What Kind of Life Insurance Do You Really Need?
I get massively ticked off when I meet with prospects for a Family Wealth Planning Session and see on their Family Wealth Inventory and Assessment they’ve been sold life insurance they don’t need.
Life insurance is critically important for families, no doubt.
But, it’s important you get the right type of life insurance for your family; otherwise, you are pouring your hard earned money into the pockets of your life insurance agent.
That makes me angry as a hornet!
Here’s the real deal, objective, hardcore information you need before you make a life insurance buying decision for your family.
There are two main types of life insurance: term insurance and permanent insurance.
Within the permanent insurance category, they are many subsets, including Variable, Universal, Whole Life, and a few others that are a combination of those I just listed. You can find the definitions of each of these here, if you really care.
Truly though, most of you shouldn’t really care. Because very few of you reading this need permanent insurance.
You almost certainly need term insurance and if you don’t have it, you should get it now. The younger the better because it gets more expensive as you age. I got a $1,000,000 policy at the age of 28 that cost me about $440/year. That same policy just three years later would have cost me double that.
Term insurance provides death benefit in a “face amount” (I have a total $1,500,000 of death benefit on my life for my kids) so long as you pay your premiums each year.
The premium payments will stay level for the term of the insurance, which could be 10, 20 or 30 years, depending on your contract. After that, if you wanted to continue the insurance, it would likely be cost-prohibitive for you to do so (unless you get a type of term insurance called convertible-term, which is generally more expensive, but allows you to convert it to permanent policy during the term agreement). With a term policy, there is no cash value build up - so, if you pay $1000 in a year and you don’t die in that year, that’s it, the $1,000 is gone.
Permanent insurance, in contrast, is a lot more expensive. For example, that same million dollar policy that costs me $440/year could cost $440/month if it was for a permanent policy.
The extra premium goes into an investment account that builds up cash value, which sounds really nice, BUT has some real downsides, including you have no control over this investment account and huge amounts of it are eaten up by commissions to your insurance agent in the first year, so you are starting your investment in the hole big time and have a lot of ground to make up before it will even come close to comparing to taking that money and putting it in a traditional investment account.
Commissions are worth it if you NEED permanent insurance, but are a waste of your hard-earned cash, if you don’t. There is only one condition under which permanent insurance makes sense for your family - if you absolutely MUST have insurance at the time of your death.
There are only 2 situations in which you absolutely MUST have life insurance at the time of your death. They are:
1. Your family will need the insurance to pay estate taxes at your death. You are only at risk of estate taxes (today) if you have more than $2,000,000 in assets. If you have less, don’t worry about it yet.
2. Someone will be dependent on you at the time of your death and you may not have enough in retirement accounts, savings or other assets to provide for that person at the time of your death.
Let’s talk a little bit more about the 2nd situation and look at some examples because if you have a potential estate tax issue, you probably know it. But, you may be uncertain as to whether you need permanent insurance to provide for dependents.
If you are married and both partners are breadwinners and you have healthy, minor children - you don’t need permanent insurance. Term insurance that lasts for 10, 20 or even 30 years (depending on the age of your minor children and your desire to provide for them into their 20s) is sufficient. If you or your partner died after the expiration of your term, you kids could provide for themselves and your partner could continue working.
If you are married and both partners are breadwinners and you have a special needs child - you might need permanent insurance, but you might not. If you have a special needs child who will need financial care forever and you will not have enough money put away in a Special Needs Trust through your own savings or gifts from other family members to provide for that care, you may want to consider a permanent insurance policy to fund that Trust for your child.
If you are married and one of you is a stay at home spouse and is not likely to ever enter the workforce - you may want to consider permanent insurance to provide for the lifetime financial needs of the non-employed spouse, if you won’t have enough in savings or retirement to provide for the lifetime needs of the non-earning spouse if the earner spouse dies prematurely, but after the term insurance would expire.
To make this one a little more concrete, let’s look at an all too common example in which breadwinner husband dies in his late 50s or early 60s after his term insurance has expired but before he’s got enough in savings or retirement to support stay at home wife who has been out of the workforce raising their kids for the past 30 years and is now left with not enough resources to support her for the next 30 years and no real prospects for supporting herself financially.
