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An Introduction to Life Insurance Print
Tuesday, 28th April 2009 (by J.D.)This article is about Basics, Insurance
Many of you have asked for life insurance information, so Ray from Financial Highway offered to provide this guest post on the subject. This is new info for me, too.
Protecting your family from financial disasters is one of the fundamental components of financial planning. Life insurance should be a core part of that planning process. This article is a basic primer on life insurance, which should introduce you to the concept and give you an idea of how life insurance works.
What is life insurance?
Most people have a basic understanding of insurance. You receive financial compensation when an insured event occurs. Consider auto insurance, for example. If your car is in an accident or stolen, your insurance company provides compensation according to the terms outlined in your insurance policy.
On the surface, life insurance is pretty straightforward. When the insured person dies, the policy pays a prearranged amount to the designated beneficiary. The following parties are generally involved in a life insurance policy:
- The Insured. The person on whose life the policy is based.
- The Beneficiary. The person who receives the payment.
- The Owner. The person responsible for payment of premiums. It is typically the insured, but it could be the beneficiary.
- The Insurer. The insurance company that issues the policy promising payment.
Traditionally, both spouses have life insurance policies in order to protect their family in case one of them dies.
Why purchase life insurance?
The main purpose of any life insurance policy is to protect your family and loved ones against the risk of financial uncertainty. Life insurance can provide for the welfare of your family in face of your death. If you have a spouse, three kids, a mortgage, car payments, and credit card bills, what would happen to them if you were suddenly to die? Would your family have enough money to keep the house, car, pay off credit card debt, and send your children to college?
Life insurance can guard your family and loved ones from potential financial disaster.
Types of life insurance
While the idea of life insurance may be pretty basic, there are some complexities to consider. The most important point to remember is that there are several different types of life insurance products, which can make it difficult to select the right one for your family and your financial needs.
There are two basic forms of life insurance — term life and permanent life, the latter of which comes in several flavors. Here’s a quick breakdown of the basic policy types:
Term life is the simplest and (typically) cheapest form of life insurance. Term life is designed to provide coverage for a fixed period of time, such as 5, 10, or 20 years. The premium for the term policy is guaranteed for the duration of the term; if it is a renewable policy, the premium will increase with each renewal. The premiums for renewals are generally guaranteed when the original policy is issued. Because term life policy is for a specific period of time and the payout does not increase, the overall cost of term life insurance is usually very low.
The other three common types of life insurance are permanent policies &mash; they last for the entire life of the insured, not just for a fixed period of time.
Whole life policies, for example, are designed to provide you and your loved one with coverage until your death. Unlike term life, there are no fixed periods for whole life coverage. Whole life is sometimes referred to as “cash value” insurance because it builds cash value over your lifetime. Whole life coverage contains both investment and insurance components. The investment portion invests your premiums, earns interest, and accumulates a cash value. On the other hand, the policy also has a stated insurance coverage amount that is paid upon the death of the insured.
One of the most popular forms of permanent life insurance is variable life. Variable life policies allow you to invest your premiums in the stock market. While a variable policy may offer more significant returns, it’s also at the mercy of stock market performance. In a poor performing market, the overall death benefit/cash value of the policy may decline — but never below a defined level. As a result, the policy may be more expensive because you may have to pay more to keep the policy active because less money is available to cover the policy’s premiums.
Universal life is a popular option that acts like whole life. It is a renewable policy — the investment component, premiums, and death benefits can be renewed and changed based upon the policy owner’s needs. The policy owner has flexibility over the policy — money can be moved between the insurance and investment components of the policy. The premiums, unlike whole life policies, can be paid out of interest from the accumulated savings.
Life insurance: A great tool
Because of its many options and overall flexibility, life insurance can be a powerful tool in your financial planning arsenal. Consider that life insurance can be used to pay for funeral costs, college tuition, mortgage payments, debts, and more. It can also serve as income replacement — providing your spouse and family with a greater sense of financial certainty.
Remember, like all insurance policies, your coverage can lapse if you do not make timely payments. If you need help to cope with the complexities of life insurance, contact an insurance professional. You should also read the fine print closely (possibly with the help of your insurance professional) to understand if there are any limitations on the policy and what it covers.
Note: Ray has submitted a follow-up article that builds on this info to offer tips for purchasing life insurance. I’ll post that soon. Also, here’s a guest article on disability insurance that I hosted last year.
April 28th, 2009 at 5:13 am
Thanks so much for this post. I was more on the confused side of things as far as life insurance goes. This was a big help.
April 28th, 2009 at 5:34 am
I’ve noticed that some of the guest posts have been written by “professionals,” that is, people who make their living by selling these products. That is, sales people who make commissions. Perhaps these posts should be balanced with posts by non-professionals? Just a thought.
I don’t know about this one in particular, but others have been written by financial planners etc. It would be helpful to warn people of the kinds of commissions attached to various products.
April 28th, 2009 at 5:37 am
Great post, I have actually just begun to think about getting life insurance with my second child on the way. I hate to think of the financial burden my family will face if something ever happens to me. Good timing.
April 28th, 2009 at 5:44 am
I have a ‘friend’ (actually, acquaintance who’s a rather obnoxious insurance salesman) who tries to push whole life insurance on anyone and everyone because of its “cash value” that can be withdrawn at any time.
I’m 31. I’ve had a whole life policy since birth that has a pretty decent cash value built up. Are there any disadvantages to withdrawing it?
April 28th, 2009 at 6:00 am
Sorry JD, but I was disappointed by this article. It really felt like an infomercial. It failed to address the single most important question of all: “How do I know if I need life insurance?”
Instead, it just said “Life insurance is great,” which is what I’d expect to hear from an insurance salesman.
I think a paragraph discussing how to determine how much life insurance you need (or if you even need it at all) was sorely needed in this post.
Incidentally, if you’re single and have don’t have any dependents or co-signers on any of your debts, you don’t need any life insurance at all. Your creditors cannot come after your family for payment if you die unless they co-signed the loans.
April 28th, 2009 at 6:01 am
In general, I think its best to keep to the simplest (TERM) life insurance and forget about the other types. With the more complicated life insurance products you are mixing insurance with investments and its easy to get confused about what kind of a deal you’re actually getting. By keeping your insurance and investments separate its easier to compare apples to apples.
April 28th, 2009 at 6:01 am
That was an interesting post Ray. I didn’t know about insurance, but now I have a stronger foundatin on the subject.
Keep upi the good work!
Blogging Banks
April 28th, 2009 at 6:03 am
If you have not maxed out your 401k, IRA, and Roths and want to invest money, max them out before investing in cash value life insurance. Don’t buy the salesman’s pitch that you get great returns and flexibility as you can get those with your IRAs and Roths as well. Review the fees in the different types of insurance categories. Also, if your looking for the worst performing mutual funds you will probably find some of them in the life insurance products. This is because the insurance company has “captive” money. You can’t remove it without penalty so they can charge you higher fees with a lower chance of you moving to another company.
April 28th, 2009 at 6:06 am
While this is a decent article, it leaves out much of the decision processing that goes on in chosing life insurance. How much should you get? What type is best now? Do you really want to make your death the lottery win for your family? etc.
Also, most insurance agents will tend to push the Whole or Universal life policies because the commisions are substantially higher, but if your goal is protection of your family during your prime earning years, you get much more bang for the buck with a term policy. For example, a $500K policy for a non-smoking, thirty year old male, may run around $45 a month (allstate) while a whole life policy for the same half million may run around $500 a month (state farm, only went to their site because I didn’t find a quick way to get a quote for anything other than term at Allstate, makes me wonder). Note if you renew the term policy at 50 and are still in reasonable health, the premiums are around $160 a month, so over 40 years of coverage (30-70) you get much more insurance if you die while paying significantly less than the whole life. That’s a big difference in the monthly budget and means if you’re looking at whole or universal life policies you are using those policies as an *investment*, with insurance benefits on the side.
While there is a place for such policies for many people in their overall portfolio, it is my opinion that most people end up being underinsured because they can only afford so much as a monthly payment since most of their “investment” money is going to IRA’s, College funds, etc. For example, if you only had $100/mo to spend on life insurance after you’ve funded retirement and the college funds, you could get a million dollar twenty year term policy, or a hundred thousand dollar whole life. The sales pitch pushes the $100K. But if you die at year 19, you get $100,000 with the whole life, but $1,000,000 with the term. If you die at year 20 plus one day, you get $100,000 with the whole life, and nothing with the term. Would it matter in 20 years? If you’re still alive will you essentially no longer need the insurance because your Roth IRA will have over $100K anyway, your kids will already have their college funds fully funded, you have no debt and the mortgage is paid off? Which is really the better deal? Which really protects your family? What are your real goals for this insurance?
If you were looking at it as an investment with insurance on the side, then you may have bumped up the amount to something more protective of your family, which is fine. But then it’s primarily an investment and needs to be looked at in that light and compared to your other investments.
Like the article said, life insurance is a tool and you need to decide how you want to use it. Check the web for some ideas of how much you should get (if you need any at all), then decide how much you have to spend and that should push your decision of term or permanent or a combination of both types. If your house doesn’t get damaged, you don’t collect on your homeowners insurance. If you don’t have any accidents you don’t collect on your auto insurance. If you don’t die, your beneficiary doesn’t collect on your life insurance. And yes, that includes the *insurance* of the whole life policy, remember, you don’t get back the insurance premiums paid. What you get back is the “investment” part.
April 28th, 2009 at 6:08 am
@ Amy If you have had the policy for 31 years that is great! Right now the premiums are probably lower than a term for you. So defiantly keep the policy, unless you really need the Cash value leave it in the policy it can be a great additional retirement income.
@ Kevin: JD and I wanted to go over the basics of insurance first, there is a follow up post that address questions re life insurance and how much you’d need.
@ Kyle 100% agreed!
April 28th, 2009 at 6:10 am
p.s. I am not sure how some get the idea that I am an insurance salesperson, I WAS one but currently NOT involved in direct insurance sales to clients.
