Buying Life Insurance? What You Don’t Know Might “Hurt” You

If you are considering buying life insurance, how do you know if the agent will show you all the products available so that you can choose the one that will best meet you and your family’s needs and goals? I am a firm believer in “comparison shopping”. The key here is making sure you know what to ask for so that you have the right things to compare. You have to ask the right questions to get the answers and information you need to make an informed choice.
When dealing with the average agent you will most likely be presented with policies that are of a type that is referred to, (in the industry), as “cash value” or “permanent” insurance. These products are often called “Whole Life”, “Universal Life”, “Variable Universal Life” or some variation of those names. These are products where, in essence, the insurance company has bundled together a death benefit and some type of account that accumulates a balance of cash, (often called an accumulation account). The way these policies work is part of the monthly amount paid to the insurance company is used to purchase the death benefit, (i.e. pay the premium), pay any required fees, and then remaining amount of the monthly payment is placed in an account where it is supposed to earn interest and grow.
What most people don’t know is that there is another option available that the agent has somehow “neglected” to present. This other option is very rarely offered to the consumer on a regular basis. This is unfortunate. I feel it is a very powerful alternative to the other products available. What is it? It is an option where the customer purchases a term insurance policy and invests the difference of the cost in a stand-alone savings/investment “vehicle”. Here is an illustration*.
First let’s look at one type of insurance plan that is often presented by agents. We’ll call it, “Plan A”
Let’s pretend that Mr & Mrs Smith want to have life insurance, (and yes, they should have it). They are both in their mid thirties and have two children. Their budget is such that they can afford to spend about $150 a month. The first type of insurance under consideration is the “whole life” policy. The Smiths are probably able to get a policy that provides $100,000 death benefit on him, and $75,000 on her. The coverage will last from now until age 100. When the Smiths reach the age of 100, the insurance company promises to pay them $100,000. If they decide they want to “take the money and run” before that, (at age 65, for example), they can terminate the policy, (end the insurance), and take what ever cash has accumulated to that point, (probably about $50,000 to $65,000). Ok, that sounds pretty good, doesn’t it?
Let’s look at the other option. We’ll call it, “Plan B”
With a 30 year, renewable term policy, Mr. Smith can get about $200,000 of coverage, Mrs Smith about $150,000, and they can get $10,000 on each of the kids. Total monthly cost, about $53. Remember, they budgeted $150 per month for this, so what would happen if they took the $97 and put it into some type of savings “vehicle”? Over the course of 30 years, $97 a month could grow to about $300,000 **. This is what is referred to as, “buy term and invest the difference”.
With this type of policy, at age 65, Mr & Mrs Smith would have the choice of continuing their insurance coverage if they felt they needed it, AND they could also take the $300,000 and use it how ever they see fit, (without ending their insurance coverage). Some agents might argue that the premium on the term policy will be higher at re-newal. That may be true, but the $300,000 would also be creating about $2500 in interest income each month**. More than enough money to pay for any modest rise in the premium costs. (Besides, if the Smiths have $300,000 saved up, do they really need to buy that much insurance any more?)
So which would you choose?
(A) Pay $150 per month for $100,000 in coverage and get $100,000 at age 100
-OR-
(B) Pay $53 per month for $200,000 in coverage and set aside $97 per month in savings, and have $300,000 at age 65 **
So why don’t insurance agents present this second option? (I’ll let you answer that one yourself)
There are some other differences between the two plans. For example, what happens if the Smiths need to use some of the money that was accumulated?
If the Smiths had gone with Plan (A), in order to get the money they needed, they would have two choices.
(1) They can terminate the policy and take the entire amount of what has accumulated. They would have their money, but now they don’t have any insurance coverage.
(2) The other choice is to borrow the money they need from the insurance company, using their account as collateral. Their coverage would still be there, but they would have to make payments on the loan, (including interest), in addition to their monthly premium payment. If one of them should die before the loan is paid off, the outstanding loan balance is subtracted from the death benefit. For example, if Mr Smith dies and they still owe $5,000 on the loan, the death benefit paid to his wife would be $95,000. ($100,000 - $5,000). Also the $5000 could become taxable as non-death benefit income.
With Plan (B), the savings account is separate from the insurance policy so the Smiths can take money out of their account, and it would not have any effect on the insurance coverage. The policy does not have to be canceled, and the amount of the death benefit paid is not reduced. Depending on the type of savings “vehicle” the Smiths use, they might have to pay some type of tax or interest penalty on the money they withdraw, but again, there is no effect on the insurance coverage.
As you can see there can be some clear advantages to buying term coverage over a “cash value” type of policy. Which type of policy works best for you is strictly a matter of personal choice, but that is the key word, “CHOICE”. You deserve to be shown ALL of the options available that best meet YOUR needs and not be steered into something just because the agent gets more commission.
* The insurance plan costs and coverages described are hypothetical and for illustrative purposes only. A actual comparison can only occur using actual policy documents issued by an insurer.
** This is an illustration only and is not a representation of a specific investment product or plan.
This above information is provided for educational purposes only and is not an offer or solicitation to conduct any type of business or transaction.
Why go it alone?
A personal financial coach can provide you with valuable insights in your quest for financial security.