by David Bach
Buying term insurance is one of the most romantic things you can do. Seriously. I say this in speeches and it gets laughs, but I’m not kidding. Please read this entire section of the book and take action if you need to.
HOW MUCH LIFE INSURANCE SHOULD WE BUY?
What I said about health coverage applies here, too: life insurance is not a place to cut corners. Ideally, you want to purchase enough coverage to enable those you love to live comfortably should something happen to you. But how much is that?
Here’s a list of questions the two of you need to ask yourselves in order to get a ballpark idea of how much life insurance you need.
1. Who relies on our income right now?
The first question you need to ask yourselves is who would get hurt financially in the event one of you were to die. If you have kids, could the surviving partner handle things financially on his or her own? What if both of you died at the same time? Don’t assume that your parents or a sibling could or would shoulder the burden in your place. That’s not fair to anyone. What if you’re in a second marriage and have kids by a first? Could you depend on your ex to pay for your children’s upbringing? If the two of you don’t have children but live in a nice house and generally enjoy the good life, would the surviving partner be able to maintain that lifestyle if one of you passed away? What about college expenses for the kids? The list can be long. You need to think this through past just the first few years of what happens after you die.
2. What does it cost those who depend on you to live for a year?
When you calculate this, make sure you include everything—taxes, mortgage payments, school costs, doctor bills, everything. How many years to you want to protect and provide income for your family if you or your spouse dies prematurely?
3. Are there any major debts that would need to be paid off or unexpected expenses you might incur?
If your spouse owes money (whether in the form of a mortgage, an auto loan, credit-card debt, back taxes, or whatever), you won’t necessarily be let off the hook just because he or she has died. In fact, you could wind up inheriting the debt. Not much fun, which is another reason you may need more insurance than you think. What about funeral expenses, probate costs, and estate taxes? These could run into tens of thousands of dollars, if not more. What if your partner owned a business? Could it continue to run without him or her? Are there business debts that would need to be paid off?
4. Does either of you have a company policy?
Many companies pay for a limited amount of life insurance for their employees. Find out if yours does, and if so, don’t forget to factor in that death benefit when you calculate how much additional coverage you need. You should also find out if your policy at work is known as a “portable policy”—meaning you actually own it and can take it with you if you leave your job. If your company policy is not portable, you could find yourself in a very scary position, with no job and no life insurance coverage. So pull out your company policy and make sure you understand what kind of coverage you’ve got.
FINDING THE RIGHT “BALLPARK”
Now that you’ve gotten an idea of how big a financial “hole” your death might leave, you can calculate how much life insurance you should purchase. My ballpark recommendation is that you take out a policy with a death benefit that totals somewhere between 6 and 20 times your annual spending needs. For instance, if it takes $50,000 a year in spendable income to cover all your obligations, you may want to consider a death benefit of between $300,000 and $1 million.
Which end of that range should you lean toward? It depends on what your current assets are and how much of your debt you feel should be paid off. Needless to say, everyone is different. Some people want to ensure that their dependents will never need to work again, while others feel a 10-year cushion is more than enough.
MAKE SURE YOU INSURE A “STAY-AT-HOME” PARENT
One of the biggest mistakes I see couples make with insurance is not insuring the parent who stays at home raising the kids. If you are married with children, or simply living together with children, don’t make the mistake of insuring just the person who is “working” out of the house. Many men assume incorrectly that if their wife is a “stay-at-home mom,” they are the only ones who need insurance, since they are the ones working. Really? What happens if Mom or a stay-at-home dad dies? Someone is going to need to take care of the kids. That means either hiring a nanny or sending the kids to day care full-time. Either way, this costs money! So be smart and insure both of you.
WHAT TYPE OF LIFE INSURANCE SHOULD YOU BUY?
There are literally hundreds of different kinds of life insurance policies. If you find yourself confused by all the variations, you are not alone. Indeed, when I ask people what type of life insurance they have, most don’t really know. Fortunately, when you break it down, life insurance isn’t really all that complicated.
There are basically two types of life insurance—term insurance, which builds no cash value, and permanent insurance, which does.
TERM INSURANCE
Term insurance is very simple. You pay an insurance company a premium, and in return the insurance company promises to pay your beneficiary a death benefit when you die. Specifically, term insurance provides you with a set amount of protection at a set price for a set period of time. As long as you pay the premium, you’re covered. Stop paying, and your term policy will lapse—meaning, no one will get any death benefit when you die.
The main advantage of term life insurance is that it’s relatively inexpensive. Indeed, term insurance is the most inexpensive type of life insurance around. It’s also relatively easy to get. You can buy it on the Internet these days, where it’s cheaper than ever.