April 28th, 2009 at 6:12 am
This is a great starting point to understand the basics of insurance, but I would love to see an article on how to figure out IF you need life insurance, and how to come up with a $ amount to be insured for.
I also want to personally say that we used Accuquote for obtaining my husband’s insurance, and we were very happy with the process and the price! (I’m in no way affiliated with them BTW!)
April 28th, 2009 at 6:16 am
Interesting and very informative post.. Gives clear idea on the various types of insurance.. I have myself worked for insurance companies and out of my own experience I can tell you that other than Term Insurance, all other insurance schemes are a big scam. They just dont get you enough in return. Term insurance ic a pure insurance and is a must for every individual. So my advice would be “Buy Term and Invest The Rest” as Dave Ramsay would agree.
April 28th, 2009 at 6:24 am
Good post. I think it is important to point out that Life Insurance is NOT for everyone. I blogged about this back in January.
http://www.twentysomethingsense.com/2009/01/do-you-have-any-dependents.html
Buying Life Insurnace when you have no dependents - someone who relies on you for support or aid - is like buying a lottery ticket that only pays out if you die.
April 28th, 2009 at 6:30 am
I found this post to be helpful because I’m not familiar with the insurance terms I’ve been reading in the financial blogs (Not sure if insurance is sold differently where I am though).
I too would like to know if I’ve got enough. I’ve got a policy through work that pays a year of my salary, but any financial calculator I’ve tried says that’s not enough. I’m single, no kids and only one debt (which is insured itself), but I’ve been thinking of getting life insurance while I’m still reasonably young and healthy.
April 28th, 2009 at 6:32 am
Most every reputable financial advice source I’ve read says “Stay away from whole/variable and stick with term!” Big emphasis on this. What I’ve heard over and over is that life insurance should NOT be used as an investment. Ideally it’s income replacement protection, just in case, same as disability insurance (which everyone should also have).
Also, a timely topic would be how to evaluate the health of an insurance company. We’re looking at unstable period in general, and there have been warnings about quite a few major companies in the news recently. How does one make sense out of various ratings and things like that? When does it make sense to move an existing policy to a new company?
April 28th, 2009 at 6:43 am
I’m going to echo concerns of earlier posters. I really hope you’ll weigh in with a more substantive post about the pros and cons of the various types of life insurance.
Most people who know about the issue consider whole life insurance a complete scam. Period. By giving it equal billing with term life insurance, you’re implying that it’s a similarly worthwhile option. It’s not all that different from discussing types of investments, and listing “Ponzi scheme” alongside stocks, bonds, and mutual funds.
No offense intended–I’m not saying you mean to promote bad investment options. I’m just saying that this post would benefit from the same type of critical thinking we’ve come to expect from GRS.
April 28th, 2009 at 6:44 am
@ Beth I am not a big fan of employer sponsored policies, if you really NEED life insurance always get an individual policy. If you are single and no obligations than you do not have much of an insurance need. there’ll be a second post with tips on how to get the right insurance policy.
@ Helen, I know many people are worried about their policies BUT all policies are backed by state guranty association in the US so if your company goes down you will still get the bailout. I am usually against switching companies unless you have a very good reason to do so.
April 28th, 2009 at 6:52 am
Get off of Ray’s back. He delivered what the title described. Introduction to Life Insurance.
Your description of term insurance is a little off. The “term” in term life insurance refers to the length of time that coverage lasts. In most term products the term usually lasts until the insured reaches ages 70-100 years old. If you look on most policies it will say something like “Term to age 80″. This means that you have guaranteed coverage until that age.
The period of 5, 10, 20, etc years you describe above is the level premium period. During this time the premiums and death benefit are level. After the level period the death benefit stays the same for the length of the term, but your premiums increase a predetermined amount each year.
April 28th, 2009 at 7:00 am
J.D. Another good article topic would be on disability insurance. From what I’ve seen, however, disability can be more difficult to get than life insurance. Furthermore disability insurance is probably *more* important than life insurance (from my understanding) since it is more expensive to be disabled.
April 28th, 2009 at 7:05 am
You can now purchase term life insurance where you get the entire premium back at the end. I think that this type should have been addressed. It is called Return of Premium (ROP). This type of insurance is sort of crossing the line of investment with term because the monthly premiums are more. Kiplinger’s did an analysis of it and determined that you would be better off investing your extra premium yourself at the end.
http://www.kiplinger.com/magazine/archives/2006/03/insurance.html
My husband and I determined that we needed enough insurance to pay off the house and have 1-2 years of salary. We got a 20 year term. Our daughter will be about 19 at that time and technically an adult. Our thinking was that in 20 years, our house would be nearly paid off and our retirement accounts would provide a sufficient buffer to help her finish up college at that time.
April 28th, 2009 at 7:10 am
@ Micheal ahah thanks for the back up. I am a little confused about the two different terms you talking about. Unless US has some different policies usually all premiums with term is level till RENEWAL, yes ones you renew your premium increases.
@ Brett agreed. Disability is important but VERY complex policy. Chances of disability before 65 is much higher than chances of death
April 28th, 2009 at 7:12 am
Wasn’t gonna comment until I saw an ad right under the article for…. insurance for your children. What’s the author’s view on that? I’ve always been skeptical from a financial perspective — and always a bit turned off on the often-emotional sales of insuring your children’s lives, even if it’s in a whole-life ‘investing in their future’ wrapper.
April 28th, 2009 at 7:15 am
Good morning, everyone. For the first time in a week, I’m available to participate in the comments.
I appreciate the concerns from those who think this post is “sales-y”, but it didn’t strike me that way. Still, I know almost nothing about this subject, which is the main reason this post had a long, tortured path before publication. We worked on it a lot behind the scenes in order to get it right. It still might not be perfect, but I think it does answer the basics.
As Ray mentioned, he has submitted a second post (which may go up this afternoon, if I finish editing it) that does a better job of asking questions about which life insurance products to purchase. (And he concludes that term is often the best choice.)
Also, I did post a guest article about disability insurance last year…
Thanks for the feedback! (And thanks to Ray for offering to write this.)
April 28th, 2009 at 7:24 am
Also, a bit disappointed to see that no one touched on the estate planning aspects of life insurance. Since the estate tax is quite high and life insurance payouts are not considered taxable income, the benefit of having life insurance to cover your estate value, can in many ways save you from losing 35-45% of your estate to the Federal Gov’t!
April 28th, 2009 at 7:26 am
I’ve been trying to find life insurance for my father for months now with no luck because he has Type II diabetes. If you have any suggestions for insurance for diabetics, let me know.
April 28th, 2009 at 7:39 am
This is something that I needed to read! I have been considering getting life insurance (even tho I”m still under 30) but did not know the types. This really was a good introduction. Thanks.
April 28th, 2009 at 7:45 am
A few things that were left out of the post.
A) Term can go to age 100 with some policies level up to 35 years.
B) Whole Life insurance builds up cash value to EQUAL the face amount at around age 95 or 100. (Funding OWN policy with OWN money)
C) Universal, Variable, and Variable Universal (at least from the ones I have seen) have a date on the first page stating when the policy will lapse IF you pay all your premiums on time as expected. Usually, it is around age 65 - 70. It lapse’s because it was not fully funded since it will eat away at that cash value.
D) All life insurance have a TERM component to them.
E) If you borrow from the cash value, and fail to pay it back, the insurance company will take the loan from the death benefit PLUS interest AND fees.
F) If you withdraw from a cash value policy, you may face tax issues.
G) It usually takes at least 3 years before you have any savings in a Cash Value policy. The money goes to the insurance company and the AGENT to pay his commissions.
H) In most cases, upon death with a cash value policy, you get EITHER the face amount OR the cash value. You have to pay MORE each month to get both.
BTW, these are things that most insurance agents wont tell you and will have a hard time finding online.
April 28th, 2009 at 7:46 am
I have both a term and whole life policy. I figure in 20 years once the term runs out I should be okay without it. However it’s nice to know that I will have the Whole Life policy forever (in my low 30’s now). I was taking a look at my investments in the beginning of the year, and the only thing that did not lose money was my Whole Life “investment”, it actually gained because of Dividends. So ultimately the way I see it is get Term as a necessity, Whole life as a luxury/hedge investment. Thoughts?
April 28th, 2009 at 7:48 am
I don’t have Life Insurance. I am 53, children all grown, live alone, house paid for, with no debt. I plan on pre-paying my funeral.
I hope it’s not a mistake but I don’t see the need for me to have life insurance. I would appreciate any thoughts, if you think that I’m making the wrong choice.
April 28th, 2009 at 8:02 am
I do employee benefits consulting work and I’m a licensed insurance agent although I do not actively sell insurance. I’ll throw in my $.02.
Need: Even if you are single and relatively young you may want to take advantage of a small cheap term policy to help pay off your funeral expenses and the costs of liquidating your stuff. Life insurance will pay a benefit faster than some of your funds may become available at the time of your death. Your loved ones will have to float the costs. Small and cheap should work. For everyone else I will echo that a term policy usually is the best.
Most of the policies described above are essentially term policies with investment vehicles attached. If you purchase a $100k policy with an investment component a portion of your premium pays the term policy (covers the $100k if you die tomorrow) and the rest goes into various investment accounts and fees to cover administrative expenses. There are exceptions to every rule but in general the only time it makes sense to purchase whole or universal policies is if you are wealthy. These policies can be used to help avoide taxes. You probably don’t need to do that unless you have maxed out your 401k and Roth IRA options and have a high annual income.
With group polies purchased through your work you may get a price break and depending on the amount you may not need to provide as extensive (or any) medical history. These policies tend to be better for older workers. The prices can often be better than in the individual market. The policies can often be rolled into personal policies if you leave the company but are generally VERY expensive when they are rolled.
Get yourself some term life coverage with some AD&D attached. If you are rich speak with your accountant.
