Acquiring life insurance is one of the most important considerations a person can do to protect their loved ones after death. Two of the most popular vehicles are term life insurance and whole life insurance. But which one is best for you? Below we will examine both insurance features and explain why term life insurance will be the better consideration of the two.
Term Life Insurance
When one purchases term life insurance, they are only covered during the contract term. These policies start at 5 years and can go as high as 40! Naturally, the longer the term, the higher the premiums. Term Life insurance offers the lowest premiums compared to other insurance policies. You also have to qualify for term life insurance through a health exam. Depending on the company sponsoring the plan, you may have to submit to some medical tests and provide family medical history in order to qualify. This will also impact the premiums you will have to pay. If you are a very active and healthy individual, your premiums will be lower than someone who does not take care of themselves. Your death benefit is only effective during the term you select. Once the term expires, you will no longer have coverage. You can always renew your term life insurance, but the premiums will increase from your previous contract. Your Financial Advisor can help you to determine the amount of term you should purchase but a standard amount, as discussed by Dave Ramsey & Ramsey Solutions is 10 times your income. This would mean someone earning $100,000 / year would want to purchase a $1,000,000 term life insurance policy. Typically, we recommend you purchase term insurance until the point with which you are self-insured, which your financial plan can help you determine.
Pros
Low Premiums
Guaranteed Death Benefit
Flexibility of Term – 10 Year, 20 Year, 30 Year, 40 year
Better discounts for Healthy Lifestyles
Cons
No Death Benefit after policy is completed
Submission to examinations to qualify
May not qualify
Whole Life Insurance
Whole life insurance is a policy that covers you till death (as long as you make the payments). A portion of your monthly premium pays the actual cost of the insurance and a portion of the monthly premium deposit's money into a savings account. This is known as the cash value of the whole life policy. This will increase the death benefit and provide more to the beneficiaries. “Policy dividends can also be reinvested into the cash value and earn interest” (Investopedia). The interest earned would grow tax-deferred. From this cash value, you are able to also take out loans. Like any loan, there is interest charged and the rates may differ from different issuers. If you have a loan out from this policy, whatever is owed at time of death will be deducted from the death benefit to the beneficiaries. When you pass away, most whole life insurance policies, keep the cash value of the life insurance, therefore passing on years of savings to the insurance company, instead of your family and/or beneficiaries. So you build a savings account, that you were required to borrow from, to actually use (thus you must pay back) and when you pass away, your family doesn’t get to keep it. Wow what a deal - for them!
Monthly Premium Comparison
Through research of a nationally recognized insurance company, I was able to gather cost information. The criteria entered are a male, low 30s, healthy, $1 million death benefit coverage, and looking for a 30 year term (in regards to term life). The cost for a 30-year term life insurance policy is $55 per month. The cost for whole life insurance is $764 per month! So, in a thirty-year span, for term you would invest $19,200 where whole you would spend at least $275,040.
Whole Life Insurance Answer = Lower Death Benefits
In our example above, which again was a quote delivered to us from a large, national well known insurance company, we see the difference between a whole life policy with the same death benefit of a term policy was $709 / month! The $764 monthly whole life insurance premium is equivalent to some family’s mortgage payment. Obviously, the whole life insurance industry is smart enough to know that most people will not be able to afford to allocate $764 / month to their life insurance premiums. That is why we normally see clients that have whole life insurance policies with only $100,000 or less death benefit. Now it makes the premium comparable to a term policy. What’s the problem with this scenario? Client are severely under-insured, which potentially creates catastrophic issues for the family they left behind.
Buy Term & Invest the Rest!
Let’s assume our client did have the cash flow to allocate $764 / month to the life insurance line on his budget. Should he buy the whole life policy with a $1,000,000 death benefit or purchase the $1,000,000 term and invest the rest? Let’s assume he had a rock star SmartVestor Pro, that got him hooked with a 30-year term policy for $55 / month. Then our client invested the $709 per month for the next thirty years. With a 10% return, which we can see from the Prudential Asset Allocation Chart, is what the stock market has averaged over the last thirty years, he would have approx. $1,602,685.
What if we only generated a 7% return? $864,959.44
Then the client no longer has premium payments and if he continues living the money will continue to grow and compound. The Whole Life Policy will most likely require continued premium payments until the cash value can pay the premium payments, which then means if you use the cash value (through a loan because you can’t take it out) the monthly premium will be required to begin again or they’ll start eating away the cash value until it’s all gone, creating a nightmare scenario later in life.
Additionally, this doesn’t account for the fact that our hypothetical male client, should be doing savings through his retirement plan and Roth IRA, while paying down his mortgage and thus by the end of the thirty year period, beyond just the life insurance bucket of money we assumed he built from his whole life insurance savings, he should be a significantly self-insured with his Baby Step 4 bucket.
Favorite Dave Ramsey Video
Dave Ramsey takes a lot of heat from the insurance industry for his common sense approach to life insurance. One of my favorite video's can be seen here of Dave debating a Whole Life Insurance Agent, who decided he would call the show and debate him in front of a national audience. Bad idea for that poor agent .
Conclusion
Life Insurance is exactly that – life insurance. Do not merge savings, investing and life insurance into one product, because as Dave Ramsey says, it’ll just provide a way for the insurance company to pick your pocket, the entire time you do business with them. To learn more about how you can have a life insurance strategy that aligns with Dave Ramsey, Ramsey Solutions and a holistic financial plan, please reach out to one of our SmartVestor Pro’s today.