LIFE INSURANCE BUYERS GUIDE
For most people who buy life insurance, the check they send off to pay the premium every month ends up being a complete waste of money. If you have insurance, I hope thats the case for you too. However, for a small portion of families, sending that check ends up being one of them most important things they ever did.
Let me start with this, I hate life insurance. I absolutely hate it. What started out as a simple and vital safety net has been layered with so many options, riders, and types of insurance that it has become very difficult to tell what you are actually buying when you start looking for insurance. In my opinion, that’s the point. The more confusing an insurance company can make the product, the less likely you will be to actually look into the product. The less likely you are to look into the product, the more likely they are to pull a fast one on you.
If you start looking for insurance the first choice you will likely be confronted with, is what type to buy. Whole life, universal life, variable universal life, indexed universal life, term life, guaranteed universal life… Did I lose you yet? I could go on. 99.9% of the time, term life is all you ever need. Of course, your agent will likely tell you otherwise. Ever notice how many city skylines are dominated by high rises emblazoned with the logos of life insurance companies? It isn’t term life that pays for those. The big bucks get made off of all the other types. Thats true for the agent too. See what happens if you ask them how much they earn off of each type of insurance. My bet is the commission is about 8-10x higher for non-term products, so you better believe they will try to convince you why you need that whole life policy.
To make this officially a “guide” to life insurance, let’s break down each type of insurance, so that you can understand what you are being sold if that guy who married your spouse’s friend from college ever calls.
Whole life
Whole life insurance is the simplest of what are labeled permanent insurance. As long as. yo pay your premium, it will stay in force until you die, whether that happens when you are 35 or 95. That type of coverage doesn’t come cheap. On average expect to pay about 15-20x more for whole life than for a similar term policy. Every premium paid into whole life insurance gets split between two places, the actual cost of the insurance (which gets paid to the insurance company) and the cash value account (an account where excess premiums are reserved and earn interest). When you are young, and the cost of insurance is low, more of your money goes into the cash value. The idea is that when you are old, and the cost of insurance is high, you will be able to use some of that cash value to help pay the cost of insurance. Any excess generated by the cash value earning interest is yours to keep. The problem, is that the cash value only earns about 3-4% while fees eat up half of that.
The reason I never recommend this type of insurance is that Every single time I have done the math it works out significantly in your favor to just buy cheap term insurance and invest that difference on your own. The rates of return on this product just aren’t high enough to make it even close to worth it. The second reason will be echoed by all permanent insurance products. That is, if you are responsible, and save and invest well, you won’t need insurance for your entire life. Most of my clients are able to become self insured sometime in their 50’s. If that is the plan, why pay more for an insurance product just so that you can continue to have it long past when you actually need it. Doesn’t make sense, to anyone but the insurance agent that is.
Universal Life
Universal life is very similar to whole life, but offers more flexibility. In whole life there is a set premium that must be payed in order to keep the policy in force. In Universal life, there is a minimum premium, but you can pay more than that in order to increase your cash value account. You can also use your cash value account to pay the premium if you encounter tough times.
Why you would be excited about a product that gives you the flexibility to add extra money to a cash value account with horrible rates of return is beyond me. But, people get convinced to buy this stuff all the time.
Indexed Universal Life
The trend here is that we are basically just adding a little bit as we move from product to product. Indexed universal life is very similar to regular universal life with one key difference. Instead of having your cash value earning a low interest rate, your cash value is tied to a market index (often the S&P 500). That means that you have the potential for your cash value to grow quite a bit faster than in a comparable whole, or universal policy. In fact, to sweeten the deal insurers will usually include a guaranteed rate. Meaning if the market has a down year and returns say -15%, you won’t lose anything, but you will in fact earn a guaranteed 3ish%. Sounds too good to be true right? Well… it is.
What is often left out of the sales pitch, which is often a radio ad, or a dinner seminar, is that the growth in your cash value is limited by a cap rate. What that means is that if the market does well, you will only participate in the market grown up to a certain percent, usually something like 8-9%. The market only averages around 10% so that seems like a pretty fair deal right? There are two ways where it really gets you.
since 2008 the market has averaged about 9%. If you bind it with a guaranteed rate of 3% in bad years and a cap of 8% in good years, your average drops to just under 7%.
Unbeknownst to most investors, a good chunk of the returns of the S&P 500 actually come from dividends. Indexed life does not account for those. From 1955 to 2019 the S&P 500 averaged 10.4%, exclude the dividends, and it only made 7.2%.
Combine both of those factors and all of the sudden you just handed about 5% annual returns to your insurance company.
Variable Universal Life
Variable universal life also has a death benefit and a cash value like all other permanent policies, however in variable insurance your cash value get invested directly into the market into your choice of various mutual funds. This gives you the chance to earn market returns on your money, less any fees charged by the insurance company. The average for these policies is in the range of 2-3%. Since you essentially get no guarantees or coverage this product makes very little sense. It will always work out better for you to just buy term insurance and invest on your own.
Term Life
At long last we have made it to the only type of life insurance you should ever be buying. Term life insurance. It’s simple, it’s easy, and for some, it is life changing.
Term insurance offers a fixed death benefit, for a fixed period of time, with a fixed monthly or annual premium. You select the amount of coverage you need, and the length of time you need it. Thats it. Whenever I start working with a family, especially a young family with children, this is the first item on the agenda. The reason is simple. Term life insurance is cheap.
$1,000,000 for 20 years can cost as little as $30 a month. If you start investing $30 a month for 20 years it will turn into a pretty nice number. But not enough to change your life. If you put that $30 towards insurance and something happens to you, it will absolutely change your family’s life. I would argue that there is no more impactful way that $30 could be spent than in protecting your family from financial ruin should something happen to you. This is something that is easy, and matters, and if you haven’t done it, call me today.
As important as it is, I still hate insurance. My first goal when someone asks about it is to figure out how little they can buy, and still take care of their loved ones. I start there because as I said in the beginning; most likely, and hopefully, it is a waste of money. So let’s waste as little as possible.
On another note, if you start the process of buying term life insurance be prepared. We will be having a very real conversation about what life would look like for your loved ones if you weren’t around. It’s a big part of how we determine how much insurance you need. So, plan something fun to do afterward. Because discussing your untimely death is kind of a downer.