Insurance Tip #3: The type of policy you buy may be as important as determining the amount of coverage you need
Filed under: Insurance
This post is part of a series where personal finance expert Dan Solin provides 10 insurance tips no one else will tell you. See all 10, plus one bonus tip!
Almost one-third of all Americans have no life insurance. The average amount of life insurance held by those that have it is $146,000 -- far below what would likely be needed.
The focus of the insurance industry has been to persuade people that they need to purchase more life insurance. Unfortunately, the analysis is very complicated, confusing and fact intensive.
Among the various formulas used are multiples of your income, a "capital needs analysis" (which determines the income required to meet the needs of survivors) and a model that projects consumption and savings. The software to compute this model was written by famed economist Laurence Kotlikoff and financial columnist Scott Burns.
The amount of life insurance you should purchase may seem staggering. In your younger years (up to age 30), you may need insurance covering almost thirteen years of income.
An even more critical issue may relate to the kind of policy you buy.
This is significant because term insurance, which provides protection for a specified period of time but builds up no cash value, is relatively inexpensive when you are young. Permanent life insurance, also called cash-value insurance, has much higher premiums because it contains a significant savings element. It is generally designed to last for the life of the insured. It combines a death benefit with a tax-deferred savings element. The policy's cash value can typically be accessed by the policyowner in the form of withdrawals or loans, either of which would reduce the death benefit and may adversely affect policy performance.
If you are uncertain about whether you might need permanent insurance in the future, consider buying a term policy with a conversion feature. During the conversion period, you will be able to convert to a permanent policy without a medical examination.
You should also look into universal life policies. These are cash-value policies that provide additional flexibility to the policyholder. Death benefits and premium levels can be altered as policyholders' circumstances change. The initial premiums on these policies are quite low.
The bottom line is that the primary purpose of life insurance is to insure a continuing quality of life for your survivors when you have not accumulated sufficient assets to do so without life insurance.
Choosing the right kind of policy is critical to meeting that need.
See 10 more insurance tips from Dan.
Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books, 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, 2008).
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Reader Comments (Page 1 of 1)
9-08-2008 @ 4:17AM
Peg said...
One very important element the writer has left out. With the "permanent" policy he speaks of that has "significant savings element" is that if you should pass away with this policy the cash value does NOT go to your family.. it goes to the insurance company!!!!!! THey will only get the death benefit and never see a dime of that so called cash value!! Better to buy term.. and invest the difference.. this way you get both..!!!
After all.. if it YOUR money in that policy.. why do you have to borrow it.. with interest????? Is that what your bank does...??? Or.. if it is cash value.. why cant you just take it out as needed....??? Ask your life rep that!!!!! ALso..it is ILLEGAL to sell the permanent life policy as a savings vehicle.... The author should have mentioned that as well....
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9-08-2008 @ 9:34AM
ray said...
Spoken like a true Primerica agent.
You left out the part about term policies paying off only about 2% of the time.
9-08-2008 @ 3:04PM
Jim said...
Peg, A liitle Life Insurance 101. Term insurance is great until you are too old to convert or it ends. Term insurance, depending on the State, only runs to age 70 or 80. Secondly, permanent insurance has what is called the net amount at risk. This is the amount of the death benefit minus the cash value. You are not entirely correct in stating that the cash value is lost at death. What you are really getting when you die is the net amount at risk plus the cash value, all tax free. That is what really makes up the death benefit. When you are paying for you policy, the insurance costs are only based on the net amount at risk, so they decrease at the cash value increases. You need to take a course instead of simplifying this discussion.
9-08-2008 @ 5:30PM
Walt said...
I am a continuing education provider -- Peg is right. But terminology is important. If the agent originally told the purchaser of the whole life or universal policy that they were buying insurance "and" an investment, then, from the perspective of the client (and their beneficiaries), at their death they lose the investment, which was actually always a part of the death benefit. If the agent told them that they were paying premium in order to have a death benefit "or" a savings plan, then the client (and their beneficiaries) don't feel that they have lost anything. This despite the likely large amount they could have had if they had purchased inexpensive term and actually invested the balance. I know - most won't, but it is a far better plan. Also, needing life insurance into a person's 70's or 80's is a sign of some very poor financial planning. Yes, I know - estate taxes, burial expenses, etc. But those are not the reasons the mass of people in their 30's buy policies. Life insurance is intended to replace the income lost when the insured dies. Period. Any other use is creative marketing, which the industry has been doing for 150 years plus.
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9-09-2008 @ 4:19PM
alan said...
thanks walt, I was with pfs. for 10 yrs part time and still would not trust any whole life company as far as i could throw them.
"trash value " or as the thieves would call "cash value" by met & n,y life own sales literature calls: "cash value is the results of over payment of premiums"
9-09-2008 @ 4:59PM
michele said...
wow, there are a lot of people out there that do not understand insurance and the tax benefits its has. If you could grow a pot of money and have all the cash earn interest on a tax deferred basis would you? Then, if you could take the money out tax free, would you? It sounds like a roth ira, doesn't it? oh, but wait, you can take the money out whenever, instead of only after 59.5? Oh yeah, and if you die prematurely, its self completing and funds your spouses retirement or your kids education. hhmmmm, sounds pretty damn good to me. let alone the fact that after a period of time all you money you spent on term insurance just got kept buy the insurance company, because chances are you are not going to die early. you have a better chance becoming disabled. now what are you missing? yes, i am an insurance agent raised by two insurance agents. term is renting life insurance, perm is buying life insurance. my two cents........
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9-10-2008 @ 5:47PM
Craig said...
The only people who still push cash value are the insurance agents who still lie to the consumer. The first two to five years of a trash value police, most cases there is nothing to pull out. I had a cash value policy for 8 years and my "tax free" money totaled $1600 dollars, so in 16 years maybe I would have had $5000 dollars...oh that is tremendous retirement money huh?? While the guaranteed interest rate on that good tax free money was only getting me 4%, which doesn't keep up with inflation, which is at 5%. Sounds like I was losing money...My IRA does a lot better than that and if a person is stupid enough to count on cash value money to live off of today...They need more than life insurance planning. Life insurance is the worst vehicle to save money, you don't save money with your Health or car insurance do you? If you rent insurance with Term, you rent insurance with auto, home, and health insurance as well.guess they keep your money as well if you don't get sick, get into a car accident, or your house is distroyed. Guess what, that is truly what insurance is for, try getting cash values and saving programs from them. It allows you the most coverage for less...today, the average Term policy benifit is well over 300,000...trash value is around 150,000. Which one would is more likely to pay off that house and take care of that family cash value genius??
11-08-2008 @ 4:38PM
kev said...
still what if you need to cover your partners expenses after your death. wouldn't cash value be a better instrument
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