Last month, I put out a request on social media for topic suggestions to write about on this blog. The most common request I received, both via email and comments on my request, had to do with life insurance.
And for good reason. Life insurance companies dominate the airwaves with ads, and sponsor sporting events across the country. If you’ve ever been to a networking event or business mixer, odds are you bumped into multiple life insurance sales reps. Insurance is a topic that seems to come up everywhere. And it’s not something that most people were ever taught about in school.
There’s a lot of information out there about life insurance. A good chunk of it, in my opinion, is misleading, at best. The good news is that if you do a little homework, this is a relatively straightforward issue for most people.
Unless you are in the top 1% of earners and are nearing retirement, run like hell if someone tries to sell you a whole or permanent life insurance policy. For millennials, buy term insurance or don’t buy at all.
You Need Life Insurance If…
Let’s keep this simple. If you just graduated college and aren’t married, you probably don’t need life insurance at all.
You need life insurance when you…
- Get married
- Have a child
- Buy a house and take out a mortgage
- Generally, you need life insurance when you have a financial obligation that would still need to be met if you were to pass away unexpectedly
In other words, you need life insurance when there is actually a need for you to, you know, have insurance.
This seems inherently obvious. But, as we’ll get to in a bit, if you sit down to meet with a life insurance salesperson, they’ll likely primarily emphasize the investment benefits of a whole or permament life insurance policy, rather than the insurance itself. I can’t say it enough, my advice to you when that happens: run like hell.
Types of Insurance
One more thing we need to run through before we talk about why I dislike most life insurance products. And that is, the difference between the types of insurance itself.
Term Insurance is insurance that is good for a set length of time, typically from 10 – 30 years. If you pass away before the insurance expires, your family gets the specified amount of the policy. If you pass away after the insurance expires, no benefit is paid out upon your death. Think of it as “renting” life insurance for a set period of time.
In almost all cases, this is the type of insurance I recommend to people who need life insurance. The reasons are numerous:
- It’s much less expensive than other types of insurance policies
- It’s temporary. Life insurance salespeople often argue that the temporary nature of term insurance is a reason not to get it. They couldn’t be more wrong. Very few people need life insurance once they hit retirement. Let’s walk through the reasons I specified as reasons to get insurance above:
- You get married- you need insurance to replace your income if you were to pass away unexpectedly. Once you hit retirement, your income typically goes to zero anyway. So, get a term insurance policy that lasts until retirement, and expires afterward. Typically, there’s no need to pay for insurance beyond that point.
- You have a child- you need insurance to cover the cost of raising your child and to pay for college. So, get a 20-25 year term insurance policy when your child is born to cover that amount.
- You take out a mortgage- you need insurance to make sure the mortgage is taken care of if you were to die. So, get a term insurance policy that matches the life of the mortgage.
- Generally, you need life insurance when you have any sort of financial obligation that would still need to be met if you were to pass away unexpectedly- get a term insurance policy that matches the length of the commitment.
Think of it this way: you get health insurance to make sure that you are adequately protected in the event something bad were to happen to you. Life insurance should work the same way. Quite frankly, if the money is “wasted” in that you never actually have to “use” either your life or health insurance policy, that’s a good thing!
Permanent Insurance, of which Whole Life Insurance is the most common type, does not expire. These types of insurance policies (of which there are numerous variations that work slightly differently) will automatically pay a death benefit when you die, and they do not expire as long as you continue to pay the premiums.
When you hear people refer to “investing” in life insurance, this is the type of policy they are referring to. The premiums you pay are invested by the insurance company, who in turn passes on a portion of the resulting gains to you in the form of a “cash value”. This cash value is an amount of money you can either take out of the policy to pay for [insert financial need here], or kept in the policy and paid out as a life insurance benefit upon your death.
See the problem here? Keep reading…
Why I Hate Permanent/Whole Life Insurance Policies
Let me count the ways…
- They’re expensive. Premiums for whole life policies can be significantly higher than term insurance policies. I’ve seen quotes for whole life insurance be 10x higher than quotes for 30 year term insurance for the same person.
- They’re complicated. Go back and re-read the paragraphs I wrote summarizing permanent insurance policies above. “Cash value”. “Death benefit”. Quite frankly, it was really freaking hard for me to summarize permanent life insurance policies in just a couple paragraphs, and I still ended up using technical terms. Not to mention I didn’t get into any of the details. These policies are incredibly complex, and it can be very easy for salespeople to highlight the alleged benefits of the policies and gloss over the complicated details.
- Life Insurance is an inefficient way to invest: If I were to ask you to come up with a good way for you to invest your money, your answer would probably be a variant of “put my money into the stock market” or “buy a few stocks or bonds”. What you probably wouldn’t come up is the following: “I think it would be a great idea to pay my money to an insurance company, have them invest the money I give them into the stock market, that investment will make money, then the insurance company will take the profits from the investment, keep a portion for themselves (since, after all, they’re in business to make money), and then give me the remaining share”. Your gut is probably telling you that that last sentence is insane. Your gut is right.
- It’s hard to take money out of life insurance: If you were to ever need to access money you have invested in the stock market, almost all of the time you’re able to get your money into your checking account within 24 hours. Money that’s “invested” in a whole life policy is much less liquid- meaning that it’s much harder to take money out of the policy than it would be for other investments.
- “Guaranteed” does not equal “Better”: Whole life insurance generally has a “guaranteed” investment return associated with the cash value of the policy. Very conservative investors tend to highlight this as the primary reason to invest in a life insurance policy. The only issue? These guaranteed returns are usually way below the historical average for investments in the market. Again, investing in life insurance is just a terribly inefficient way to invest.
- Hidden Fees and Commissions: Finally, there are a lot of hidden fees and charges baked into the premiums you pay for whole life insurance. And, they can be huge. Frequently, the life insurance salesperson who tries to sell you whole life insurance gets paid 100% of your premium for the first year you buy the policy, and a good cut of the premium each year thereafter. No wonder these life insurance reps almost always recommend whole life insurance over term insurance! Simply put, life insurance salespeople are paid an astronomical amount to push whole life policies, even when term life insurance may be more appropriate. Just say no.
So, What to Do?
If you need life insurance, find a fee-only insurance agency or financial planner to discuss appropriate coverage amounts. “Fee-only” generally means that the advisor isn’t paid by commission and charges a level fee regardless of what you buy. This helps to put you and the advisor on the same side of the table and removes conflicts of interest, to allow you to get the best advice possible.
An advisor who charges a flat fee is able to analyze your situation and get paid the same amount regardless of what type of policy they recommend.
And whatever you do, look for low-fee, low-cost term insurance first when you are considering life insurance. If you want to invest, invest in the stock and bond market. Use your life insurance for just that- life insurance. Your wallet will thank you!