I meant to get this post out on Thursday, when we were all feeling very focused about the work week. Or at least early this morning before you realized that it's now Friday. Because, really, I can't think of a more un-Friday-like topic than life insurance. But it's been a busy week, so here we are planning for death on Friday afternoon. You can leave work early and grab a drink or a tub of ice cream afterward. I promise.
Under the circumstances, let's just straight to the point. If you actually need life insurance, there are two basic categories to think about. About 98% of you will want the first type.
Term Life Is Where It's At
Term Life has been the choice of the masses since insurance salesmen started wearing gabardine suits. It's cheap, and it works. You pay your premiums (monthly or annually), and if you kick off before the term of the insurance contract is out your beneficiary gets the money. The biggest pitfall here is in not doing your shopping. Insurance companies come in various levels of financial stability (it doesn't work if the company dies before you do), and they choose their ratings differently. To get the best deal, find someone who works with an independent broker to shop for you, or look for an online service that does the same.
There is one more catch—you should know how much insurance you actually want and how long you need the policy to last before you choose your policy. That means you should always know what "gap" in your financial plan you are trying cover.
Permanent (Whole) Life For The Other 2%
I have never sold insurance (too lazy to fill out the paperwork), so before writing this post I asked my partner how often he has sold permanent life insurance policies to people over the past 15 years. He figures it's two or three times. You can probably guess the big advantage of permanent policies from the name—you buy the policy and it lasts your entire life so long as you pay the premiums. The insurance company generally builds in a sort of mini-investment account to these policies to help pay for the premiums and to serve as an add-on benefit of the policy. Most insurance sales people put a lot of the focus on that component.
The catch here is that these policies are more expensive—usually a lot more expensive. And there have been cases where the returns from the attached investment account did not cover the premiums. Policy holders that are counting on that automatic premium payment need to be careful that policy does not lapse, undoing all of their investment.
So who should look at permanent life insurance? We see these used most often during estate tax planning, where it's not so much about covering a financial gap as making sure there is a lovely inheritance. So if you are working with an estate attorney, you might discuss it with her. And some people just kind of like the idea of having a policy that lasts their entire lives.
For the vast majority of us, though, the best financial choice is to get term insurance and in just the amount and term needed. You can use the money you saved from those permanent life premiums anyway you want—a strong investment account, a gift for you heirs while you are still around, or just a fund for ice cream purchases. Because no financial plan will stave off mortality, but at least you can enjoy your Fridays while you've got them.
Some Terms To Know
Participating: A “participating” plan pays dividends depending on the company’s returns; these can be used to pay premiums, taken in cash or left in the invested portion of the policy.
Premium payments: premium payments can be “level” (stay the same throughout the policy), “limited” (higher but for a limited period), “single” (just one, large payment), or “adjustable” (the company reserves the right to increase or decrease premium payments).
Variable: In a variable policy, both the value of your investments and the death benefit will vary according to the how well the investments in the account perform. Traditional variable policies will guarantee you a minimum death benefit as long as premiums are paid.
Universal: A universal policy allows you and the company to move money around amongst the premiums due, death benefit amount and investment account depending on investment returns and premium adjustments. Universal life is flexible but risky unless carefully managed—you can find your policy lapsed if not enough of your money is going to premiums.
Surrender Charges: the fee for cancelling your policy and withdrawing your cash balance.
Something about the fall makes people start to wonder about life insurance. I can't explain this phenomenon, but I can give you a little primer on how life insurance works...and doesn't work. Let's start with this, though—a lot of people do not need life insurance. Are you one of them?
First, check to see if you fall into one of these categories:
1. You Are Someone's Financial Support.
The real purpose of life insurance is to fill in for the financial support that one person is providing for others if the provider dies. If someone (your children, your partner, your parents, etc...) is counting on you to provide for them, life insurance probably makes sense. How much the policy is worth and how long you want that coverage for will depend on the costs you are trying to cover.
2. You are a business owner.
Insurance companies provide "key person" life insurance policies to help cover the costs to the business of losing a key employee or owner. Those costs can range from hiring someone to fill the "key person's" place to paying off their family as shareholders, to paying the costs to shut down the business. Notice that unlike the category above, the beneficiary of this policy isn't a person—it's the business, itself. Sole proprietors are generally fine to use a standard personal life insurance policy, instead.
3. You are working with an attorney to avoid estate tax problems.
Trust & Estates attorneys often make use of insurance policies to move wealth to an heir while keeping down taxes. In most cases, this becomes an issue if your estate is worth more than your state and federal estate tax exemptions (an impressive $5.43 million for 2015 for the feds but $1,000,000 for my state of Massachusetts). But imagine you own a large family property or family business, both of which could easily top exemption amounts. Your attorney might talk to you about an insurance policy that allows your family to pay the estate taxes without selling up. As you might have guessed by now, if you are buying insurance for tax purposes start by talking with your attorney, rather than your insurance agent.
Don't fall into one of these three categories? Then you probably don't need life insurance. And that's good news, as it means you can start putting the money you might have spent on premiums into something you can enjoy while you are still kicking around. If, on the other hand, you do think you need life insurance, stay tuned for my upcoming post on understanding the kinds of life insurance out there and how they work.