By: Andrew Rosen, CFP®, CEP®
Many new clients (as well as most everyone else) are underinsured when it comes to life insurance. Being underinsured is a topic for another blog post. However, it’s worth mentioning now due to its overwhelming importance.
With this post, I’d like to focus on the improperly insured. Like being underinsured, a great many people don’t understand the stark differences between term & permanent life insurances, and therefore ignore its’ value.
Term Life Insurance- The Basics:
Most of us have heard about term life before. But, what is it? How does it work? Term life insurance is actually quite simple, and works essentially how it sounds. You purchase life insurance at a certain amount of death benefit (let’s say $1,000,000). You’ll then have this insurance for a certain period of time (typically 10, 15, 20, or 30yrs – the Term). When the term runs out, so does your coverage. Many refer to this as “renting” insurance. Generally, this type of life insurance is much less expensive than it’s more complicated big brother, permanent insurance. Some term life insurances have an option to convert to permanent insurance during the term period without additional underwriting requirements. However, you will be required to pay the rates at the age you convert.
Permanent Life Insurance- The Basics
Permanent life insurance comes in many varieties, such as whole life, variable life, universal life, and guaranteed life to name a few. While this can be confusing, the nuts and bolts work fairly the same. Typically, permanent insurance has two main features. First, much like its less expensive counterpart, you have a death benefit. Unlike term insurance; however, permanent insurance’s death benefit is just that – permanent. Thus, it doesn’t run out at the end of any term.
The second main feature of permanent insurance is some sort of cash accumulation. How does that work? Generally, an “overpayment” is built into the cost of insurance each year. In the early years, your internal insurance costs are much less; however, they are much greater in the later years. Since permanent life insurances’ cash grows tax deferred, you accumulate cash on a tax deferred basis into some form of cash accumulation/investment vehicle. The intent is the cash, or investment, continues to grow and compound. This growth allows the excess dollars to help fund the shortfall in premium dollars during your later years, when the cost of insurance far exceeds the premiums you are paying. Another possible benefit of the cash value could be tax free loans, if needed by the owner.
Ok so when to Term & when to Perm?
I’d say most people end up needing term insurance the majority of time. Typically, the liability trying to be covered is temporary in scope. Take me, for example. I have two children and a wife; they rely on me as the primary earner. If something were to happen to me today, there would be a major gap in financials to replace my earning potential over the next 30 years (not to mention college for my girls and other one-off items). Now, let’s fast forward 30 years. I’m retired, the kids are out of the house on their own, and I’ve paid off the mortgage. At this point there is no financial hardship if I were to pass. If I am retired, it’s because I’m comfortable that my assets are in a place that they, on their own, could support my wife and I for the rest of our lives.
Another reason to purchase term insurance is day-to-day finances. Although I don’t want anyone to be insurance poor, I also want people to have the proper coverage. That said, term insurance is relatively inexpensive compared to permanent insurance. The most important thing about life insurance is that you have the proper amount of coverage in place. Thus, if cheaper term insurance affords you that opportunity, don’t pass it up.
Here is an easy test to determine if permanent insurance is right for you. Do you have a permanent need for life insurance (or a permanent want)? If the answer is “no,” than I’d recommend term life insurance.
What is a permanent need? A few examples are: for estate planning purposes, having a child with special needs, having to work forever, or for pension planning techniques. The question is this, if you should pass at any point in the future are there financial responsibilities which need care?
A permanent want is something you want to leave behind. Some examples are: a charitable bequest or wanting to leave dollars to children (or grandchildren) to pay for colleges.
Additionally, there are some interesting permanent insurance hybrid products out there, too. Some combine with long term care benefits, and in certain instances (typically for extremely high net worth individuals) there may be some cash accumulation alternative strategies. However, in most cases I am not a fan of purchasing a permanent life insurance policy for the cash accumulation purpose. Generally, there are much better investment vehicles for those additional premium dollars.
That was easy.
Remember, regardless of which insurance you decide is right, insurance covers a need in your life. I recommend an insurance check up with your insurance agent, or financial planner to make sure you have the proper amount of coverage in place.
In his role as Financial Planner, Andrew forges lifelong relationships with clients. He coaches them through all stages of life and guides them to better achieve their life goals. For more information about Andrew or the other firm partners, Kyle Hill and David Levy, click the link below.