The catch is that this type of policy builds no cash value. You can literally pay premiums into a term policy for 30 years, but if you then decide you no longer want or need it, you walk away with nothing. The point of term insurance is solely to provide your beneficiaries with a death benefit. That’s it. It’s a protection plan, pure and simple…and cheap.
Term insurance comes in two basic flavors—annual renewable term and level term.
Annual Renewable Term With annual renewable term insurance, your death benefit remains the same while your premiums get larger each year. That’s because the older you get, the more likely it is that you will die within any given year. (Cheerful thought, isn’t it?) More than likely, this is the type of policy you have if you work for a company and signed up for life insurance through the benefits department. The biggest advantage of an annual renewable term policy is that it is really inexpensive when you are young. Indeed, it is by far the cheapest way to buy insurance when you are just starting out. The problem is that as you get older (and the likelihood of death increases), the premiums can become prohibitively expensive.
Level Term Under a level term policy, both the death benefit and the premium remain the same for a period of time that you select when you first sign up. The period can range anywhere from 5 to 30 years. While this type of term insurance is initially more expensive than annual renewable term, it can actually turn out to be cheaper over the long run. For this reason, I usually recommend this type of term insurance to clients. If you choose a level term policy, I suggest you take it for a minimum of 15 to 20 years. If you are in your thirties or younger, a 20-year policy would at least protect your family in the years in which they are likely to have the greatest need for your income.
WHO SHOULD CONSIDER TERM INSURANCE?
This is actually an easy choice to make. Unless you are purchasing life insurance as an investment (which in most cases is not what you should be doing), I recommend you buy term insurance—specifically, a level term policy. The most sensible deal is probably to sign up for a 20-year policy.
THE TIME TO SHOP FOR CHEAPER INSURANCE IS NOW!
Over the last 10 years, the cost of buying term insurance has been cut in half. What this means is that if you’ve currently got a policy that is more than five years
old, you should either get on the Internet or call a good insurance agent to see if you can find a better deal.
In most cases, you should be able to save yourself hundreds of dollars a year in premium costs. Alternatively, you can increase the size of your death benefit without having to pay an increased premium. I’ve had many clients actually double the size of their death benefits while continuing to pay the exact same premium.
As with so many other things we’ve discussed so far, this is not difficult to do—but it won’t take care of itself. You need to do it. I remember a few years ago reviewing the finances of a couple in their early forties named Richard and Leslie. For the most part, they were in great shape, saving plenty of money and maxing out their 401(k) plans. But when I looked at their life insurance, I noticed that they were overpaying for the coverage they had. At the time, Richard was carrying a $250,000 policy, and I explained that for the exact same premium he could double the death benefit to $500,000. He and Leslie both nodded in agreement and said they would take care of it.
Unfortunately, this was one chore that never got done. A few years later, I heard some terrible news from Leslie. Richard had suffered a heart attack while they were on vacation and had passed away. Because they had neglected to change their policy, the death benefit Leslie received was half of what it might have been.
Leslie told me later that she and Richard really had intended to update their insurance policies. “We left your office really motivated to act,” she said. “It’s just that we got busy. I didn’t expect Richard to die at 42. It wasn’t planned.”
The sad reality of life is that this sort of thing never is planned. So go check your policies now, and if they’re more than a few years old, get yourself a better deal! Do not, however, cancel your old policy until the new policy is approved, paid for, and in force.
PERMANENT INSURANCE
Permanent life insurance is also known as “cash value” insurance. To put it simply, it’s like taking a term policy and combining it with a forced savings plan that can help you build a nice nest egg. Eventually, you can either dip into these forced savings for income or use them to pay the annual premiums on your policy. If used correctly you can also borrow the money tax-free and use it during your lifetime, or leave a large cash cushion (potentially tax-free) to your beneficiaries. The catch here is that permanent insurance is a commitment and it’s expensive. Indeed, it can cost as much as 5 to 10 times more than term insurance.
There are four main types of permanent life insurance: whole life, universal life, universal index life, and variable universal life. Let’s go over the basics.
Whole Life Imagine paying for term insurance but adding a 50 percent surcharge to the cost of the annual premium and having some of that extra money put in a money-market account, where it can grow tax-deferred into a little nest egg for your old age. That’s what whole life is. It’s a term policy with a little cash-value basket added onto it. The problem is that the money is invested so conservatively that it seldom earns more than 4 or 5 percent a year—which is to say that the policy’s cash value grows too slowly to really amount to anything. At the time of this update, the rates are even lower.
