| Today, life insurance is based around the idea that
if you or your spouse dies, that your family will be made whole by
replacing your spouse’s income. This essential foundation for
effective financial planning is often overlooked by many individuals.
Most advisers agree that life insurance is necessary.
This is where the agreement between financial professionals ends
abruptly, because the next question that arises is: OK, so what
kind of life insurance should people buy? The debate between which
is better - term or cash value/permanent life insurance - is seemingly
a “never ending battle”. For many various reasons, many
investment houses, stock brokers, mutual fund managers (and the
agents who sell their funds), as well as many popular financial
“gurus” like Suze Orman, Ric Edleman, and Dave Ramsey
presumably (according to their many published books and comments
on national radio and television) hate whole life insurance.
Life insurance agents of course love cash value insurance. The
investment industry does a pretty good job of putting down the insurance
industry. So…who’s right?
It’s surprising that the financial industry is supposed to
be the educator. I say that only because many of the financial advisors
in my industry seem to be more concerned about what the next “hot”
mutual fund is…or manipulating interest rate returns, eliminating
or disguising fees and disregarding suitability with respect to
their clients.
I say that in light of the fact that on both sides of the debate,
neither is doing a very good job of defending their position. Many
financial professionals are simply leaving out critical information,
or appear to not have a very good grasp of how life insurance really
works.
The motivation for lying can be as simple as “money”.
There is a lot of money floating around in the financial industry,
and everyone is competing for it. So, while isn’t anything
wrong with demonstrating flaws in a financial product, it has to
be done objectively. In regards to life insurance, it’s not.
The attacks are baseless and unsound, and most, if not all, of them
are coming from very well known financial professionals. Here are
a few of the misconceptions being passed around. Many of them have
been repeated so many times, that most people think they are true
(they aren’t)
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| Lie number
one
Cash value life insurance is a waste of money. It is the worst type
of insurance you can buy. The BEST kind of insurance is term insurance
because it’s cheap. Insurance companies are shady and always
try to take advantage of policyholders and cash value insurance
is proof of that.
Fact: Term insurance can be the best type of insurance if all you
are considering is the cost. But it is generally the worst type
of insurance you can buy to insure your life if you want it to pay
off, at least statistically speaking. To understand this, we need
to understand how life insurance companies position their product
line, and how they make money.
Insurance companies use the Law of Large Numbers. They sample a
group of people (similar age, height, weight, etc.). The larger
the group of people they insure, the more accurate they are about
the number of losses they will see.
If I started a life insurance company and I only had one customer,
I would be taking on an incredible risk because of the nature of
life insurance, if that one person dies, I could be out of business
very quickly. If, however, I have thousands or millions of customers,
then I can manage the risk. Since no one can predict when a specific
individual will die (i.e. no one can predict when I will die), I
need a large number of people to study to formulate a statistic.
With a large enough number of people, I can make surprisingly accurate
predictions about the number of individuals within a particular
group that will die in any given year. So…what do the statistics
say?
They tell us that term insurance just doesn’t pay…well
not for policy owners anyway. Most people live until age 65. After
that premium costs spike dramatically. This is why I say that, on
most accounts, permanent is cheaper, even though there are probably
a few critics saying “no Dave, it’s cheaper on all accounts”.
Oh yeah? Watch this:
A male (let’s use Jim again), age 25 and in good health with
a wife and a child finds that he needs life insurance. Jim is looking
for $250,000 in coverage. A typical 30-year term policy - a policy
that has level premium payments for 30 years - should cost Jim around
$370 per year until he reaches age fifty-five. At that point, the
premiums jump up significantly (as all term insurance premiums do)
to a tad over $4,700 per year.
After 65, will have spent $58,780 in premiums. That’s a lot!
Also, remember that this is money that the insurance company collects
and never has to give back. Since there’s no cash value associated
with term insurance, the insurance contract pays off only when he
dies.
What would have happened if he had purchased the same amount of
death benefit but used a universal life insurance policy? His annual
premiums would have been higher - $1739. By his 65th birthday, Jim
has a total premium outlay of $69,560 ($1739 x 40). Wow! But, he
will have built up $157,000 of cash value inside the policy.
