Wednesday, February 27, 2008

Let's talk life insurance

Another one of those topics people do not like to talk about, much like the need for a will . For some reason, we just don't like to think of our own mortality...even though it is guaranteed. Whether from old age, or an accident at a young age, it WILL happen, and we need to prepare for it - especially if we have any family or loved ones. Part of this is some form of life insurance.

There are two basic types of life insurance, term and whole. There are other types, but for the most part, they are similar to whole (also called universal). First we need to define what each is, than we can look at which is best.

Whole is a type of insurance that can build cash value, that you can borrow against (and if you cancel the policy, what you get refunded). It is often promoted as an investment or retirement vehicle, as the amount of money you put into it grows. Sounds good, right? Not so can you be sure you know what the rate of return on them is, and never mind the high commission fees and costs of the "investment". Not to mention, often the commissions paid can eat up the first year or two's premiums (in other words, the money you pay every month for a year or two goes to pay the agent their commission, not in building any value in your policy). They're right when they say it is a retirement account...but whose? Yours or the insurance agent's?

Term is a type of insurance that only pays upon the death of the insured. It is usually set for a distinct period of time (hence the "term"), which can range from a few months to 20-30 years. The premiums are set (the younger and healthier you are when you start, the cheaper it is). You build no cash value to borrow against, but the premium savings are astronomical.

Here is an example I found from Smart Money :

To get a real sense of the value of term, let's compare a term policy and a universal life policy. Say a 40-year-old nonsmoking male has a choice between a $250,000 Met Life universal policy with a $3,000 annual premium and a same amount of renewable term coverage with a 20-year fixed premium of $350. At the end of one year, the universal policy, assuming it paid 5.7% per year, tax-deferred, would have a cash value of exactly zero (cash value is the amount you would get back if you canceled the policy). But say he had instead invested $2,650 (the difference between $3,000 and $350) in a no-load mutual fund that averaged a total return of 10% annually. At the end of the first year, he'd have $2,841, accounting for taxes on the earnings at a 28% rate. At the end of 10 years, he would have accumulated more than $46,000 in after-tax savings in the mutual fund. Over the same period, the cash value of the policy would have climbed only to $31,819.

See that? That right the end. The difference is almost $14,000, in ten years! That number will only get bigger with each passing year, due to our best friend compounding interest! Why would you let someone else get that money that you worked so hard for, by paying high commissions and fees, when that money can work to make YOU more money?

Now what about when the term runs out, then what? Okay, so it runs out...if you planned correctly, and saved and invested, you should be fine. Over the 20, 30 or even 40 years, you have (or should have) been developing a nice retirement account. Life insurance is there to provide a cushion in the early years, mainly your working years. It is there to replace your income, in the event you pass away, and your family needs to continue to be provided for. A good rule of thumb is to get a term amount of ten times you annual salary. Say you make $50,000 a year, get $500,000. If you or your spouse dies, the interest you would receive off the payout would be close to the salary that partner made while alive. While nothing will replace the loss of a loved one, knowing the income level won't change much is one less thing the family needs to worry about. By the time of term ending though, with a properly funded retirement account, an income won't need to be replaced...the retirement funds should already be providing the income, so when one partner dies, the income won't disappear, because the income is no longer dependent on the work of the person who is gone, but it comes from the investments.

So, when considering insurance, first know, you NEED it. Then choose the best vehicle...namely term. Then with the difference you save between term and whole/universal insurance, invest that money, along with your other investment strategies, and prepare for when the term runs out. You'll be able to save more money, and make more money, when it is all said and done.

No comments: