in as part of the benefit of such a policy.
Using this method, you can get a policy with close to a 4% tax free return with a guarantee of about a 2.75% to 3% guaranteed tax free return.
Of course, if you compare this to a stock mutual funds return of somewhere around 10%, it's tough to call this a good return. However, if you remember that the 10% is taxable and not guaranteed, then there isn't such a huge difference. That 10% could be as low as 6% over time, depending on market conditions. The two don't stand alone though because with the whole life insurance policy, you are guaranteed the death benefit at some point, which will likely give you a return much higher than the 4% tax free.
Most people also do not invest 100% in stock mutual funds over time. A target allocation fund might make more like 7.5% over time. Again, this will vary with the market. That return could be as low as 5% or so and it's a taxable rate.
A taxable bond fund will make between 4% and 7% over time, and now we see that a whole life insurance contract, properly structured does return about the same (after tax) as this category of investment, but remember we still have our lifetime death benefit in the whole life contract, which depending on the age at death, could increase the return by 30% or so. This would make the policy's rate of return closer to a 5.2% to 5.5% tax free rate of return or equivalent to a 7.5% after tax return, depending on your tax bracket.
While some may still not like the whole life policy because they would rather risk the chance of making more money, those same people are also risking the chance of making less money.
This is where the matter of preference comes in. Risk preferences make a big difference in who is attracted to a whole life policy. A whole life policy used as a personal bank or line of credit can also increase the internal rate of return on the policy because by using the cash in the policy to invest in other activities or to reduce interest expense paid to banks, a person can leverage his or her own whole life policy to either increase total return or else decrease other living expenses. These savings have to be factored in as part of the benefit of such a policy.
Saturday, April 19, 2014
Response to 4 Life Insurance Policies You Should Never Buy
Neal Frankle (a CFP) wrote an article for U.S. News in July of 2012 giving four types of policies that he thinks you should never buy.
The four are:
1. Guaranteed Issue
2. Life Insurance for Children
3. Travel Insurance
4. Whole/Universal Life Insurance
While I'm not a big fan of numbers 1 and 3, there are reason to buy at least three of four types of insurance at certain times. So, let me outline a couple of things about insurance, in general.
First, you buy insurance for a couple of reasons, but the main reason is to protect against risk. Different people value risk differently. You can look at the math, but the fact is that if someone says you have a 20% chance of dying before age 80, and you want or think you might need to be insured until age 80, then you are taking your chances if you don't purchase life insurance that extends that far. This is the same with any type of insurance. For example, who needs an umbrella policy? Who needs a disability policy?
Second, you buy insurance for risks that you cannot afford to pay out of pocket. You buy life insurance because almost no one has enough savings to make up for the lost income of a spouse, especially if it is the working spouse in a one income family.
So, let's get to the specific types discussed by Mr. Frankle.
1. Guaranteed issue - With guaranteed issue insurance rates are high. Why? It's because everyone, regardless of health or other risks, can get it. Therefore, rates are high. Who would buy this insurance? The people who would buy this insurance are people in high risk categories who are otherwise uninsurable, but who need insurance. It's not that I think everyone should consider it--far from it. I do think that if you've applied for life insurance and been denied or been put in a high rate class, then you should consider it, but always compare. Also, make sure you compare to a good and dedicated life insurance company. Do not buy life insurance through a company that specializes in home and auto. The rates will be high.
2. Life insurance for children - I presume that Mr. Frankle is not talking about whole life as he doesn't think that anyone should ever purchase whole life. So, yes, it is stupid to purchase a term life insurance policy for a child. However, if you have the cash available, there are many reasons to buy a policy on a child or a grandchild. Leaving a legacy in a non-taxable account is a great idea for some people.
3. Travel insurance - Mr. Frankle has some good logic here. If you have life insurance, you have life insurance. The only time that I might even think this is a wise choice is if you do not have any life insurance and you are leaving for a trip that could be dangerous. However, if it only covers you while on your flight, then it's pretty useless. The number of times a plane goes down is far lower than the chances of dying in a car accident.
4. Whole\Universal life - I am not a big fan of universal life. Whole life, on the other hand, can be structured to reduce fees and commissions and have a reasonable interest rate. Mr. Frankle bases his opinion on the fact that he has been a CFP for twenty nine years. One thing he does not say is that the CFP program is biased against whole life insurance. He says that he has never seen a policy that pays off and that the fees eat up all of the interest. I do not know how many policies he has looked at, but it could not have been many. I haven't looked at many bad policies, but the ones that I've sold and recommend have internal rates of return in the 3.7% to 4% range over time. That is a tax-free rate of return equivalent to about 4.7% to 6.5% depending on your tax bracket. The guaranteed rate is a little lower, but it's a guaranteed rate. Given that money markets range from about .3% now to about 2% in good years, I'd say that a whole life policy is a great idea for many people. That's just the savings piece. That doesn't even consider that you still have some life insurance in force.
There are many ways to buy insurance. Term life insurance can be great, especially when coupled with a whole life policy. Many people need life insurance longer than they had thought. That's especially true now with people having to wait longer to retire due to the poor stock market returns over the past fifteen years.
Of course, my main point was simply to dispel the idea that there is no place for the insurance policies listed by Mr. Frankle. I think it's pretty obvious that for some people all of these policies can be useful, even if some of them are not as useful as others.
The four are:
1. Guaranteed Issue
2. Life Insurance for Children
3. Travel Insurance
4. Whole/Universal Life Insurance
While I'm not a big fan of numbers 1 and 3, there are reason to buy at least three of four types of insurance at certain times. So, let me outline a couple of things about insurance, in general.
First, you buy insurance for a couple of reasons, but the main reason is to protect against risk. Different people value risk differently. You can look at the math, but the fact is that if someone says you have a 20% chance of dying before age 80, and you want or think you might need to be insured until age 80, then you are taking your chances if you don't purchase life insurance that extends that far. This is the same with any type of insurance. For example, who needs an umbrella policy? Who needs a disability policy?
Second, you buy insurance for risks that you cannot afford to pay out of pocket. You buy life insurance because almost no one has enough savings to make up for the lost income of a spouse, especially if it is the working spouse in a one income family.
So, let's get to the specific types discussed by Mr. Frankle.
1. Guaranteed issue - With guaranteed issue insurance rates are high. Why? It's because everyone, regardless of health or other risks, can get it. Therefore, rates are high. Who would buy this insurance? The people who would buy this insurance are people in high risk categories who are otherwise uninsurable, but who need insurance. It's not that I think everyone should consider it--far from it. I do think that if you've applied for life insurance and been denied or been put in a high rate class, then you should consider it, but always compare. Also, make sure you compare to a good and dedicated life insurance company. Do not buy life insurance through a company that specializes in home and auto. The rates will be high.
2. Life insurance for children - I presume that Mr. Frankle is not talking about whole life as he doesn't think that anyone should ever purchase whole life. So, yes, it is stupid to purchase a term life insurance policy for a child. However, if you have the cash available, there are many reasons to buy a policy on a child or a grandchild. Leaving a legacy in a non-taxable account is a great idea for some people.
3. Travel insurance - Mr. Frankle has some good logic here. If you have life insurance, you have life insurance. The only time that I might even think this is a wise choice is if you do not have any life insurance and you are leaving for a trip that could be dangerous. However, if it only covers you while on your flight, then it's pretty useless. The number of times a plane goes down is far lower than the chances of dying in a car accident.
4. Whole\Universal life - I am not a big fan of universal life. Whole life, on the other hand, can be structured to reduce fees and commissions and have a reasonable interest rate. Mr. Frankle bases his opinion on the fact that he has been a CFP for twenty nine years. One thing he does not say is that the CFP program is biased against whole life insurance. He says that he has never seen a policy that pays off and that the fees eat up all of the interest. I do not know how many policies he has looked at, but it could not have been many. I haven't looked at many bad policies, but the ones that I've sold and recommend have internal rates of return in the 3.7% to 4% range over time. That is a tax-free rate of return equivalent to about 4.7% to 6.5% depending on your tax bracket. The guaranteed rate is a little lower, but it's a guaranteed rate. Given that money markets range from about .3% now to about 2% in good years, I'd say that a whole life policy is a great idea for many people. That's just the savings piece. That doesn't even consider that you still have some life insurance in force.
There are many ways to buy insurance. Term life insurance can be great, especially when coupled with a whole life policy. Many people need life insurance longer than they had thought. That's especially true now with people having to wait longer to retire due to the poor stock market returns over the past fifteen years.
Of course, my main point was simply to dispel the idea that there is no place for the insurance policies listed by Mr. Frankle. I think it's pretty obvious that for some people all of these policies can be useful, even if some of them are not as useful as others.
Friday, April 18, 2014
So you want to know about life insurance?
Life insurance is a tricky product. No one wants to talk about it. No one wants to buy it. It's difficult.