That money can be used on a tax-free basis to supplement his retirement
or left alone to continue growing. This is an example of one of
many living benefits that permanent insurance has (didn’t
your adviser tell you about that?). Some permanent policies also
offer an option to spend down up to 100% of the death benefit for
any reason in the event of a critical, chronic, or terminal illness.
This can be especially useful if you haven’t been able to
accumulate a lot of money and something tragic happens to you…and
you live!
Lie number two
Cash value life insurance is overpriced for
what you get. You never know how much money you are spending
on the death benefit, how much money is actually going into
the cash value of the policy, and how much interest you are
really earning. Term insurance is so much simpler.
Fact: With whole life insurance it is often
difficult to determine how much the death benefit is costing
you. If that bothers you, then don’t buy whole life
insurance. However, universal life insurance is, in actuality,
a term policy with a separate savings account - often called
‘the pot of money’. As such, you can easily determine
the cost per thousand dollars of insurance, how much is going
to pay the death benefit, and how much is going into the cash
value of the policy. Cash value insurance can seem expensive
in comparison to term insurance because of the front load
(commissions and administrative fees) nature of the contract
and the fact that you are forced to save money in a cash account.
This is a point that is really driven home by the anti-cash
value life insurance crowd.
Be thankful that you pay some of the fees
that you do. It makes saving and investing money a lot easier
than having to fire a lawyer to negotiate every individual
contract you sign. A life insurance contract can be set up
to maximize the death benefit (maximizing the cost of the
contract), or it can be set up to focus on cash accumulation
(minimizing expense charges to .5% - 1% of the interest earned
over the life of the policy). The expenses associated with
a permanent life insurance contract can be made just as efficient
and in some cases more so than what the antagonists suggest
as an alternative - which is usually some type of mutual fund
- without sacrificing the practicality of owning the contract.
But again, why are the antagonists trying to compare the cost
of insurance to an investment?
Over the long-term, you should get all of
your money back that you put into a cash value policy with
interest (note: the exception to this is variable life insurance
which doesn’t guarantee cash values). If the policy
is structured properly, you can also be left with a sizable
amount that can be drawn on in retirement
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Lie number three:
If you are smart with the money you have today and you get rid
of your mortgage, car loans and credit card debt and put money into
retirement plans you don’t need insurance 30 years from now
to protect your family when you die.
Fact: You might need insurance to protect your children from a
big tax burden. Even if you are “smart” with your money,
you can’t predict the future with absolute certainty. Some
people alive today are experiencing a 40% loss in their retirement
accounts 5 years before retirement. This is money that was supposed
to be there for them and it isn’t. If your investments take
a hit right before YOU are ready to retire, it doesn’t matter
how “smart” you were with your money.
Also, consider that dying isn’t free. Ask a funeral director
in your home town how much a funeral costs…and then ask him
or her how much it should be in 10 years…20 years…when
you expect to die. You will be amazed…and not in a good way.
Also, ask any child whose parents left them any amount of money
what they paid in taxes and if it was financially disruptive.
That cash value life insurance policy that your financial guru
told you to ditch could have bypassed probate, provided an income
tax free death benefit and, inside of a life insurance trust, completely
avoided the estate tax thereby giving your heirs what they deserve.
There are an alarming number of financial professionals that try
to draw a connection between life insurance and investing. It’s
a huge mistake (even supporters of CV insurance make this mistake).
Comparing cash value insurance to investing is like asking “how
many walkmans does it take to equal an Ipod?”. Even if you
find an investment strategy that “beats” the insurance
product…so what? Cash value insurance is supposed to provide
a death benefit with a savings component, not an investment component
(despite the mistakes of variable life).
Before you make any decision on whether to buy term or cash value
life insurance, think about what you are trying to accomplish. If
you want to invest your money, then learn about investing. Learn
how to value corporations and buy stocks, bonds, no load mutual
funds. If you want a long-term savings, then find an adviser that
can maximize your savings through cash value life insurance. |