April 28th, 2009 at 8:17 am
Although I agree with posters that stated that young people without dependents do not need life insurance, there is a risk factor involved in holding off on a policy. A few years ago I thought $100K on top of one year’s salary was plenty (I was living in a rental apartment with a girlfriend). Then I was diagnosed with cancer. Although I recovered (after lengthy chemo), it means I am now blacklisted and, with a mortgage, spouse and child, I am still limited to that same amount I signed up for as a carefree 20something. After 2 1/2 years of super-aggressively paying down the mortgage, I am finally at the point where the policy would pay off the remaining principal so my spouse can keep the house if I were to die. However, even now she would have to go back to work within several months after such an event, arrangte for daycare, and live super-frugally, which means most likely she would sell the house. I now wish that I could tack on a few $100K. In reality, I am this recession’s worst consumer, because every penny goes into mortgagte prepayment or savings to make up for the fact that the insurance policy is lower than it should be.
April 28th, 2009 at 8:22 am
@omar the reason the policy grew was because it is not an investment. It’s closer to a savings account earning between 1 and 4%. It wasn’t a dividend. A dividend in life insurance is a return on intentioanlly over paid premium. Does that spound fair to you?
@axe I advise against ad&d policies. Only about 2 to 5% of claims pay out because death was not caused by an accident. In otherwords, if in a car wreck, you better die at the scene BEFORE the ambulence gets there, otherwise you died due to complications and NOT the accident. A fine line forsure, but one so the company doesn’t have to pay.
April 28th, 2009 at 8:28 am
@the beagle
Wait a few more years. After 5 years of being clean, companies will start looking at you. Once that 5 year mark hits, try adding every 6 months until you get the extra coverage. Miracles will happen if you work for AND expect them.
April 28th, 2009 at 8:36 am
@ Beagle
Thats a good point. It really depends on you personal situation and related risk tolerance. The odds are still very small that a person will contract cancer while relatively young however each person’s needs are different.
Keep in mind too that the cost of Life insurance in the group market has been fairly level. In reality it should be going down as people live longer and efficencies in administration and underwriting increase. A young person stands to get a better deal on a term policy in a few years vs. in today’s market although that value will be incremental and also relative to inflation. In other words probably too small to really make a big difference.
I suspect that many people will cut back or eliminate life insurance as savings measure during this down economy which may prompt insurers to get more agressive with pricing. Keep in mind that agressive in life insurance is only worth a fraction of a premium dollar and may not make that much of a difference to the buyer.
I think you played your cards right based on the information you had at the time (not knowing all the facts in your case).
April 28th, 2009 at 9:20 am
I’ve done my research when I bought my term life policy recently. I think anything other than term is a waste as you’ll be paying the agent a nice bonus. I’m 31 but have four kids, and my wife currently stays home so insurance is a must. I settled on a 1mill 10yr policy at $390 a year (I got lower premiums by taking health/blood tests). By purchasing the insurance through my home/auto provider, I saved on those policies as well.
Colin pointed out a big point, as life insurance payouts are not considered taxable income; your beneficiary will receive the entire amount tax free (if your estate is below the tax limits). Although one more point that should be stressed, make your wife or the beneficiary the owner of the policy this way the insurance won’t count toward your estate.
April 28th, 2009 at 9:24 am
There is a lot of talk and focus on the different types of life insurance there are and which type is best for an individual. In general (not just here), this is an over-emphasis that leads to more confusion than it is worth. Some agents I know even use the vast number of types (not all are listed here) and technical details to confuse and steer clients towards the agent’s favorite choice.
Folks should focus on their needs and the purpose behind the insurance first. Once they define that, then go shopping. This will eliminate a lot of confusion because you would only consider relevant choices and keep you from being “sold” something that doesn’t fit your needs.
Having said that, if someone will not only have an emotional loss but also a financial loss when you die, consider life insurance. There’s no right or wrong here because it is ultimately a very personal choice.
Overall, this is well written because life insurance is such a hard topic to write about. I’m speaking from experience. I was a little disappointed with the amount the word “investment” was used because cash value should not be the primary purpose of a life policy. Also, planning to access cash value down the road often ignores the risk the life insurance company poses to the owner, which is separate from any investment risk, not to mention the potential tax consequences.
April 28th, 2009 at 9:30 am
Along with some of the other commenters, I demand to know why this post, along with the vast majority of other posts on this blog (including the ones I’ve written) don’t cater to my exact life scenario, knowledge base and intelligence?
Seriously - good post Ray - looking forward to the part II.
I have term insurance only. From what I understand - all other types of insurance have high fees.
I’m kind of a “keep things separate” kind of guy - I want my insurance products to be insurance-only and I want my investment products to be investment-only.
“Combination” products almost always mean higher fees.
April 28th, 2009 at 9:37 am
@Beagle
I had something similar happen, EXCEPT I’d just gotten the insurance less than a year previous. We’d had one kid and I’d just gotten pregnant with the second, so we realized we really needed to get some life insurance. We insured ourselves appropriately, and one week after the birth of my second child I almost died of a pulmonary embolism, a blood clot in my lung (a rare complication of pregnancy). Although no underlying clotting disorders were found, I still have 20x the risk of having a second embolism, and I might not survive it if it happens again. I don’t know whether I can’t get insurance, but even if I could it would be horrendously expensive. Instead I am paying the usual premium for a healthy 20-something.
