In an earlier article (“Why Buying Term and Investing the Difference is One Big FAIL!”), I discussed why buying term insurance and investing the difference is generally inferior to simply buying a cash value life insurance product. For the vast majority of people, buying term and spending the difference is the default, meaning that the theory of building greater wealth through a systematic investment program rarely materializes. Further, term policies can get painfully expensive in middle age, resulting in people dropping their policies, or, if they purchased a level term product for a long period, say 10 to 20 years, they may find their health will make them uninsurable or the cost beyond their means when the time comes to replace the expired policy. And they often find that the returns on the investment portion of their portfolio do not come close to equaling the life insurance coverage they need.
The second issue deals with taxes: the “invest the difference” part of the equation will almost invariably have tax consequences: unrealized capital gains and dividends for non-retirement investment accounts will result in a tax bill. What that means is that, as the fund manager buys and sells stocks for the portfolio, the capital gains on those transactions result in a tax liability. Similarly, dividends that are reinvested are also taxable. In both cases, you will be getting IRS Form 1099s in the mail around January of each year, which will show the gains and dividends and must be accounted for at tax time. In both cases, you will have no money in your pocket but you will have more in taxes to pay. This effectively lowers your rate of return.
Whole life insurance products don’t have either tax problem: the dividends grow tax-free and the cash value can be paid out later in life on a tax-free basis. And, of course, the death benefit is not subject to income tax if paid out (although it could be subject to estate tax).
I now continue with others myths concerning life insurance. Probably the biggest one is that young, single people don’t need to buy life insurance. This myth developed and has been promulgated by the popular financial services publications because life insurance is supposed to protect survivors’ ability to remain financially solvent in the event a breadwinner dies prematurely. Therefore, according to this myth, young people, who are typically single, don’t need life insurance.
The fact is, that young, single people will almost invariably get the most preferred premiums: even substantial whole life policies are relatively inexpensive. And because young people are typically in the best health of their lives, they are unwritten at the best rates. As one gets older, the risk of having a rated policy due to health issues increases, which can dramatically increase the cost. In addition the cash value of these policies not have a far larger time horizon to accumulate.
For example, using the projections of a top-rated mutual insurance company, a $500,000 policy at age 21 will have a monthly premium of approximately $320 per month; waiting until age 31, the monthly premium increases to approximately $470 per month, and waiting until age 41 increases the monthly premium to approximately $730 per month, or more than double the premium at age 21.
What is more interesting is the cash accumulation for each example: starting the policy at age 21 provides over $600,000 in cash value at age 65 and over $1,175,000 in death benefit; at age 31 the cash value is a little over $454,000 at age 65 with a death benefit of approximately $931,000, and starting the policy at age 41 provides a little over $322,000 in cash value and a $754,000 death benefit.
Now, keep in mind, the amount of death benefit needed to maintain a lifestyle for a family will typically increase as both responsibilities and income increase. However, the earlier you start the life insurance component of your financial portfolio, the less expensive it will be and the more you will have accumulated for yourself or your heirs later in life. And a guaranteed insurability rider will allow a person to purchase additional coverage at specified times without having to prove insurability.
The next myth is that employer provided life insurance is sufficient to provide the necessary income for a family if the employee dies. Typically, most companies that offer life insurance as a benefit will provide coverage equal to one year’s salary, with the employee given the option to purchase additional coverage up to around five times their salary. These are always term policies, and generally only remain in force only during the time of employment.
Another myth is that only people with dependents need life insurance. People who are married and have no children still should begin a life insurance portfolio. Even if no children are planned, the surviving spouse will need a source of income to maintain a lifestyle and replace what the decedent generated while alive, even if the surviving spouse works. And if children are planned, then getting a life insurance plan in place while a person is young and healthy will make the costs more manageable as family expenses increase. And with the trend toward having children later in life, getting a permanent life insurance policy makes a lot of sense: the policy has grown in value, and the health problems that would preclude underwriting an older age are no longer an issue and the cost of maintaining a policy purchased at a young age is far more affordable.
A big myth perpetuated by the popular press is that life insurance brokers and agents are more interested in selling the product that makes them the most commission, not the one that provides the best coverage for the client. The vast majority of agents and brokers are highly ethical professionals. They are going to provide the best plan for their customers not only because of their ethics, but because it makes good business sense for them. A good agent is looking for a client for life, not a one-time transaction. And he or she is also wants to maintain an impeccable professional reputation: word that an agent is doing the wrong thing just to increase commissions will spread quickly and will destroy his or her reputation very quickly. It also can result in censure or loss of license by the state insurance commission.
This article discusses some of the key myths that agents deal with regularly as they deal with prospective clients. Unfortunately, journalists who lack training in the complexities of insurance, authors trying to sell books, or companies that peddle an “insurance solution” to demonize the rest of the industry and make themselves to be the only ethical players in the business, often perpetuate these myths (if you run into one of these agents, head in the other direction!). Life insurance may seem like a simple product to most people, which make them susceptible to the myths I discussed. In fact, building the right insurance portfolio is often a complex undertaking, that involves decisions about needs, affordability, and long term goals to find the right product mix that provides affordable and needed protection. That means working with a professional in the business who will provide the right solution for each client, not a “one size fits all” solution that likely will not meet the needs of the client.