For most people seeking financial advice from an advisor or planner, death is the last thing that they probably think about. “Why would I need to worry about money when I’m dead?” For those who are young with dependents needing their income, the risk of death can spell failure in attaining the goals of the household. The first question that must be answered is, “Do I need life insurance?” If you have others whose financial futures are depending on you, the answer is likely “Yes”. Otherwise, the answer is “No”.
Life insurance does not insure your life. Rather, life insurance is designed to provide monetary resources that are needed by the survivors of the decedent (a fancy word for a dead person). If there are no survivors who need monetary resources upon the decedent’s death, there is no need for her to purchase a life insurance policy, as the risk of loss of income does not exist. For those who have financial dependents, a second question should be asked, “How much do I need?” This question will be taken up in a subsequent financial tip and it should be followed by, “Which kind should I purchase?” The rest of this Tip introduces the types of life insurance.
There are two basic kinds of life insurance; whole life and term life. Term insurance is pure insurance and provides the greatest amount of coverage for one’s premium dollars, particularly when one is young. As one ages, the probability of death increases and the cost of term insurance increases. Term life is so called, as it only lasts for a specific period of time, or term. The advantage of term insurance is that you get a lot of coverage for a little amount of money, albeit over a short period of time. If it is guaranteed renewable term insurance you may repurchase the policy, with higher premiums, at the expiration of each term. One’s greater need for insurance coverage, coupled with the lower cost of term insurance, may make term insurance the most attractive.
A person’s life insurance needs may extend longer than one’s working life and they may desire to have constant premiums. Examples of a long-term need for life insurance are issues stemming from estate planning issues, like business succession or estate taxes. This second primary type of life insurance is known as whole life. Whole life insurance is in force for one’s whole life, if premium payments are continued, and contains both insurance and savings elements. Due to its long term nature, the constant premium will purchase less insurance, as one gets older, forcing the portion of the premium going to savings to decrease. What is not used for insurance is saved in a tax-advantaged account.
A benefit of whole life insurance that is little understood is that life insurance savings (called cash values) can be accessed while the insured is alive. The savings portion may be “borrowed” to provide retirement income with the repayment coming from the reduced death benefit upon the insured’s ultimate demise. Moreover, an older insured may have need for income protection beyond their working years, if they have special needs dependents or have young children late in life.
The cash value portion of the policy grows, as long as the policy is in force. A characteristic of whole life insurance savings is that the cash value may be used while you are alive without any tax penalty and you can use the money for any purpose. If you decide that you are one of the minority of the public who has a need for life insurance for their whole life, it is always best to get it from a financial secure company, rated AA, and who pays the greatest dividends, everything else being the same.
Beyond these two basic types of life insurance are variable and universal life insurance policies, as well as combinations. Universal life insurance policies combine a term insurance policy with a savings element, typically invested in safe, short-term financial products. Universal policies “unbundle” the premiums enabling the insured to know how much of the premium purchases insurance and how much to savings, unlike whole life products. Moreover, universal products allow the insured to vary premiums and to put more, or less, into savings. On the other hand, variable life insurance allows the insured to invest the saving portion in higher risk, potentially higher return, investments like mutual funds. Yes, you guessed it. There are even variable universal products which combine the ability to change premium payments with greater expected return investment vehicles.
If this sounds confusing, it should. Life insurance is mixed with options other than straight term life insurance. It is recommended that you consider the type of life insurance which best provides adequate protection for your family. Often, there is only one type of policy a consumer can afford which delivers adequate protection. Thus, you need to give careful consideration to your life insurance needs. Whichever type you decide to purchase, make sure that you do not get too much, or too little. It is not wise for a salesperson to say, “You need six times your salary in insurance coverage. Now, sign here!” Rather, find an insurance agent who takes the time to walk you through a risk analysis, in order to determine that best estimate of the amount that fits your needs and your budget. When you’ve listened to her, call another agent and see what they recommend. If they both agree, you can more easily rest assured in their answers and to then purchase a policy from the most secure company at the best price.
- Robert O. Weagley, Ph.D., CFP(r)
Chair, Personal Financial Planning