How much do I need? What does it cover? How long do I need it for?
These are some of the questions out there. As an advocate for life insurance and the fact that you need it, and the fact that you probably want to think about both term and whole life insurance, let me explain. I do not have an axe to grind against the Primerica and Dave Ramsey "buy term and invest the difference" folks, but I do sell whole life and believe that when properly structured and understood can be a great addition to a person's cash management strategy.
First, you need life insurance. Everyone over the age of 18 probably does.
You say, "I have no dependents." That may be true, but it's like you will. If you plan on having dependents, then the earlier you buy a policy, the cheaper it will be. If you buy term insurance, it's like you'll need a second policy at some point, and the sooner you buy the first one, the younger you'll be when you need the second one, meaning lower rates on that one as well.
Another reason to buy young is to buy when you are healthy. Especially if you have a family history of any illnesses, you want to buy the insurance before you become ill. Some illnesses will not only cause rates to go up, but will make you uninsurable. Even if you buy a small policy to begin with, you should buy something.
There are term policies available for 30 year level term. If this is attractive to you, then buying now will make those rates very affordable. A 20 year old would end up with insurance to age 50--not retirement age, but at an age where you could still get another reasonably priced term policy if you are still healthy. In addition, if you are a confirmed "buy term" person, you might not need insurance at age 50 if you've attained a large degree of wealth and your kids are out of the house.
Second, term and whole life are completely different products. I find that those who are on either extreme represent the other product unfairly. I've heard people even say that whole life is a scam or people say that term life insurance is a waste of money. Both statements can be true, but they are not necessarily true.
Term insurance is life insurance for a specified term. When you purchase a 20 year policy, you have life insurance for twenty years. The sole purpose for a term insurance policy is to protect your family in case you die within that term. You can extend the insurance past the 20 years, but the rate is so exorbitant that it almost never makes sense to continue the policy. If you are still insurable, it almost always makes sense to buy another policy. Often you'll want to replace that policy or add another policy prior to the 20 year term expiring as you know what your insurance needs are or will be. The reason people say that it's a waste of money is the same reason that it is so "cheap." Almost no one ever collects on a term policy. Term policies expire before most people are likely to die. For that reason, a term policy isn't really "cheap." You can see that it all depends on how you look at it. It also means that there is never a reason to over insure with term insurance, unless your agent is just really good at scaring you. Remember that all insurance is based on risk factors. All investments or uses of cash are based on your risk tolerance. You can always choose to self insure, which means you save enough money to protect your family in all situations. Most of us can't do that, so we buy insurance, even if we do not expect to use it.
Whole life insurance is a different animal entirely. In fact, when I propose whole life insurance to people I ask them to do two things. 1. Look at the savings portion of the policy first, 2. then look at the insurance amount. I also do something that many agents don't. I structure the policy to minimize fees (the main reason people say that whole life isn't worth the money).
So, as life insurance, whole life is very expensive because their is a savings component. It is not just life insurance. It serves a completely different purpose. The rates on whole life also vary a lot from company to company, so if you are looking at whole life insurance, you need to get different quotes from different companies. You can use the same agent, but make sure they quote a policy from a mutually owned dividend paying company. This way you will get the best savings component of your whole life policy.
The nice thing about whole life insurance is that:
1. the death benefits is forever
2. the cash value builds up at a reasonable tax free rate of return
3. commissions and expenses can be reduced by structuring the policy with a low base premium and increasing your savings in the policy with paid up additions.
4. You can loan money to yourself out of your policy without a scheduled pay back period. You can use this money for any purpose (e.g. investing, college, remodeling)
Who benefits most from whole life policies?
People who want or need insurance forever
People who want to leave a legacy to grandchildren or great grandchildren or a charity
People who have children with disabilities that will not be able to support themselves
People who want a place to put savings other than a money market or CD or Treasury Bill
People in high tax brackets
People who want a place to put ready cash that will be periodically used for other purposes (e.g. fix and flips, auto savings, leasing companies)
People who want a place for their safety reserve that pays a guaranteed higher rate of return than most guaranteed investments and don't mind waiting a few years until the fees pay for themselves.
A whole life policy can also work for people who want to create a legacy and don't need insurance for themselves. This is why I encourage people to consider their entire life plan when looking at a whole life policy.
What are the cons of term/whole life?
