NOTE: This post is part of an ongoing education series. This information is for educational purposes only. This information does not constitute investment advice. No rational person would make investment decisions based on a blog post. Please consult with your financial advisor before taking any action. If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.
Today we are going to talk about life insurance. There are many different types and it can get very confusing. One of my basic investing philosophies is KISS (Keep It Simple Silly). If you don’t understand what you are buying – YOU SHOULD NOT BUY IT!
Today I will talk about the difference between Whole and Term life insurance. Term insurance lasts as long as you pay for it. It is like car insurance, if you stop paying the bill, the insurance stops! Term insurance is VERY cheap because your odds of dying are very small, at least while you are young and in good health. However, Term insurance will adjust (and go up) each and every year. When you get over 50-60 it gets quite expensive. You can also get term that keeps the rate same for 10, 20 or even 30 years. You start by paying more – but the payment will stay level.
Whole insurance is a type of permanent insurance. It will last until you die, if you pay the bill! It starts at a much higher rate but, never goes up. Generally, these policies will have an age at which they end, often 100. It is very hard to buy straight whole life. Usually, it is sold as insurance and investment combined. They will give you projected returns which almost never come true. This type of policy also costs much much more per year.
There are many other types of life insurance. I will cover some of them in later posts. With some rare exceptions, I generally think the more complicated an insurance policy it – the worse it is for you. Remember KISS! I also think that insurance is a poor investment. I am a strong proponent of, “buy term and invest the rest.”
I will now go over a specific example of Term vs. Whole life.
Our sample person is a 30 year old male and has his first kid on the way. He is in good health and does not smoke or engage in risky activity. He wants to have life insurance long enough for this child and any others that may show up to make it thru college. He thinks that $1,000,000 should do the trick so he starts to compare the two choices.
The 30 year level pay term insurance will cost as little as $700 per year or less than $60 per month. He will have $1,000,000 of insurance from the age of 30 to 60. After that time more insurance will be quite expensive. The same coverage could be about $5,000 – $6,000 per year.
Whole life will cost this same person about $9,600 per year. You not only have the insurance but you can build cash value. If needed, you can loan yourself money. However, it often takes several years for the cash value to start to build and the extra funds from the first few years pay all of the expenses and you may have a cash value of $0 for several years. After that the money may grow at 2-4% per year. A sales person may show you a projection with 6 or 7% return as an estimate. Your return is determined by the insurance company.
Now some fancy math….
If you buy the Whole life you will have $1,000,000 in life insurance for the rest of your life. If you make it to 100 years old – They give you the $1,000,000. If you want any money out your insurance before then you have to take a loan against your insurance and those you care about may get less than you expected.
If you buy 30 year level pay term and invest the extra $8,900 in the stock market and make an annual return of 10% per year your investment will have a value over $1,000,000 in just 26 years. You won’t need to borrow money – you have money. After 30 years you let the term policy expire. The kids are grown, out of college and you now have $1,600,000 – who needs insurance?
After the 30 years are over you can retire and spend your money or if you don’t need it, let it keep growing. Let’s say you die at the age of 80. What would you prefer to leave to your wife and kids….$1,000,000 or around $10,000,000?