April 28th, 2009 at 9:50 am
I can’t read through every comment, but regarding the tax side of life insurance: I deal with estates and inheritance tax and I’ve often seen where a person will die with no beneficiary listed on their policy, or the beneficiary on their policy has died and the default is the estate. When this happens, the proceeds are taxable on the fiduciary return, as well as Indiana Inheritance tax returns.
A note of advice: Keep beneficiaries current and list more than just a primary beneficiary. List a second…a third…even a fourth.
April 28th, 2009 at 10:14 am
The issue I have come across many times discussing life insurance with friends is that we tend to look at a life insurance payout like a lottery win for our family after we are gone.
The part that is more difficult to understand is how the insurance company is making a profit from my premiums while still paying a large sum when I die.
April 28th, 2009 at 10:16 am
Tones of good comments and some questions I think some of it was answered I’ll try to get to a few of them.
@ Richard those are great points, but again JD and I wanted to keep it very basic and just an introduction to the topic.
There will be a second post with tips.
@ Beagle sorry to hear your situation, there are too many in your situation that is why I think insurance planning is so important. Depending on the type of cancer and your health status you can still qualify for insurance.
I suggest you find a REALLY good agent, they will supply extra information to the insurer. I have been able to get insurance for individuals who thought they were not able to get it, so there is hope.
Taxes and estate planning. Yes insurance can be a great estate planning tool and often used for estate equalization needs. Agree with HEATHER always name couple of beneficiaries so u dnt end up with tax bill.
April 28th, 2009 at 10:18 am
Good basic info. I carried term life while I was young and raising my family. That expired and now I have only a small whole life policy that I pay into until I am 65. At that point I can just let it sit, borrow against it, or cash it out. I was maxed out on 401K’s and IRA’s so this seemed like a no brainer to me. But as a rule, term is your best bet if you want lots of coverage while raising your family.
April 28th, 2009 at 10:44 am
I am taking Estate Planning for my CFP this semester and this is what I’ve learned about life insurance. It depends. That’s it. It depends on your individual circumstances. It is reckless to agree that the best way to deal with life insurance is to buy term and invest the difference.
While I do agree that for a large portion of the population that is 40 or younger, term is a more cost effective measure, it is not the only solution. For example, if you own a small business that has generated a fairly large estate for your family and at the age of 40 you bought a term policy, as you get older, in most cases your rates will increase and at some point the premiums will become a large burden. If you allow that policy to lapse and then pass away your family is stuck with the bill for estate taxes with no way to pay them, except for liquidating the family business. The right insurance product could prevent this kind of family crisis.
Dave Ramsey is great for advice on how to get out of debt, but like most thing is personal finance individual circumstances should always be considered, and blanket advice can cause more harm than good.
I don’t write this as criticism to the person who wrote this guest post, but a word of caution to those who always believe it is better to “buy term and invest the difference.”
April 28th, 2009 at 10:54 am
While life insurance might have its merits, it is not something that a family revolving non-mortgage debt from month to month should invest in. Setting financial priorities is key.
April 28th, 2009 at 11:07 am
@Lisa You will still be paying for that policy till you cancel it or you die. Instead of coming out of your pocket, they take it out of the cash value.
After all, the purpose of the cash value in a whole life policy is to reduce what the insurance company has to pay. At age 100, your CV = Face amount.
@DebtGoal If a family has revolving debt they have a need for life insurance. Upon death, the debts get paid out of the estate or by whom ever is a joint on the accounts. Most families, although the debt is separate, their bank accounts are linked. Therefore, the credit companies dip into the account and take all that is due. Life insurance can be used to offset that.
@lesly You may still have a chance. I am dealing with a client now that has had that happen twice. There is still a good chance she will go our top rating since, in her case, it is related specifically to pregnancy and documented as such.
@chett If they planned correctly with intelligent lawyers and accountants, the estate issue in regards to a business is moot and wont factor in.
April 28th, 2009 at 11:11 am
@Chett (#44):
You make some good points, but I wanted to provide a counterpoint. Someone who buys a term policy at age 40 could very well need life insurance. However, as they grow older and the premiums increase, they should have less and less need for life insurance. They should have accumulated assets on their own that would enable their surviving spouse to carry on without them.
That’s one thing that’s always bothered me about the life insurance industry. If you watch a little daytime TV, you’ll eventually see commercials featuring an elderly couple discussing life insurance, and how they regret not getting any because at their age it would surely cost too much. Cue the narrator who saves the day with news that the septuagenarians can qualify for a $250,000 policy with no medical, and they’re “guaranteed not to be declined!” Personally, I find it sad that so many elderly people out there are so woefully unprepared for old age that they still need life insurance. By that age, their house should have been paid off long ago, there are no more kids on their way to college, and they’re already collecting Social Security. What possible need could they have for a quarter-million dollar life insurance policy?