Personally, I’d rather see this scenario avoided by ensuring that each spouse in a marriage always has the capacity to earn a living by working together to build a business that would support either spouse with passive income later in life, but if that’s not realistic for your family, permanent insurance may be a necessary solution.
Bottom line?
Term insurance unless you know you are going to need insurance when you die to pay estate taxes (in which case the insurance should be owned in an Irrevocable Life Insurance Trust) or some type of permanent insurance if you want to guarantee to have some coverage in place for a non wage-earner spouse or special needs child no matter what age you are when you die.
Next week we’ll talk about how to decide how much life insurance is right for your family.
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April 10th, 2008 | #
[...] the rest of this great post here [...]
April 10th, 2008 | #
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April 10th, 2008 | #
[...] post by Admin Comments [...]
April 10th, 2008 | #
I like your blog. There is always need for good financial atips. Especially for families, which need whole variety of insurance products and they often don’t realise, how different their portfolios could be. It’s different when considering
partner’s jobs, number of children, age…
We have some Life insurance tips, disability tips and long care tips on our website, check it if you are interested.
April 10th, 2008 | #
This was really informative.
Do you have any recommendations for single, working women who will likely, though not definitely, have dependents later in life? Is it worth it to get term insurance now so that I can lock in the lower rate?
Thanks!
April 10th, 2008 | #
Your explanation of who might need term and who might need permanent insurance is excellent. Term life insurance rates are at their lowest. For those that are looking to buy, now is the time.
April 11th, 2008 | #
You write: “There is only one condition under which permanent insurance makes sense for your family - if you absolutely MUST have insurance at the time of your death.”
If you don’t need it when you die, why buy it at all? I would reverse your admonition–Always buy permanent insurance so that you know it will be there when you die UNLESS you just want it to see your family through a predicatable term such as until the kids get out of college or the mortgage is paid off.
The reason why term premiums are so cheap is that insurance companies rarely have to pay a death benefit. If all you claim to need is term then you should re evaluate whether you need it at all.
If you do choose term insurance at least get the conversion rider. If you are about to reach the end of your term and find out you have cancer you can convert it to a permanent policy without another medical exam.
Another feature I like to see on a term policy is a premium waiver if the insured is incapacitated.
April 15th, 2008 | #
First and foremost - I really LIKE your site and this blog. You are willing to open up and give valuable information that people need.
In general I agree with your thoughts about life insurance - for most estate planning purposes, term life is the way to go, but watch out when using blanket statements.
Permanent insurance DOES have many uses, when purchased as part of a long-term strategy (as you mentioned in the article). First, the strategy must be long term (7 years plus) because of the up-front costs (including commissions which can’t really be avoided - the industry has that one rigged).
Second - almost universally, the benefit with permanent insurance isn’t the “insurance” at all, but rather the ability to build a tax advantaged asset. Wealth inside a cash-value policy grows with no tax consequences and can be removed (by borrowing against the policy) with no tax consequences either.
At retirement, this tax-free income stream will supplement income from other retirement sources and minimize the taxes on those by lowering the overall annual reported taxable income of the retiree. One last benefit - Wealth inside a cash value policy is invisible to FAFSA - the universal financial aid application process for college.
95% of the time, permanent life insurance is sold for the wrong reasons (to generate a commission to the agent) and in the wrong ways (maximizing the face value on the policy - which BTW generates an even larger commission). Better to buy a longer term policy (30 years) to bridge the income gap before retirement.
But for most middle-income families, it CAN be an extremely powerful tool. Don’t throw the baby out with the bathwater.
May 17th, 2008 | #
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This is a nice site for to get information about insurance but there will be need about Term Life insurance provides a cost-effective solution for your temporary life insurance needs and gives you the flexibility to change your policy should your temporary needs turn into permanent goals.
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Great recap, I don’t think many people even think about the long term implications of having a special need child and how that might affect their decision to purchase term or whole life insurance.
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