Life Insurance: Part 2

Sandy Botkin
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Previously, I gave a formula that will help you in computing your life insurance need. I noted that young couples with children probably have an insurance need between 2-4 million dollars at that point in their lives, which should decrease over time with increased savings and decreased obligations. This post will deal with what type of insurance should you get.

Essentially, there are two ways to go: Term or permanent insurance. Each has some variations, but I will discuss these two primarily.

Term insurance is where you are paying for the mortality costs based on your life expectancy. The insurance company charges a premium to cover the actuarial chance of dying, plus an extra premium each year for some profit and to cover costs. Unless you get level term for a period of time, it will go up each year. Thus, as you get much older, the term insurance costs become prohibitively high, and most people will drop it if they life a long life.

NOTE: This might not be as bad as it sounds since , if you are smart and have been reading my posts, you should have a substantial savings in retirement plans and other savings and investments to make up for the loss of insurance.

Permanent insurance such as whole life insurance, variable life etc., is a hybrid product that provides lifelong protection, and the ability to accumulate cash value on a tax-deferred basis, which reduces the risk to the insurance company over time. A permanent insurance policy will remain in force for as long as you continue to pay your premiums and unlike term insurance has level premiums as long as there is enough cash value to help offset future higher mortality costs.

So which should you have?

Let me begin that permanent insurance such as whole life insurance and variable life has been given a “bad rap” by many financial writers for some good reasons. Why?

  • First: The initial yearly cost is usually much higher than what you would pay for term insurance.
  • Second: Although you do accumulate cash value, it is used to subsidize the future higher premiums that would be incurred due to increased chances of mortality.
  • Third: The insurance company front loads their costs into the first two years of premiums ,which leaves little cash value in the first two years. You would lose almost all of the premiums paid in during the first two years.
    Sandy’s elaboration: The lapse rate of insurance, even permanent insurance is huge. This is quite a business model for insurance companies. They have their customers paying in a lot of money, but very little gets paid out due to the high lapse rate!
  • Fourth: The commissions on permanent insurance are MUCH higher than that of term; thus, encouraging insurance agents to push permanent insurance over that of term. If you borrow money from the cash value, you pay interest on basically your own money. This happens because the cash in the insurance policy isn’t really yours. It is used to generate enough dividends to prevent the policy from cancelling in future years.

If you fail to pay premiums or the cash value doesn’t have enough to cover future costs, the policy can cancel. Thus, as you can see, there are some good reasons why financial writers have railed against any form of permanent insurance. However despite this, there are some very good reasons to acquire permanent insurance as discussed below.

Now that we know the difference, here is bottom line. If you have a temporary need that will eventually be reduced or even disappear within 20-25 years or so, get term insurance. If, however, you have a permanent need that will last throughout a lifetime, permanent insurance is the way to go.

Thus ., what are some permanent needs that would warrant some form of permanent insurance. Here are some examples:

  • If you have a handicapped child or spendthrift child and need to provide an endowment upon your death that will support them for their lives, this would be a permanent need.
  • If you want to cover a buy sell agreement where you can buy out partners up their death and you expect to keep the business for many years ( at least 25 years), permanent insurance might be warranted.If you expect to sell the company in a period of time less than that, term insurance might be better.
  • If you know you are going to have an estate tax problem in that your taxable estate might exceed the 10.5 million dollar exemption, permanent insurance is the way to provide funding for the estate tax. This has always been a big reason why people buy permanent insurance and might want to keep it beyond the initial reasons for its purchase.
    Note: Donald Trump, however, wants to eliminate the estate tax. However, we will see if that will pass Congress.
  • If you have a business that you expect to keep for most of your life and have some very key employees, permanent insurance might be warranted in order to cover pay for training of a new person. Even then, term might be a better choice.
  • Permanent insurance would also be warranted if you wanted to create an endowment to a college or charity upon your death.
  • You don’t want to pay for long term care insurance, whose premiums have risen exponentially, and would rather combine life insurance with a rider that will cover you if you medically can’t take care of yourself such as not being able to walk or bathe by yourself or are incontinent, or can’t walk etc.
  • To pay for burial costs.

For most other needs, however, term insurance is the better approach. Sadly, because insurance agent commissions on permanent insurance are so much higher than that of term insurance, permanent insurance is usually recommended over that of term insurance and usually results in a big deficiency in insurance coverage.

Bottom line: After all this, the bottom line is simple: If you have a need that will last forever, get permanent insurance. If you have a temporary need that won’t last more than 25 years or so, get term insurance. If you need a certain amount of insurance, but can’t afford permanent insurance despite the long term need, get some permanent insurance with a dividend reinvestment option and the remainder in term insurance.

Tomorrow, I will discuss the differences between Whole Life insurance and Variable or Adjustable Life insurance. Here is a preview: there is a big bomb for many people that bought Variable or Adjustable life insurance.

I will end the series with types of recommended riders that people should have if they get permanent insurance.


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