Term life -
1. you pay for something you don't want to use and most likely never will
2. it will run out at some point, perhaps before you want it to
3. you might be uninsurable when your term runs out
4. a child or spouse might become disabled such that you need a permanent policy
Whole life -
1. It takes 5 to 10 years, depending on policy structure to break even
2. If you are going to use the policy as a revolving loan account, it takes discipline to pay the money back.
3. Not everyone needs the tax advantages of a whole life product. For people in a lower income bracket, they cannot often afford or do they need the tax advantages of a whole life product. That's not to say that a small whole life policy can't be used as a vehicle for a low income person. It's just that it's more difficult.
As I said earlier, insurance (and life) is all about risks. Some people bungee jump, sky dive or are active in all sorts of other risky activities. They enjoy it and don't mind the risk. Buy term and invest the difference involves some risk, and it's not a fair comparison to whole life because most advisors would not recommend putting all of your assets into a whole life policy. Market risk is a factor and given the past ten to twenty years, you take the risk of whether or not historical returns will continue at between 7 and 10 percent (before tax).
With a whole life policy, the risk is that you could do better elsewhere. However, risk of loss of capital is largely removed from the equation. Good life insurance companies have been around since well before the Great Depression. The guaranteed 4% that one company I work with currently offers works out to about 3% tax free after expenses and commissions, depending on how we structure the policy. This is about 5% in a taxable return. Where can you get 5% guaranteed return? The same company's current dividend rate works out to about 4% tax free after expenses and commissions. For someone in the top income bracket, 4% tax free is about the same as a 6.75% taxable investment, so that's not bad, especially with the guaranteed minimum return.
As with any use of your money, a whole life policy for savings depends on what you are comparing it to and the time horizon. If you need all the money within five years, then you do not want a whole life policy. If you are looking for a way to use cash over your lifetime in a way that beats a money market account, then it would be foolish not to consider a whole life policy. If you are comparing to an S&P 500 index fund, then it depends on your risk tolerance and your assumptions and whether or not you'll be fully invested in the market and for what period of time.
Remember that with a whole life policy, you still have the death benefit. So, comparing return to return doesn't work either. I like to show it that way because when you see that the return really isn't that bad AND you have insurance for life, you can see that this is not a scam after all. It may not suit everyone's needs or risk tolerance or discipline level, but it's nowhere near a scam.
Later I'll write about why you should/could buy a whole life policy on your children or grandchildren to maximize your legacy potential.
How much do I need? What does it cover? How long do I need it for?
These are some of the questions out there. As an advocate for life insurance and the fact that you need it, and the fact that you probably want to think about both term and whole life insurance, let me explain. I do not have an axe to grind against the Primerica and Dave Ramsey "buy term and invest the difference" folks, but I do sell whole life and believe that when properly structured and understood can be a great addition to a person's cash management strategy.
First, you need life insurance. Everyone over the age of 18 probably does.
You say, "I have no dependents." That may be true, but it's like you will. If you plan on having dependents, then the earlier you buy a policy, the cheaper it will be. If you buy term insurance, it's like you'll need a second policy at some point, and the sooner you buy the first one, the younger you'll be when you need the second one, meaning lower rates on that one as well.
Another reason to buy young is to buy when you are healthy. Especially if you have a family history of any illnesses, you want to buy the insurance before you become ill. Some illnesses will not only cause rates to go up, but will make you uninsurable. Even if you buy a small policy to begin with, you should buy something.
There are term policies available for 30 year level term. If this is attractive to you, then buying now will make those rates very affordable. A 20 year old would end up with insurance to age 50--not retirement age, but at an age where you could still get another reasonably priced term policy if you are still healthy. In addition, if you are a confirmed "buy term" person, you might not need insurance at age 50 if you've attained a large degree of wealth and your kids are out of the house.
Second, term and whole life are completely different products. I find that those who are on either extreme represent the other product unfairly. I've heard people even say that whole life is a scam or people say that term life insurance is a waste of money. Both statements can be true, but they are not necessarily true.
Term insurance is life insurance for a specified term. When you purchase a 20 year policy, you have life insurance for twenty years. The sole purpose for a term insurance policy is to protect your family in case you die within that term. You can extend the insurance past the 20 years, but the rate is so exorbitant that it almost never makes sense to continue the policy. If you are still insurable, it almost always makes sense to buy another policy. Often you'll want to replace that policy or add another policy prior to the 20 year term expiring as you know what your insurance needs are or will be. The reason people say that it's a waste of money is the same reason that it is so "cheap." Almost no one ever collects on a term policy. Term policies expire before most people are likely to die. For that reason, a term policy isn't really "cheap." You can see that it all depends on how you look at it. It also means that there is never a reason to over insure with term insurance, unless your agent is just really good at scaring you. Remember that all insurance is based on risk factors. All investments or uses of cash are based on your risk tolerance. You can always choose to self insure, which means you save enough money to protect your family in all situations. Most of us can't do that, so we buy insurance, even if we do not expect to use it.
