As a product that goes hand in hand with our untimely demise, life insurance isn’t exactly a fun topic to dwell on for too long! Still, it’s perhaps the most important piece of asset protection that we can put into place, so it’s worth our time to choose the best product to protect our families. With insurance companies on the never-ending prowl for more premium payments, finding unbiased information online can be very difficult. That’s where this month’s blog comes in!
We’ll start with a simple question that should be the basis of our decision to purchase life insurance. Do I need life insurance? To put it simply, if someone else is depending on your income, the answer is: yes, you do need life insurance. Now that that is settled, how long do you need it? This question can be answered using similar logic as the first one. You need life insurance for as long as someone else is depending on your income. For most people, that’s not their whole life (some foreshadowing there). Once you hit retirement and begin drawing from your retirement savings, for most people, the need for life insurance is almost nonexistent. While you are working, a life insurance payout is made with the intent to replace a future stream of income that is no longer there. For most people in retirement, there is no future stream of income that would need to be replaced by a death benefit should you pass earlier than expected.
So, if you decided that you do need life insurance, which product is right for you? We’ll start with term insurance. As the name implies, term insurance covers you for a defined term. Typically, between 15-30 years. During that term, you pay a level premium (it doesn’t change for the life of the policy) that keeps the policy in force. Should you pass during that term, the insurance company will pay the policy’s death benefit to your beneficiary. Once the term is up, however, that’s it, no more insurance. This can seem a little anticlimactic after making premium payments for all those years, but it’s not that dissimilar to home or auto insurance. You receive coverage for a specific need for the length of the policy. Holding insurance in this manner is far and away the most cost-effective way to guarantee a specified death benefit. In fact, the average cost of a $500k policy with a 30 year term on a 30-year-old man’s life is about $25 per month. That’s a bargain relative to the $421 average monthly premium of a $500k whole life policy on that same 30-year-old man!
Why spend the extra $400 per month on a whole life policy? Whole life policies do have certain benefits that can seem attractive as you’re shopping for life insurance. First and foremost, again as the name implies, a whole life policy covers you for your whole life. Well, technically it turns into an endowment after age 100 or 121 depending on how the policy is written, but for all intents and purposes, as long as you continue to make the premium payments, you’re covered for the rest of your life. The other big selling point is that part of the premium payment you make goes partly to the death benefit and partly to the policy’s “cash value”. This is an amount that builds up over time that you can borrow against, and should you decide you no longer need life insurance, you can surrender the policy and receive that balance. This cash value offers a certain guaranteed amount of 1-5.5% depending on performance. The growth in the policy’s cash balance is tax deferred as well so you don’t owe any income or capital gains tax on the growth until you take it out of the policy.
On the surface, a whole life policy seems great. It’s a form of tax deferred savings plus the death benefit will always be there for you as long as you keep making the premium payments. When you look more closely at the policy, however, cracks begin to form.
- First, there are a lot of fees built into the premium payments that you are making into the policy. Particularly in the policy’s early years. These fees include vague things like; premium tax charge, Federal Deferred Acquisition costs, Sales loads, administrative fees, underwriting and issue charges, specified amount charges, etc. The bottom line, unfortunately, is that these fees can add up to be around 11% of each of the premium payments that you are making.
- Second, while you may be able to borrow against the cash value of the policy, you are paying interest to do so. As a reminder, it was you that put money into the cash value of the policy in the first place. You are paying interest to borrow your own money!
- Third, borrowing from the policy can reduce the death benefit for your beneficiaries which was the whole point of the policy in the first place.
- Fourth, while the cash balance offers a guaranteed rate of growth, that growth rate is typically much lower than other options for guaranteed returns like US Treasuries. Even the variable returns offered by the insurance company are typically much lower than the average return on the S&P 500 index, for example.
The last point leads many advisors (including us at Innova Wealth Partners) to recommend that most of their clients buy a term policy and invest the difference. Using the average premium payments discussed earlier of $25 per month for a $500k, 30-year term policy and $421 per month for a $500k whole life policy, the difference in monthly premium payments is $396 per month. So, for example, the client that purchased a term life policy and then invested the difference into index funds averaging 8% per year would have an account valued at about $538,322 (assuming they buy and hold their investments) after 30 years! This money could be earmarked to be used for the client’s beneficiaries should the client pass away, which would essentially replace the term policy that matured after 30 years. It could also be used for whatever the heck the client wants! This is because, as mentioned earlier in this blog, there’s a good chance that life insurance is no longer needed after age 60 as those dependent on the client’s income become independent and other liabilities were paid down over time.
In the end, like all things related to personal finance, the best product is specific to your needs. Please reach out to us at Innova Wealth Partners for a needs analysis and to help you decide on the best protection for your family!
INNOVA is a SEC registered investment adviser. Information presented is for educational purposes only intended for a broad audience. INNOVA is not giving tax, legal or accounting advice, consult a professional tax or legal representative if needed. The opinions expressed herein are those of the firm and are subject to change without notice. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Any opinions, projections, or forward-looking statements expressed herein are solely those of author, may differ from the views or opinions expressed by other areas of the firm, and are only for general informational purposes as of the date indicated. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein.