Life insurance…blah! There’s no doubt the majority of us benefit from having it, especially when there are people who are counting on us. My interest on the topic of life insurance didn’t happen until after finding out my wife was pregnant. Like many people, so many thoughts started running through my head. “What will happen to my family if I died all of a sudden?” “How will she replace my income if I’m not alive anymore?” These questions kept haunting me for days and weeks. Believe me, I understand this is not an easy topic to discuss. However, this is one of the most important topics that every family needs to talk about.
There are so many factors to consider when signing up for life insurance. Where to get one? Permanent life insurance or term life insurance? How much and for how long? With so many different types of life insurance out there my hope is to give a high level overview and make it presentable here so you can choose what’s right for you and your family. I’m going to discuss the two types of life insurance: term and permanent. At the end of this article I’ll also give you my strategy that can help you save thousands on life insurance while securing your financial future. This way you are well informed from someone who has nothing to gain from whatever type of life insurance product you choose.
Allow me to make two very important points on life insurance: 1) unless you are financially independent with millions and billions of dollars to your name and no debt, YOU ABSOLUTELY NEED LIFE INSURANCE! 2) Never buy a financial product you do not understand! Got it? So let’s get started.
Term Life Insurance
What is term life insurance? Well one definition is, “life insurance that pays a benefit in the event of the death of the insured during a specified term.” Basically life insurance that is effective for a certain amount of years from 1 to 5 to 20 to 30 years. Nowadays you can find some insurance companies that offer term periods as long as 35 years! So if you plan accordingly you can maximize coverage with an affordable 30 or 35 year term insurance policy in your 20s or 30s and when your 45 you can sign up for a 35 year term policy. This is only effective if you can save and invest your money into assets like the stocks, bonds, real estate and maintain good health.
What’s so great about term life insurance? For one it’s the cost. Term life insurance premiums offer the lowest rates of any type of life insurance. You’re typically going to pay a significant amount less than most other life insurance products. Term life insurance products are about 10-20 times less than term permanent life insurance products. I personally like this cost benefit for young people and people who are healthy, because you can get a 15 or 30 year level term policy and build your wealth through real estate, the stock market, CDs, or other means during that time.
If you’re a 30 year old male and in good health you can get a $1,000,000 dollar 30-year term life insurance policy for as low as $60/month. A 50 year old male with good health can get a $500,000, 30-year level term policy for about $125/month. Fortunately for women, the cost of life insurance is usually lower than what men pay.
One of the downsides could be that term life insurance is temporary insurance. However, I look at it as if I have a certain amount of time to save and invest my money so that later my family and I don’t need to worry about life insurance in the untimely event of my death. Remember, financial independence is the ultimate goal. There are different rates and products to work with so do check with a professional and compare each product.
Types of Term Life Insurance
Now there are mainly two types of term life insurance to choose from. Level term life insurance and annual renewable term life insurance. With level term you simply pay a flat fee for the term of the policy. In our previous example of the 30 year old, the cost is $60 every month for 30 years or until you reach a point where you no longer need life insurance. You can walk away from you life insurance plan by simply not making payments anymore.
Annual renewable term provides coverage one year at a time up to a certain age which varies from state to state. For example, in New York the maximum age is 80. One major benefit of annual renewable term is you have the option to renew the policy without having to take a medical exam. This can be a great option for people who are interested in a long term insurance policy. In contrast to level term the premiums for annual renewable term do increase each year and sometimes can be dramatic increases. Make sure to compare the costs for both term products and choose what best fits you.
There is another type of annual renewable term life insurance policy called decreasing term insurance which provides a death benefit that decreases over the life of the policy. The idea is that you can decrease the amount of coverage you need every year and pay lower premiums, however this is not always the case. Of all the research I’ve done I haven’t read anything that would make me promote this option over the first two. You can and should always check with a professional and calculate the opportunity costs. Who knows, you may find that this option works for your situation.
Permanent Life Insurance
I told you there are many different types of life insurance products out there right? In the beginning we discussed various temporary life insurance products. And now we will talk about permanent life insurance. There are three main types of permanent life insurance that we’re going to cover here on a high level.
Whole Life Insurance
First, let’s look at whole life insurance. Whole life insurance is exactly how it reads. Life insurance for your whole life essentially. Whole life insurance policies offer fixed premiums and also have an investment component referred to as the policy’s cash value. This savings aspect of whole life insurance can be attractive depending on the dividends the insurance company is able to pay to you.
Another factor in the whole life insurance product is the ability to take a loan out against the cash value you have built up. As you all know I am not a fan of debt, except mortgage debt. For some people, this may be a plus as you build up the cash value you have an option to borrow against it. You will have to pay it back or else the amount is deducted from your death benefit.
One of the biggest complaints about whole life insurance is that only the death benefit is what your beneficiaries receive, not the cash value. This is an important detail many people who sign up for permanent life insurance products overlook. Make sure that you understand whether or not the permanent life policy you sign up for will distribute your cash value to your designated beneficiaries upon your death.
Universal/Adjustable Life Insurance
The next type of permanent life insurance to review is called universal or adjustable life insurance. This type of policy is a little more flexible than whole life insurance. With a universal policy you can adjust the policy amount pending a medical examination which would also impact your premiums. This is a benefit that gives the policy holder more control over the life of the product as they can adjust the benefit amount as needed. The cash value is set up similarly to the way a whole life insurance policy is so you will want to make sure you understand the details of this product before you sign up.
Typically the investment returns on these cash value policies are very low. Review where your money is being allocated to and analyze the history of the investments within cash value policies. “Past performance is never a guarantee of future results,” but you can study how well a company has handled the ups and downs of an economy and what their returns have been. This way you get a general idea of what to expect and make reasonable comparisons with other life insurance products. Take the time to study the returns of investments within cash value life insurance products.
Variable Life Insurance
The final type of permanent life insurance I’m going to introduce is variable life insurance (VL). Variable life insurance is similar to the first two types of permanent life insurance. The main difference is how the cash value is invested. In a VL, you can invest your cash value in stocks, bonds, money market funds and other assets. Of course you assume all the risk, so it’s really important to review the investment choices that are in a VL policy. Also, it is good to note that the growth of your investments in a VL products grows tax-deferred.
With a VL policy you will want to pay close attention to the fees and premium costs. Typically you’re going to pay higher premiums and incur higher fees for investments within a VL as opposed to investments within a 401k, IRA or even HSA.
Permanent life insurance products can offer estate planning benefits like protecting your assets when you die. With permanent life insurance policies you can work with a professional to ensure your assets avoid as much estate tax as possible. This is really only necessary if your total assets are above the federal estate tax exclusion amount. In 2019, this amount is $11.4 million for the individual and is usually adjusted for inflation. Make sure you fully understand the concept of this benefit so you can be sure you provide the best chance of survival for your family or whomever survives you.
My Strategy For Life Insurance
Now that you have a high level overview of the different types of life insurance available, hopefully you can choose the best product that meets your needs. I will confess that I am one who looks for every opportunity to save and invest with as much control as possible. Generally, for all young people level term or annual renewable term will be your best life insurance option. This is because you have 20, 30+ years to get your finances straight and become self-insured. Meaning you have amassed so much wealth that you won’t need life insurance. Remember, the goal is always financial independence NOT financial dependence. Save, invest and stay away from debt.
Based on the research I’ve done, if you have time you have options. Getting into a high cost life insurance product is simply not maximizing your future earning potential. I’m going to share with you my strategy for maximizing life insurance while securing your financial independence no matter your income or age.
When you analyze a life insurance product take into consideration other factors that play a role in your goal of financial independence. I’ll go over a few of those considerations below. Just know that this strategy is about having many tools in your financial toolbox, not just one.
Understand Estate Tax
Without sounding too morbid, when you die the government taxes your transferable assets above a certain amount. In 2019, estates with a value equal to or less than $11.4 million do not have to pay the federal estate tax. This number is usually changing as it is adjusted for inflation. Any value above this amount is taxed at 40%. Ouch! Also, the life insurance policy amount is also considered to be part of that estate.
There are strategies out there like keeping your assets in irrevocable trusts or an LLC to minimize the tax impact of your estate when you die. I highly encourage you to learn more about estate tax, because as you continue on your path towards financial independence you will need to find optimal ways to protect your assets that you pass on. Personally, I like the idea of setting up an LLC or a trust where I can minimize the impact of taxes and possibly even avoid that impact all together.
Even if your assets never go above the $11.4 million mark or whatever it is, having a trust is always a good bet so that probate is avoided. That’s an expensive process involving lawyers that you can easily avoid with a will and a trust. I’ll discuss more in detail about trusts and transferring assets in a later post. For now, just know that having a will and a living trust are basic, essential tools you can greatly benefit from having.
