You Know You Need Life Insurance but Don’t Know What To Buy

*Disclaimer/Disclosure – I am not a licensed agent in all states and I am not providing recommendations or advice as to specific companies or products within the industry.

As we already discussed in No Matter Who You Are, No Matter Where You Live, There Is Only One Universal Guarantee, YOU WILL DIE!, everyone needs life insurance because everyone will eventually die.

*The only caveat to that is if you are wealthy enough to “self insure” for your final expenses and are happy with what you will be leaving to your heirs based on your net worth.* I would argue that even in this position, you would still be wise to utilize strategies involving life insurance to expand on your net worth upon your death and be able to leave even more to your family, friends, and charitable causes. I know there are some financial people out there that don’t believe in any life insurance products other than term insurance and they encourage the concept of “buy term and invest the difference”. It has not be my experience that this is the best way to go and I don’t believe that a “one size fits all” approach such as this is ever appropriate in personal finance.

In the world of life insurance products, there are many companies to choose from and each one will have their own set of products to offer you. At their core the products are based on the same concepts, but each company has the ability to alter or customize their products through adding riders, determining their underwriting requirements and qualifications, setting the rates (cost) for their products, and in naming their products. Prior to offering a product to the consumers, the company must file a request with the Department of Insurance (DOI) and they have to review the request and approve it prior to the product being sold to the public. Every state has their own DOI that reviews and approves products based on state insurance law. As a result, the same company may offer certain products to one state but have to offer something different or nothing at all in other states. This is also why insurance agent’s have to be licensed in each individual state in order to provide advice and products to the consumer.

The purpose of this post isn’t to give you advice or recommendations on certain products or companies because that wouldn’t be possible with all of the various options available and the uniqueness of each state’s insurance laws. The purpose of this post is to explain the basics of life insurance products so that you will have enough understanding to make informed decisions with the guidance of an honest, knowledgeable, licensed agent in your state.

Basics

Life insurance products start out with two basic options, term insurance and cash value insurance. From there companies may decide to offer multiple products under each umbrella so that the consumer has some choices when choosing a policy.

Term Insurance is what it sounds like. It’s life insurance coverage for a set term or amount of time. Common policy lengths are 5, 10, 15, and 20 years but some companies will offer time periods outside that range. Once the policy’s time period expires, the policy ends and there is nothing left. If you die within the policy’s time period your beneficiaries would receive the agreed upon amount of the policy.

What a lot of companies will do is offer a term policy that has an annual renewal clause meaning when your original agreed upon term expires the policy will continue to renew, usually up to a certain age, but each year your rates will increase based on the age you are at the time of the renewal. This can be a good thing for the consumer if they are in poor health or have reached an age where they wouldn’t be able to get a new term policy but still need life insurance. If you are still healthy and below the age threshold you will likely end up paying a lot more than necessary if you don’t cancel prior to the annual renewal periods starting. Either way make sure you know what happens to your policy at the end of the original term.

Companies can offer policy riders, different lengths of time for the term, different amounts of death benefits, varying renewal terms, return of premium options, conversion options, and other extras. As with any purchase you make, make sure you are comparing the cost of policies between multiple companies as “apples to apples”. Just because it’s a term life insurance policy, doesn’t mean it’s the same as another. Ask the questions to find out exactly what you are paying for because if a feature is “included” in the premium (price you pay), the company isn’t just giving it to you for free, it’s built into the cost structure somehow. That doesn’t mean that it won’t still be the best option or the best price, but make sure you know what you are paying for and that you are making an equal comparison between your options.

Cash Value – These policies are often known as whole life policies. In its basic form a whole life policy is designed to cover the consumer (insured) for the length of their life. Most of these policies have a stated age of 121 years old which is well past the average life expectancy at this time. The requirement is that you continue paying the agreed upon premium for the length of the policy or in some cases you can choose a separate set amount of time to make payments like a period of 10 years or 20 years rather than having to make payments until your death or you reach age 121. Personally I wouldn’t want to have to make payments on the policy much into retirement when your on a fixed income so if there’s an option to pay over 10 or 20 years and then you own the policy out right, take it.

The premium on these policies is higher than a term insurance policy because the company is now essentially guaranteed to have to make a payout upon your death because you keep the policy for your whole life. It is also higher because of the cash value feature that is built into these policies.

Cash value comes into play if you choose to surrender the policy prior to your death or age 121. You would receive an amount of money that would be determined based on the specific policy contract you agreed to when you made the purchase. This amount of returned money is considered your cash value. Many companies will allow you to withdraw money from your policy while it is still in force as well. These is considered a loan and can have significant financial implications so you should always speak with your agent and do some research prior to making that decision. Depending on the policy, the cash value may increase your overall death benefit upon your death as well.

Unlike a term insurance policy, if you decide to no longer keep the policy you would “have something to show for it” because of the cash value, but at the end of the day it may not be much more than the difference between what you paid in premium for the whole life policy compared to a term insurance policy. You would have to do that math to make that determination.

There are variations of whole life policies available through many companies today. Those variations include variable life insurance, universal life insurance, variable universal life insurance, indexed universal life insurance, and more. Each variation will have certain features it offers and different ways that the cash value is calculated. Some carry additional risk because the cash value funds are put into the market and returns fluctuate as a result. If you are considering one of these products, make sure you understand how they function and where you money will be at any given time. Also worth noting is that these policies often times have high levels of costs and fees built into them. You likely won’t see them because they are calculated into the premium you pay for the product, but they are there and worth being aware of.

I personally don’t believe that life insurance is a matter of either or when it comes to term or cash value policies. It is a matter of strategy and what your financial goals are that you are using life insurance to reach.

As I stated above, I don’t believe financial advice can be a one size fits all approach and I don’t agree with blanket statements like “buy term and invest the difference”.

As an example, take a couple in their 20’s in good health starting a family or planning to in the near future. They might want to consider taking out a larger death benefit through a term insurance policy with a term length of at least 20 years and maybe even 30 years. The death benefit would need to be enough to pay off their mortgage, other debt, and leave a remaining balance that could be used to purchase a single premium instant annuity that would supply the surviving partner enough monthly income for a period long enough to replace their income while the family adjusts to their new normal following the death. I say 20 to 30 years to ensure that there is a policy in place while there are still minor children in the home. They should also consider purchasing a cash value policy while they are still young and healthy for an amount that would cover their final expenses such as final disposition costs, funeral/memorial services, outstanding debt, and possible medical expenses remaining from end of life care. This couple may want to consider using the conversion option on their term policies when they are within 5 years of expiring and convert some or all of the death benefit into another cash value policy depending on their financial position and health status at that time.

The above mentioned “plan” wouldn’t meet the needs of someone in their 40’s or 50’s who’s kids are either out of the house or close to out of the house and their major liabilities like a mortgage may be much smaller in comparison to the couple in their 20’s. Due to age alone premiums will be higher for the same policy as the couple in their 20’s and there’s a good chance health concerns have happened by that point in life too. All these factors change the needs and goals of the consumer and would require a different plan to help them achieve their desired result. They still need life insurance because again they will still die at some point, but they may need a lot less of it or need different products.

The major takeaway is that purchasing life insurance is best done when the person whose life is being insured is young and healthy because even something is better than nothing in the world of life insurance.

There’s a lot of disagreement on whether or not children need life insurance and a lot of people struggle to have that conversation because they don’t want to think about children dying, but it does happen and it is worth having a conversation. It’s also worth considering ways to insurance children that isn’t as much about getting them life insurance based on the idea that they will die in childhood, as it’s about protecting their insurability for their adult lives. This is a topic for another day and another post.

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