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.
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