Saturday, October 13, 2012

Do You Have The Wrong Life Insurance?

After sitting at the kitchen table with a lot of people to talk about financial stuff, I can definitively say there are a lot of different financial products out there, and several of them I would NEVER promote or sell in good conscience.  At the top of the list is cash value insurance.  This includes whole, universal, variable, or whatever creative name an insurance company wants to call it.

Don't get me wrong.  If you own it, it could have been the right thing to do at the time.  Cash value insurance was once thought to be the best thing out there.  But with term insurance being so affordable nowadays, cash value insurance belongs in the past, like the rotary phone and rabbit ear antenna.

For most cash value policies, the cost is about $10/month for every $10,000.  So if you have a $50,000 policy, the monthly cost is be around $50.  It may be more or less, depending on the different riders of the policy and the insured's health at application.  The monthly premium is used to fund the insurance coverage and cover the company's costs, with the rest going into an account that grows a cash value for the insured over time.  That last part sounds fine and dandy, until the policy owner realizes how little that amount actually is and that it will take years to accumulate any decent cash value.

With term insurance, that same $50/month can purchase a total of $310,000 of insurance coverage with a 35 year term.  This quote supposes the clients are husband and wife (ages 31 and 30 respectively) and have no medical history or tobacco use.  The policy includes $150,000 of coverage on him, $150,000 of coverage on her, and $10,000 for every child (under 25) they have listed on the policy.  The actual cost of the monthly premium is only $41.95. 

For $50 a month, what would you rather have: $50,000 or $300,000 in life insurance coverage?

So you might be thinking- what happens after 35 years?  At age 70, the cost of term insurance will be much higher (because the insured is much more likely to die).  At the same time, the mortgage should be paid off and their kids should be financially independent (or so we hope), therefore they won't need such a large amount of insurance.  If they still want to have the $50,000 that would have been provided by a cash value policy, there's a simple answer.  When the policy is issued, take $20 a month, and invest it in a good mutual fund or managed account.  After 35 years, they will have $59,278 to insure themselves.  (This assumes $20/month with a 9% return over 35 years.)  We'll talk about more of the savings/investment side of things once I become securities licensed.

If $50/month sounds too expensive, there are ways to lower the cost of life insurance.  The younger you are when you purchase life insurance, the more affordable the premiums are.  Obviously, stay healthy and don't smoke.  If you have the ability to, pay your insurance premiums annually instead of monthly- this would save the policy owner 1-2 months of premium with most companies. You could also opt for a shorter term, such as 10 or 20 years.  While your coverage would not be in force as long, the premiums would be much lower.  (Using the example above and all other values being equal, a 10 year term is only $22.72/month.) This might be helpful if you foresee your insurance needs changing in the next few years and are expecting to buy a replacement policy in the near future.

One thing that has been really helpful for a lot of families is an increasing benefit rider.  Let's say the insured can't afford the premium for $300,000 of coverage.  Primerica offers a 10% benefit increase every year for the first 10 years of the policy with no questionnaire or medical exam.  The insured only has to pay the cost of the additional coverage.  So, the insured can purchase a $150,000 term policy, and have the option to increase the benefit of the policy every year by 10% until it reaches $300,000.  If the insured no longer needs the $300,000 later, the rider can be cancelled and the policy goes back to $150,000 at the original premium. 

I guess you could say that I'm biased, since I am a Primerica independent representative who only sells term insurance.  Well you don't have to believe me, but you should probably believe the experts.  Dave Ramsey is pretty opinionated when it comes to cash value insurance.  His website is where I stole the picture from.

You can also read the 3rd Edition of Personal Finance for Dummies by Eric Tyson.  Turn to page 337 where he talks about life insurance.  I'll warn you, he starts off by saying: "I'm going to tell you how you can save hours of time and thousands of dollars...Buy term life insurance."  He also provides a good analysis that shows the problems with cash value insurance.  Of course, you don't need the part where he talks about how to buy term insurance- for that, you should talk to me!

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