Making sure you have adequate insurance coverage is important for your family and finances, but which type of life insurance is right for you?
Ok, so insurance may not be the most exciting financial topic but it is certainly an important one. After all, if you spend any amount of time and energy building your career and your wealth, you want to make sure you’re protecting it and the loved ones you support.
While I don’t sell insurance, many of my clients look to me to help advise them on their insurance policies. Making sure you have the right insurances in place and enough insurance to cover your needs and your family’s needs in case there is disruption to your income is one of the smartest financial steps you can take. Building wealth and protecting wealth go hand-in-hand.
So how do you decide between whole life and term insurance? This is a great question with a pretty straight-forward method to assess which type of insurance is right for you.
The Difference Between Term and Whole Life Insurance Policies
Term Life Insurance: Term life insurance is just as it sounds. It is a type of life insurance that guarantees a predetermined death benefit during a specified term, like ten, twenty, or thirty years. The policy expires at the end of the term. Term life insurance tends to cost significantly less than whole life insurance.
Whole Life Insurance: Whole life insurance is still a type of life insurance, but it behaves a little differently than term life insurance. Rather than expiring after a certain amount of time, whole life insurance covers the insured and its beneficiaries for the entire life of the insured. Additionally, whole life insurance also includes an investment component that translates into a cash value to the insured if they ever decide to terminate their policy early.
But it’s rarely as good as they say. For example, it turns out nearly half of all policyholders stop paying the premiums before they die. In other words, you stand a significant chance of paying that higher premium for years and never reaping the benefit!
Which Type of Life Insurance is Right for You?
How Long Do You Need It?
So then the question becomes how long do you need life insurance? Typically, people get life insurance once they are married or have dependents. If anyone else is relying on your income or you so that certain expenses aren’t incurred, it’s time to get life insurance.
As I advise my clients, you should have life insurance coverage until your children no longer require your income and you and your spouse's long-term financial goals are funded.
Term life insurance is perfect for this scenario because it covers your financial interests during your highest income-producing years. Most people hate the idea of their family struggling financially in their absence. For the vast majority of people, term insurance is all you’ll ever need.
People may opt for whole life insurance when they have a child with special needs and know they will always require their income. In these rare situations, if someone will always rely on your income, whole life insurance policies may be worth considering if you can afford the more expensive premiums.
Another reason to consider whole life insurance is if you really want to guarantee your children or heirs will receive a minimum inheritance. I’ve actually never had a client come to me with that desire, but I have heard of it being done!
Finally, whole life is a reasonable option for you if you are very high net worth (in 2018, if you have more than a $22 million married net worth, $11 million if single), will owe estate tax, and do not want your heirs to have to liquidate your estate (as in, sell real estate) to pay the estate tax, which is due relatively quickly after the second death.
What Else Are You Trying to Accomplish with Life Insurance?
Whole life insurance policies claim to double as an investment vehicle. And many people like the idea of the cash value of the policy so that money can be used toward funeral costs or paying down estate taxes. But here’s the thing, the money you could save by paying lower premiums with a term life insurance policy could easily go into other investment vehicles that can accomplish the same things with lower fees and better returns.
Remember, the purpose of life insurance is to provide a benefit at your death. I do get a little antsy when I see high-cost insurance products masquerading as an investment tool. And while it is a tool that can be used for what it describes, is it the best tool?
Using the Right Financial Tools with Life Insurance
Having helped settle many clients’ estates and seen what happens when heirs attempt to unwind complex financial plans, I can say with certainty that insurance should be used as insurance, and investments should be used as investments. When you try to get double duty out of an insurance product by asking it to act as an investment, your expectations will almost never be met.
Instead, consider having a term life insurance policy that meets your needs and then address your savings and investments with separate financial tools. The best places to grow your wealth are no mystery: First, make sure you are maxing out your employer 401(k), especially if they offer matching. If you don’t have access to a 401(k), contribute to a Traditional or Roth IRA instead. Once those are maxed out for your income level, the remainder of your budget for long-term savings should likely be in a brokerage or trust account. These investment vehicles are far more effective at helping you build wealth than a whole life insurance policy.
Ultimately, you want your life insurance policy to cover your wages for the length of time your family would need them. I typically recommend clients purchase about ten years’ worth of their current income and that both spouses insure for the same amount (yes, even if one isn’t working…).
For saving and investing, keep in mind that with proper investment and management, your money can grow with the potential to yield more than your principal contributions. Of course, it really matters what you invest your savings in once those dollars are in investment accounts. For that, remember a professionally constructed diversified portfolio that is appropriate for your risk level and time horizon can help you prepare a financial plan that supports your needs and goals.
When you have a financial plan in place to build wealth and are properly insured to protect that wealth, you have a winning combination. This duo helps you create the life you want to live and ensures that the people you love, whom you might leave behind, are also well-cared for.