Investing and Saving
Saving can be fun. Investing can be scary. However, understand whether you invest in a taxable or non-taxable account you need this tool in your financial independent toolbox. The average of all the 40-year periods for the S&P 500 since 1928 has yielded about an 11.8% with dividends reinvested. I am not taking into consideration the average inflation rate of 3% since 1928. So, investing in an S&P 500 index fund for 40 years you can expect returns of about 8-9%. You can do the math yourself, but any 40-year period investment in the S&P 500 has never been negative. The worst 40-year period yielded a compound return of 8.9%.
The strategy for young people with life insurance is to save and invest as much as possible. Get a low-cost annual renewable term life product if you want life insurance until your 60 or 80. Then invest in yourself and your education. Invest in the stock market. Low-cost index funds are the way to go in taxable and nontaxable savings accounts. I personally am a fan of the S&P 500 Index fund and Total Stock Market Index fund. You can’t go wrong with either choice. The fees are extremely low and your money is spread out across hundreds of companies. Both index funds are available at companies like Vanguard, Charles Schwab and Fidelity (in order of my preference). I talk a little about these companies in this article. Don’t be a fool if you’re young. Get term life insurance if you have people who depend on you, starting saving and investing early and stay the course.
Saving and investing in a life insurance product can be dangerous if you’re not careful. If you absolutely want a permanent life insurance product, make sure you understand the fees, charges, pros and cons before you sign up. Simply having money in a high yield savings account earning 1.3-1.5% interest could actually be a better option. In the event of an untimely death, that money gets passed down along with the life insurance policy amount. In my opinion that’s the strategy I would go with if I was insurable in my 60s or 70s and had no savings. I think that’s another blog article right there. Hmmm, “How to plan your financial independence with $0 saved in your 60s.”
How Much Life Insurance?
The amount of life insurance is going to vary from person to person. Remember, my strategy for life insurance is that it’s a temporary placeholder until I build and secure my financial wealth. This means my family and I may have a mortgage, educational expenses for the kids, or in a rare a situation a loan that may exist. Make sure the amount of life insurance in your policy is at least 10 times your income and covers all the liabilities for you and your family. Life insurance for stay-at-home-parents is needed and that amount will vary from family to family. $250,000 to $500,000 should cover most stay-at-homes. You could look into more depending on your family’s current situation.
Another strategy of looking at how much term life insurance to sign up for is by analyzing how much your family needs yearly to survive and multiplying that amount by 25. For example, let’s say you want your family to have $50,000/year to live off using the 4% rule. You would need a life insurance policy for about $1,250,000. A 35-year old male with good health in the state of Georgia would pay $83/mo for a 30-year level term policy. I have a feeling 30 years is enough time for you to make a lot of money with a simple S&P 500 index fund that history shows can yield 8-9% returns over long periods.
Know What You Have
The need for life insurance should slowly decrease as you age and build wealth. As you introduce other assets besides stocks, like CDs, real estate, bonds and other money making tools your reliance for life insurance should ultimately disappear. This is my strategy and I understand there are people out there who may disagree with this philosophy. However, I have done the math and the research to know what is best for me and my family. I am a term life insurance fan, because of the flexibility I have to allocate my money to other assets while maximizing the death benefit amount. I am simply more liquid with my money.
Another piece of advice I’d like to offer. Do not think having life insurance through your employer is enough. You do not know how long your role at your job will remain. You need to have a separate policy outside of work. This way you also ensure yourself in case you get laid off or decide to leave your job unexpectedly. Get a separate policy!
There is no way around not having life insurance when you are providing for others. Whether you choose a term or permanent life insurance product that you qualify for is ultimately your decision. However, you cannot afford to simply sign up for a financial product you do not understand. And your loved ones who depend on you cannot afford for you to not have life insurance. Fellow parents and providers, let us be more responsible to our loved ones. Do this one thing if we haven’t for those we care about. Consider for a moment you are in a car accident and no longer alive to provide and care for your family. What have you left them to survive with?
Best Life Insurance Companies?
This all depends really. Currently, my life insurance policy is with Mass Mutual and I’ve been pleased with their service and rates. If you’re interested in getting life insurance I recommend checking out Haven Life or Health IQ and they will help you get some of the best life insurance quotes online. I received my Mass Mutual policy via Haven Life and so far I’ve been very pleased. Go ahead and shop around so you get the best deal on one of the most important financial decisions you will make.
