Here’s a question a lot of people ask and then the next question is what kind of life insurance do I need. Let’s start by outlining the two main types of life insurance by categorizing them as Term Life and Permanent Life Insurance. There are many variations of both types of these policies and even hybrids of both types of these policies. For the purposes of determining how much and what type, we are going to look at the basic Term policy and basic Permanent Policy.
Term Life Insurance is a life insurance policy where you choose a death benefit and then how many years you would like to have that amount of coverage. Those terms can range anywhere from 10 years out to 40 years typically. Term Insurance provides a specific dollar amount of a death benefit for the period of time you select, then at the end of that initial term, you have to make a decision. During your term period, you pay the exact same amount each month or year or what ever interval you chose to pay it. It doesn’t change until the end of the term. At that point the company will allow you to continue to renew, but the premium will be adjusted for your age and it will adjust each year you choose to keep paying it. It typically becomes very costly after your initial term expires. If you do not want to renew it, you can convert it to a whole or permanent life policy up to the dollar amount of coverage you have on the term. If you choose to do this, you will again be paying the amount that is based on your age, plus it’s now a permanent policy which you will have usually to age 95 or longer, as long as you continue to pay the premium. The downside to this is that permanent insurance is more costly dollar for dollar of death benefit than term, but if you convert, you get to keep the same health rating your received when you took out the term policy initially. This could be very beneficial if you have seen your health deteriorate in the later years of your term policy. If you had to take out another policy, you may have to go through another exam and the results may not be to your favor. You also can choose a dollar amount you want to convert. It doesn’t have to be the full amount of the death benefit you had on the term policy. If you had $1 million in death benefit, you can choose to convert just $50,000 or $100,000. Otherwise, if you do not choose to renew the term at the higher rate or convert to a permanent policy, the other option is to just let it lapse.
Permanent Insurance can come any a lot more forms than term insurance. There are whole life policies that accumulate cash value which grows at a fixed rate. Some whole life policies link the cash value to certain stock market indexes that can grow the cash value at a market like return. Other policies are considered Final Expense policies where the cash value doesn’t really grow much but it’s main purpose is to provide funds to coverage burial expenses and other miscellaneous expenses at end of life to help the family pay. Typically, permanent insurance does not have a term, it typically will continue in force until you choose to stop paying the payments or you reach a certain age such as 95 or even up to 120 years of age at which point the policy has been fully funded and the insurance company will write you a check for the balance of your death benefit if you make it to that age. Dollar for Dollar permanent insurance is more costly than Term insurance due to its nature of covering your life for a much longer time period and typically in your later years where the event of you having to use the policy are much greater. Most people like the idea of permanent insurance but don’t like the premium that comes with it. It’s important to understand the key differences between the basic types in order to understand how they can be beneficial to your overall financial plan.
I believe the best uses for each of these types of insurance are to have an adequate amount of term life insurance during your earning years which are usually in your 20’s to your 50’s and supplement your other needs with the permanent policies. Your earning years are when you have a family, you’re trying to accumulate wealth, you have a mortgage, possible student loan debt, consumer debt, and your kids may be going to college. This is the period in your life when you need the most possible coverage you can afford because you don’t want to leave your family with debts they can’t pay or no income to live on, especially if you were the primary bread winner for the family. In order to calculate the amount of term life insurance you need, it’s important to add up all of your current debts which include mortgage, consumer loans, credit cards, student loans, anything you are making a monthly payment on. Next you want to consider your income. If something happened to you today, how much income would your family need to help them survive for the next 20, 30, 40 years, without your income. Let’s say you’re 30 years old and make $75,000 a year. I would want to make sure my spouse could be comfortable for at least 30-40 years. Take $75,000 and multiply that by 30. That’s $2,250,000. Add your mortgage and other debts on top of that number. The other thing you may want to consider is if something happened to you before your kids went to college, would you want to make sure that was paid for also. That could be another few hundred thousand dollars to add in your calculation. When you start calculating everything you would want your life insurance to cover, it’s very easy for that number to get in the millions fairly quickly. Here’s the good news, it’s very affordable for someone in their 20’s and 30’s to get a million dollar plus policy for under $100 a month. You’re typically young and health, so the rates are very much in your favor. Plan sooner rather than later and you will be able to save more on the premiums in the long run.
PRO TIP: If you do your analysis and realize you may need several million dollars in coverage, don’t think you have to do it all at the same time. You can ladder your term polices. Maybe take out a $1million policy for 30 years, then the next year take out another $1million. You can keep doing that for as many years as you need. Don’t feel like you have to cover every single thing day one especially if it would put you in a financial bind.
Permanent insurance I believe should be used more on a use case. There are so many different types of permanent insurance types, you need to focus on what your goal is you are trying to accomplish. One of the goals many people want to accomplish it to make sure their burial and estate settlement is taken care of for their family so they are not burdened with trying to come up with those funds. This is considered a Final Expense policy. You typically choose a smaller death benefit such as $10,000, $20,000, $50,000 etc. This policy does not have much of a cash value, it’s purpose is to cover those final expenses. A lot of people think about taking these policies out sometime in their 50’s and 60’s. You typically have to pay these types of policies the rest of your life and the premium stays the same too. Final expense policies are also fairly easy to qualify for even if you don’t have the best health. Another great use for a permanent policy I believe is to take one out when a child is very young. You can choose a permanent policy with let’s say a $25,000 or $50,000 death benefit amount or more if you want. I would choose a 20 year paid up option so that after 20 years, the policy is paid in full and your kids do not have to pay anything else on the policy for the rest of their life. A lot of people ask why would you buy life insurance on a young child? They don’t think it makes sense. Here’s the rationale. The younger the person, the more affordable the monthly premiums. The main reason is that there is always the possibility that a child can develop some kind of disease or condition after they’re born. Those conditions may result in them never being able to attain life insurance later down the road. What you are doing is guaranteeing them they’re insurable with this type of policy. The 20 year paid up option also keeps them from having the burden of paying when they get older. Insuring a child is not about covering them when they’re young, it’s guaranteeing they will have a policy later in life in case they develop unexpected health conditions that could deny them from having coverage. If you think about, you are also giving them a paid for final expense policy later down the road.
PRO TIP: Paid-up options would be great for Burial polices too. The last thing you want to do is have more monthly payments when you’re in retirement. Get those burial policies funded and paid up so you have less expense in retirement.
There are many other types of permanent policies that you utilize. Some policies have the ability to growth your money tax deferred and provide you with tax free income later in life. Some policies are used to provide wealth transfer to their beneficiaries. When you start looking at those types of policies, you need to work with an advisor that can help you implement the proper plan to accomplish your goals. Those types of policies require much more in depth analysis of your situation and require much more planning than a basic life plan.
Based on what we’ve discussed thus far, it’s apparent that almost everyone in their 20’s – 50’s is in need of some kind of term policy. You have to do some calculations to determine how much you think you may need. I would do this before ever looking at prices. You need to understand how much you want your family to be covered, then you can start shopping the prices. It’s good to have that number in your head before hand, so you don’t let the pricing sway you too much in the wrong direction. At some point in life, everyone will probably need some kind of permanent policy to help with their final expenses. It’s not a question of which one is better, it’s a question of what are your goals and needs. For the most part term and basis whole life can accomplish most needs. As mentioned, if you’re needs and goals start to become more complicated, like providing tax free income, then you need to find a financial planner or advisor that is versed in those types of policies to help you put together a good financial plan with more complex life insurance products.