Straight Talk About Life Insurance
Few financial topics are as difficult to obtain unbiased information about as life insurance. The industry is a profit machine and typically the only people who really know much about the products are those who stand to collect a commission from them. Let’s settle some of those questions with a little straight talk about life insurance.
What is the purpose of life insurance?
It’s often billed as a good investment, but when it comes down to it, life insurance is there to provide for your dependents in case you are no longer alive to do so. If your family could survive without your income, you probably don’t need life insurance. What?!? I’ll say it again: if you have no dependents relying on your income, you do not need life insurance.
But I might someday – isn’t it cheaper to buy it when I’m younger?
Of course life insurance is cheaper when you’re younger. The premium amounts are based on an actuarial calculation that is designed for the insurance company to collect more from you over your lifetime than they’d have to pay out in benefits. Premiums are less when you’re younger because, in theory and in all hopes, you’ll be paying longer.
Waiting until you’re 70 to purchase a policy gives the insurance company less time to cover their risk, which is why it’s so expensive later in life. Don’t buy life insurance if you don’t need it yet just because it’s cheap. Put that money in a long-term savings account instead.
How much do I need and for how long?
The face amount of your life insurance policy should be enough that your dependents could invest it and receive enough income from that investment to cover the expenses that you can no longer cover. Which means it’s a pretty big number. At a 4 percent withdrawal rate, you’d need a $2 million policy to generate about $80,000 worth of annual income.
As for how long, you’ll need it in place until your dependents no longer depend on you financially (or at least until they should be able to provide for themselves, for those with boomerang kids). Which means that you need what’s called a “term” policy that covers you for a set amount of time. Purchasing a 20 or 25-year level-term policy upon the birth of your first child should be enough and the premiums (which will stay the same due to the “level-term” type) should be affordable.
Most insurance salespeople will try to talk you into permanent life insurance, often called “whole life” or “universal life.” These policies never expire (as long as you keep paying the premium) so will pay out no matter when you die. Most of the policies also build cash value, which can be taken advantage of when you no longer need the policy in place.
This type of insurance sounds great: it’s an investment, you have a guaranteed payout, your premiums go toward something instead of vanishing into thin air when your term is up, etc. Here’s the problem: it’s much more expensive. Which means that you’ll probably end up buying less than you need or you’ll eventually find the premiums to be too much. And in the unfortunate case where you might die young, your policy will not be able to serve its true purpose, which is to provide for your dependents when you’re no longer there to do so.
Permanent life insurance is a good idea for the “1 percent.” For the rest of us, a term policy will suffice, freeing up your cash to enjoy while you’re alive, still knowing your family will be financially ok if something happens. Remember the true purpose of life insurance and make sure your family is taken care of.