Furthermore, with respect to estate taxes, if the spouse is still alive, it’s a moot point. There are no estate taxes. All of the assets simply become sole property of the surviving spouse. The surviving elderly spouse is not suddenly going to get hit with a big tax bill.
April 28th, 2009 at 11:46 am
I don’t want to get in an argument over details that are beyond basic life insurance. I just wanted to make a point that the advice to “buy term and invest the difference” does not apply to all. The argument could take a lot of different directions and in the end a person should contact professionals to see what is best for *them*
I don’t work in the industry, I don’t sell anything. I just think readers here should not take a few comments from a blog and make a decision that could cost their family money, without talking to a professional planner, not a professional salesman.
April 28th, 2009 at 11:55 am
@Chett you are right. It doesn’t apply to all. Sometimes it is just invest, others it is just buy term.
You don’t work in the industry yet you are working towards (or keeping) your CFP? Hmm. That’s odd because a CFP does work in the financial services industry and is a salesman like any other agent in the industry.
April 28th, 2009 at 12:04 pm
@ Richard CFP is not necessarily involved in the sales of products
April 28th, 2009 at 12:06 pm
True, but that does not mean they are not salesmen like the rest of the industry. They still have to sell themselves and may receive a fee for their time.
April 28th, 2009 at 12:15 pm
I really did feel like I was reading a brochure instead of an analysis. And some other commenters have said, an intro to life insurance would be more like what does it do?, what can it do for you?, when shouldn’t you get it? and when should you get it?
Some basic analysis comparing the overhead costs of getting a policy versus self-insuring or managing your own investments would also be appreciated.
April 28th, 2009 at 12:17 pm
I’m looking forward to part II, as this is something I’ve been wondering about lately, too. Thanks, Ray.
April 28th, 2009 at 12:20 pm
Thanks for the feedback, everyone. Ray’s second post will go up in about 40 minutes. It’s still not going to satisfy those that are hungrier for more meat, but that’s okay. What we’re trying to do here is a lay a foundation for future articles on life insurance. As I mentioned elsewhere, I’ve always avoided this topic because I don’t know anything about it. I wanted to start at ground zero so that we can build from there in the future.
April 28th, 2009 at 2:19 pm
Ray re employer-sponsored policies. Disagree - can be a good deal IF they’re portable, in other words, if you can take them with you when you leave the company. Many employer-sponsored policies ARE portable and you get the option of converting to an individual policy. The conversion usually carries over the group rate you were getting through the company, so you’re paying less than if you went out and bought an individual policy.
ALSO - would like to see more about options related to those of us non-breeders who enjoy matrimony sans kids. My hunch is to go with a term policy that would help my S.O. pay off the house if he wants to, and also helps make up for the fact that there’s just been a drop in joint earnings and savings.
April 28th, 2009 at 2:26 pm
@The Beagle
Once you’ve been “cancer free” for five years you are eligible again. Check into it!
April 28th, 2009 at 9:57 pm
Very insightful post there GRS, thanks.
One of my friends is actually a life insurance broker and been in the industry for around 4 years now, prior to that he was a car sales man and a bloody good one, he could sell snow to inuits if he needed to.
April 29th, 2009 at 11:22 am
Aron re Beagle, insurance underwriting is a whole other confusing story. It really depends on the type of cancer, treatment, stage, grade, and quality of follow-ups. I’ve seen standard insurance offers within a few years and declines outside of eight years.
Everybody’s different and every agent has access to different expertise and distribution channels (also no one agent has access to all companies). We really need personalized quotes from multiple perspectives. Other options fall short, in my opinion.
April 30th, 2009 at 12:32 pm
Regarding the many people saying that you don’t need life insurance if you are single and have no dependents-
Personally, I have set my parents as beneficiaries for my policies in the event that I get myself killed in some stupid stunt that young people often do.
I consider it the least I can do to repay them for spending so much of their life’s earnings to raise me and put me through school.
April 30th, 2009 at 9:16 pm
Dave C
Although I do agree with your point, when I tell my clients that they have no need for insurance, I still recommend they get at least enough to bury themselves with and cover any unexpected medical bills.
As for repaying for taking care of you, that is what paying for a nursing home is for.
Just kidding.
The other side of that though is this. What if you have, say, $900k in the bank, no dependents, no debt, you have no real need for it (assuming average middle class here).
Or even married with no dependents and no debt with $500k in the bank. Again, no real need, but a nice want.
Every situation is different.
May 1st, 2009 at 8:41 pm
All types of insurance serve a different purpose. Term life is great if you covering something specific for a certain amount of time, be sure to pay attention to your state laws regarding at what age term insurance is no longer in force. Whole life is a great way to be insured while building cash value to provide flexibility in your life. Universal Life is a very similar to term, in that it is pure insurance with a very small cash value, whereas term has none. Variable life is a universal life insurance product, not a whole life product. It is set up similarly to a basic universal life product, but it has a separate rate account that is tied to the market, similar to how a brokerage account would hold mutual funds. Hope this helps clear some things up, and corrects some of the article.
May 5th, 2009 at 7:50 am
Jesse, spoken like a true cash value agent.