Whole life insurance is a different animal entirely. In fact, when I propose whole life insurance to people I ask them to do two things. 1. Look at the savings portion of the policy first, 2. then look at the insurance amount. I also do something that many agents don't. I structure the policy to minimize fees (the main reason people say that whole life isn't worth the money).
So, as life insurance, whole life is very expensive because their is a savings component. It is not just life insurance. It serves a completely different purpose. The rates on whole life also vary a lot from company to company, so if you are looking at whole life insurance, you need to get different quotes from different companies. You can use the same agent, but make sure they quote a policy from a mutually owned dividend paying company. This way you will get the best savings component of your whole life policy.
The nice thing about whole life insurance is that:
1. the death benefits is forever
2. the cash value builds up at a reasonable tax free rate of return
3. commissions and expenses can be reduced by structuring the policy with a low base premium and increasing your savings in the policy with paid up additions.
4. You can loan money to yourself out of your policy without a scheduled pay back period. You can use this money for any purpose (e.g. investing, college, remodeling)
Who benefits most from whole life policies?
People who want or need insurance forever
People who want to leave a legacy to grandchildren or great grandchildren or a charity
People who have children with disabilities that will not be able to support themselves
People who want a place to put savings other than a money market or CD or Treasury Bill
People in high tax brackets
People who want a place to put ready cash that will be periodically used for other purposes (e.g. fix and flips, auto savings, leasing companies)
People who want a place for their safety reserve that pays a guaranteed higher rate of return than most guaranteed investments and don't mind waiting a few years until the fees pay for themselves.
A whole life policy can also work for people who want to create a legacy and don't need insurance for themselves. This is why I encourage people to consider their entire life plan when looking at a whole life policy.
What are the cons of term/whole life?
Term life -
1. you pay for something you don't want to use and most likely never will
2. it will run out at some point, perhaps before you want it to
3. you might be uninsurable when your term runs out
4. a child or spouse might become disabled such that you need a permanent policy
Whole life -
1. It takes 5 to 10 years, depending on policy structure to break even
2. If you are going to use the policy as a revolving loan account, it takes discipline to pay the money back.
3. Not everyone needs the tax advantages of a whole life product. For people in a lower income bracket, they cannot often afford or do they need the tax advantages of a whole life product. That's not to say that a small whole life policy can't be used as a vehicle for a low income person. It's just that it's more difficult.
As I said earlier, insurance (and life) is all about risks. Some people bungee jump, sky dive or are active in all sorts of other risky activities. They enjoy it and don't mind the risk. Buy term and invest the difference involves some risk, and it's not a fair comparison to whole life because most advisors would not recommend putting all of your assets into a whole life policy. Market risk is a factor and given the past ten to twenty years, you take the risk of whether or not historical returns will continue at between 7 and 10 percent (before tax).
With a whole life policy, the risk is that you could do better elsewhere. However, risk of loss of capital is largely removed from the equation. Good life insurance companies have been around since well before the Great Depression. The guaranteed 4% that one company I work with currently offers works out to about 3% tax free after expenses and commissions, depending on how we structure the policy. This is about 5% in a taxable return. Where can you get 5% guaranteed return? The same company's current dividend rate works out to about 4% tax free after expenses and commissions. For someone in the top income bracket, 4% tax free is about the same as a 6.75% taxable investment, so that's not bad, especially with the guaranteed minimum return.
As with any use of your money, a whole life policy for savings depends on what you are comparing it to and the time horizon. If you need all the money within five years, then you do not want a whole life policy. If you are looking for a way to use cash over your lifetime in a way that beats a money market account, then it would be foolish not to consider a whole life policy. If you are comparing to an S&P 500 index fund, then it depends on your risk tolerance and your assumptions and whether or not you'll be fully invested in the market and for what period of time.
Remember that with a whole life policy, you still have the death benefit. So, comparing return to return doesn't work either. I like to show it that way because when you see that the return really isn't that bad AND you have insurance for life, you can see that this is not a scam after all. It may not suit everyone's needs or risk tolerance or discipline level, but it's nowhere near a scam.
Later I'll write about why you should/could buy a whole life policy on your children or grandchildren to maximize your legacy potential.
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