Universal Life After decades of being sold on whole life insurance, people began to wake up and realize that it was not the great retirement vehicle they had been told it was. So the insurance industry came up with a new and improved angle. “Instead of just putting your extra premium money in a money-market account,” the industry told potential customers, “we will invest it more aggressively and pay you a great rate.” Some insurance agents sold these policies on the promise that policyholders could earn as much as 11 percent a year. They would flash fancy illustrations showing that if you earned 11 percent a year, your cash value would be just enormous in 20 years. These illustrations always looked really impressive. The problem was they were just illustrations, not guarantees. Universal life works great when rates are high and the insurance company invests well, but it can be a disaster when the company doesn’t or rates simply go down like they have in the past decade. Many people who bought universal life policies back when rates were in the high teens have been shocked in recent years by annual returns of just 6 percent—and they still have to make premium payments. I intentionally left these numbers from the original book update to show how much things can change in a decade. Today people would be pretty happy with 6 percent. The point here, as I said before, is to focus on the guaranteed return, not the projected return.
Variable Universal Life (VUL) Insurance If you feel strongly about purchasing permanent insurance—which is to say, if you want life insurance that can also double as a retirement vehicle—you might consider a VUL policy or an IUL policy (covered next). With VUL you get a cash-value policy that allows you to control how the savings portion of your premium is invested. A good VUL policy may offer more than a dozen different high-quality mutual funds from which you can select. If you want to be conservative, you can choose a bond fund. If you want to be aggressive, you can choose growth funds. The point is, you are in charge. What makes this especially nice is that, as with a 401(k) plan or an IRA, the cash value of your policy can grow tax-deferred. That is, you can change investments, buying and selling funds as market conditions dictate, without having to pay taxes on any gains. Of course, as with any speculative investment, you can also lose money. There is no guarantee that your cash value will only go up.
Indexed Universal Life (IUL) Insurance This is the biggest change in permanent insurance since this book was originally written. Often referred to as IUL or equity indexed universal life, this type of permanent life insurance takes a “hybrid” approach. Basically, you are able to get a guaranteed rate on your policy (a minimum fixed rate) and then an indexed account option. The best way to explain this in plain language is that you get the security of a universal policy with the potential growth of a variable policy linked to an index (for example, the S&P 500). The catch is that you don’t get the full benefit of the market index (say, the S&P 500 returns), you get a predetermined percentage. Make sure you’re really clear about the index the policy is tied to and the percentage before you sign on the dotted line. Also, ask a lot of questions about how the minimum rate is calculated because it’s complicated and you want to understand this clearly before you invest.
WHO SHOULD CONSIDER INDEXED UNIVERSAL LIFE AND VARIABLE UNIVERSAL LIFE INSURANCE?
While I think that term life insurance makes the most sense for most people, there are certain circumstances under which you might want to consider buying an indexed universal or variable universal life policy. If the following five characteristics apply to you, IUL or VUL may actually be a good idea.
You want to build cash value for retirement.
You have at least 15 to 20 years to invest in the policy.
You earn a high income (at least $100,000 a year).
You are already maxing out contributions to a qualified retirement plan.
You understand the risks associated with mutual funds and the market.
Keep in mind that IUL and VUL are complicated insurance products that are often sold to the wrong people. At the very least, you shouldn’t even consider them if you’re not already fully utilizing a 401(k) plan, deductible IRA, or other tax-deferred retirement account.
The reason insurance agents and some financial advisors are so motivated to sell you a permanent policy (whether in the form of whole life, universal life, or variable life) is that they make a lot of money from this kind of insurance. Which is fine, provided they explain this to you in detail, you understand it, and it’s right for you. In some cases, the sales commission on a permanent insurance policy can be as much as 100 percent of the first year’s premium. With this all said, I personally own a variable universal life policy (I bought it in my twenties); today, If I were doing this again and had to choose a policy, I would definitely select the indexed universal life over the variable universal life (I think it is worth the trade-off of not g
etting all the upside of the index in exchange for the fixed guarantee). I do fundamentally believe in permanent insurance (IUL and VUL) for the right investor. The key words are right investor.
WHERE SHOULD WE START?
If you are going to buy life insurance, the two of you should meet with a life insurance professional—not a salesperson. Ideally, you should find a true financial planner—someone who has been in the business for at least 10 years and really knows what he or she is doing. Make a point of asking friends and getting recommendations. Insurance is complicated, and because of this I recommend getting professional guidance.
However, some people prefer not to buy through an agent or broker. If you’re one of these people, do your research on the Internet. It’s never been easier to buy basic life insurance on the Internet (specifically, term insurance), and it’s never been cheaper. Here are some great sources you can use:
