In my career, I have known widows who were in their 40s when their husbands died. They had a reasonable amount of life insurance, but they could have had more, or they had been sold a small permanent insurance plan.
An agent gets a much higher commission by selling permanent insurance, types of which include whole life, universal life, and variable life. These certainly are viable types of insurance, but people often purchase permanent insurance when what they really need is a term policy.
Permanent insurance often is sold to young people as a means of building wealth—as an investment as well as income protection. In my career as an advisor, I’ve never had a client come in with an insurance policy that has worked out meaningfully as an investment. Some have built $20,000 to $100,000 of cash surrender value over decades, but they have also not had the amount of insurance they needed to protect their families The only cases where I have seen a permanent policy generate real wealth are when a mutual insurance company converts from ownership by policyholders to ownership by shareholders. The policyholders then receive stock, which can be a significant windfall. However, I would not buy insurance and wait for that to happen.
A term policy, which provides a much higher level of benefits, protects your family for a specific period while you are building your savings. Term insurance is less expensive for two main reasons—in almost all cases the policy term ends long before the insured dies, and it does not build a cash value. It is very inexpensive for nonsmokers who are in good health. Term insurance is a particularly wise strategy for young families in which one spouse does not work or earns significantly less than the
We recommend that our clients obtain term insurance until they build up enough assets to drop it. The term lasts as long as the risk; a lot of clients recognize that when they reach their late 50s and early 60s, they no longer need this coverage.
Successful people often do not realize how underinsured they are. They think they are in good shape if they have a policy that provides coverage for three times their earnings or at most five times. It’s far from enough. This is a particularly acute problem among highly successful business people. The reason they are underinsured is that they started out making $50,000 or $100,000 a year and now and themselves making $300,000 to $500,000 a year, but they have not revisited the insurance issue. In this case, their assets are typically far behind their income because their salary recently jumped.
It can be difficult to grasp how much money it will take to replace your income if you were to pass away. I have often met people in their 40s who are doing well, but if they died, their spouse’s lifestyle would suffer. It is important to get a professional evaluation and not simplistic guidance like “The amount of your life insurance should be seven times your income.” Think carefully about your assets, liabilities, special needs, and how long you will need protection. This analysis is how you determine how much coverage you should purchase.
We help clients project the time required to accumulate adequate assets so insurance will no longer be necessary. As your wealth builds, you can gradually cut back the amount of life insurance.
It is important to take good care of your health—not just so that you will live longer, which is of course the prime benefit, but also because you will save a lot of money on your life insurance. If you smoke, for example, the cost of your insurance will be two to three times higher than for a nonsmoker.
Permanent insurance does have a purpose, so please do not take my criticism of it as meaning that it never makes sense. Permanent insurance is named as such because it is insurance that you have your entire life. It is primarily used today as an estate-planning tool and is very effective as such. As I mentioned earlier, I do not see this as an investment vehicle. The cost of insurance simply makes it a less effective way to invest.
Life insurance policies have exclusions and/or limitations. The costs and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges. In addition, if a policy is surrendered prematurely, there may be surrender charges and income tax implications. Guarantees are based on the claims-paying ability of the insurance company.
For more about when life insurance is a good investment, check out my book, The Power of Persistent Planning: A Review of Successful Financial Planning Strategies, here.
All opinions are those of Douglas Gross and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.