The following is a guest post by Neal Frankle, CFP. He is also the owner of Wealth Pilgrim. He recently published an in depth Prosper review.
I believe in life insurance. Without it, I never would have been able to go to college. I might have even ended up homeless. And I’ve seen what happens to survivors when the family provider dies without having the right amount of life insurance. Yes, life insurance is really important. But that doesn’t mean that all life insurance policies are created equally.
Remember, life insurance is a great tool to replace your income if you die prematurely. Most of us have that need only for a specific period of time. Once our children grow up, our house gets paid off and our investments are large enough, we probably don’t need any life insurance.
We’ll get to that shortly. First, let’s take a brief look at the various kinds of life insurance and explore their strengths and weaknesses.
Whole Life or Universal Life Insurance
This is called “permanent insurance” because you theoretically own it at some point if you pour enough money into it. The theory is that a portion of the premium you pay goes towards mortality expense and the balance goes into an investment account for you. That investment account builds up. One day (the tale goes) that pot of money will be large enough to earn enough on its own to make those premium payments so you don’t have to pay for it yourself.
On the face of it, whole life and universal life look pretty good but don’t let looks deceive you. These policies have highly inflated costs and commissions. The “savings” portion of your premium gets eaten up by these costs. The policies rarely work out as advertised. The only time permanent insurance works is if you have an estate tax concern or it’s very important for you to leave a sizable amount to someone else no matter when you die.
Guaranteed Issue Insurance
You’ve seen guaranteed issue life insurance advertised by has-been “B” rated actors on late night T.V. They sell you on the illusion that you can get coverage no matter what – even if you are ill. While this is true, there is plenty more these sharpies neglect to tell you about. The most important omission is that the life insurance won’t pay off if you die within some period of time – usually 2 years. If that happens, all you get is your money back. The policies usually offer a very small amount of death benefit and the premiums are high. This is not a good proposition for most people.
Accidental Death Life Insurance
The odds of you dying while bungee jumping or swinging from a tree are pretty remote. Accidental death insurance is extremely cheap and that’s because the carriers know the odds of them having to pay you are very low. This is bad coverage to have because it doesn’t cover you for your real risks – which are death as a result of an illness. Some folks think that by having this coverage they have taken care of their responsibilities but it’s sadly not true. If you die from an illness, you’ll still be dead and your family will still need to be taken care of but this policy won’t pay a dime. Don’t rely on accidental death as your life insurance foundation.
Term life Insurance
For most of us, term life insurance is the best choice. In essence, this is life insurance you rent. You make payments over a set period of years. During that time, your premiums are fixed as is the death benefit. The premiums can’t go up. The death benefit can’t decrease. Once the term is up, the policy goes away. It is far cheaper than permanent insurance and offers a great deal more coverage for the dollar than any other kind of life insurance. I don’t recommend buying the cheapest term life insurance because there is a difference between companies. But for the most part this is the best coverage you can buy.
Who Should Never Buy Any Life Insurance
You should not waste money on life insurance if your death wouldn’t hurt other people financially. In other words, if you have no financial dependents, what do you need life insurance for? You don’t.
Life insurance is a tool. That tool is specifically designed to replace your income if you die unexpectedly. If at any point in your life, nobody relies on your ability to work and make a living, you just don’t need life insurance anymore.