Last I checked my states laws, there was no limit on length of term insurance EXCEPT for what the company is willing to offer.
Whole life’s cash value is LOST upon death. The insurance company keeps it to offset their losses related to your death.
Universal Life was created to combat AL Williams & Associates on Buy Term and Invest the Difference. Sadly, the average it does after fees is around 5%. Although it gave you the chance of a higher death benefit, you had to PAY for it with even higher premiums.
Variable Life allows the premiums/face amount to fluctuate as to what you could afford.
Variable Universal Life took the best of both Variable and Universal. Averages about 7% after fees (the underlying funds still average around 12%). Same as Universal Life regarding the cash value, you have to pay MORE to keep it.
When you break all these products down to the core, they are all TERM products with a low yield savings plan with higer fees.
The only real benefit Cash Value products offer, is a lower risk to the insurance company and a higher commission for the agents selling them. The user get screwed. Or did you forget about the FTC investigation in ‘79? The same one that caused the commissioner to get fired and the insurance companies that created those cash value products to push a law through preventing any further investigation into the industry without the industry’s permission? Kinda like you have to ask the Feds permission to sue the Fed.
If you are going to speak truth, speak ALL truth and not just sales pitch truth.
July 13th, 2009 at 1:06 pm
I sell life insurance. And I confess that I steer clients to the policies I like. I like certain policies because I believe they are a better value. I buy them for myself.
The amount of rash judgment towards life agents in these posts is a little disgusting to me. Some of you said not to listen to an agent because he is an agent and receives commission. That is not advise, discussion or reason but rather an ad hominim attack on a whole profession. It sounds as brainless as talk radio to me. Whatever.
I recognize that 50% will not consider anything I say because of my profession. Too bad for them. I now work with high net worth individuals because articles such as this have poisoned the water for selling to the middle class. They ( the middle class) are just no longer worth the effort and it really is too bad for the middle class, because whole life is the one most suitable financial product for the middle class that there is. How has your 401(k)done the last ten years? Is it safe? Is it liquid? Is it there as cash when you really need it? Can you get equity out of your home when you are between jobs? The answer is yes to all of those questions with whole life except in the early years when the cash value stinks because of the up from commissions. After the early years, it start to work very well.
In contrast, qualified plans (IRAs and 401k’s) and aggressive equity investing has hurt a lot of people. Most middle class people over rely on equities in 401(k)s and home equity on the asset side of their balance sheet. As a result they are very illiquid in this bad environment. Also, putting so much saving in qualified plans has encouraged the use of debt to provide household operating capital. This reliance on debt for normal household capital expenses (cars, roofs, weddings etc.)becomes a lifelong leak in capital formation and creates long term wealth…for the bankers.
I have clients with old whole life contracts that have provided insurance for twenty plus years and have returned North of 5% on premiums paid in cash value and that will provide North of 10% if the client were to die this year. So what has been the “cost” to the client of insurance? Not exactly a screw job. Now the consumer does need to be careful as there are bad companies and bad products, but whole life insurance from a mutual company is a good asset in terms of a family balance sheet.
Also, these old whole life contracts have outperformed the S&P 500 over the last ten years. Bonds have now out performed stocks since 1968 according to John Mauldin. For an intelligent discussion of stock vs bond returns see: http://www.safehaven.com/article-12949.htm If one assumes a 4% risk premium for equities over bonds going forward, it is hard to make a case for whole life. At this point, I’d say it is pretty hard to make the case that equities can deliver that kind of premium and an aging culture such as is ours.
I hate to sound mean, but reading through these posts sound a lot like listening my fourteen year old son when he gets together with his friends and they talk authoritatively about things they don’t really know very much about.
My advise, talk to an agent from a mutual life insurance company and fully disclose your situation and let him come up with a plan. It will contain whole life. It might be a crummy plan, but I suggest you look at his work with an open mind and look how the contracts have performed historically. Use your head, ask lots of questions and look at the merits. But if you do buy cash value insurance, be sure to buy whole life and only from a mutual company. You will also need to buy some term insurance in order to afford the total amount of coverage you need.
Sorry for the long post.
November 13th, 2009 at 7:48 am
You’ve made a good case, Robert. I’m really sorry to say this but people in our profession have brought us the bad name. Hence, the stereotype that insurance agents will always misguide you for their interests. Nowadays, however, I’m hoping that the feeling has changed a bit since online quotes are being offered. When consumers compare the rates and different options, they feel more comformtable discussing them with the insurance agents. Probably because in the process of getting a quote they have done their homework. It leaves less room for insurance agents to scam people and consumers have more constructive questions to ask. But there will always be a dearth of insurance agents who are sought after and who have the ability to help their clients make more informed and calculated decisions. That’s why many times it depends on how good your insurance agent is because that’s why they are professionals in the industry by making a living out of helping people meet their needs and theres nothing wrong with that. If one believes that an insurance agent will always sell you something that is of more benefit to him than the consumer, then everything is a scam. Stop watching commercials, listening to radio, and doing business at all. Not everyone likes to sit in the corner behind the desk. interests drive initiatives and a better life.