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What You Need to Know Before You Buy Life Insurance
by Paige Estigarribia
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If you're an adult, you've likely been told you need life insurance. A whole host of questions arise when you start to look at all of your life insurance options. To help us sort through some of the information, we reached out to David Carroll of Rockbridge Investment Management in Syracuse, New York. Here's what he had to say:
Q: Is life insurance important for everyone?
Mr. Carroll: That's a great question, and the answer to this question will vary based on who you ask. If you ask a life insurance "agent" or salesperson this question, I am sure their answer would be different than mine.
Insurance of any kind is usually purchased because the insured cannot afford to take the risk the insurance policy is covering or they are not willing/comfortable with taking that risk on their own (self-insuring). With that being said, life insurance is no different. Some investors are in the fortunate situation where they have sufficient financial assets to protect against premature death and may not have a need for life insurance, but that doesn't mean they are willing to take the risk.
To answer your question, no, I do not believe life insurance is important for everyone. We typically find it valuable for younger families where the death of a spouse would result in a significant lifestyle change for their family, which term life insurance can protect against.
Q: What are the different types of life insurance?
Term Life Insurance - Term life insurance, often called "pure insurance," is the most affordable type of life insurance. It can be purchased for 10-, 15-, 20-, or 30-year "terms." For example, if a 30-year-old purchases a 20-year term policy, the policy will terminate when the insured reaches 50 years of age. This is typically the most appropriate life insurance, as it covers a point in your life when you need the most amount of life insurance. It's when your children are young, debt is high(er), and retirement savings balances are relatively low. The need for insurance after 60+ years of age does not really exist for most clients.
Whole Life Insurance - In my experience, whole life insurance is the most oversold type of life insurance currently on the market. There are very rare situations where whole life insurance makes sense. I have seen salespeople sell these products as a better alternative to 401(k) accounts, college savings plans, etc., which is entirely false. Unlike term life insurance, whole life insurance covers the insured's "whole life." In fact, if the policy is still in force when the insured reaches 100 years of age, the insurance company will write the insured a check for the death benefit. Whole life premiums are substantially higher than term life insurance, and salespeople may be inclined to sell a client whole life insurance rather than term life insurance to generate higher commissions. These policies have a "cash value" component of the policy that is often very misleading. For example, if you pay a $100 monthly premium for a policy, $60 may go to the insurance company for the actual cost of the insurance, and $40 may go into a separate forced savings account (cash value). Often times, insurance companies project 7% growth on these cash value accounts, which is entirely unsustainable. There are various components we look at with these policies ("guaranteed" and "non-guaranteed" projected values, dividends, etc.) that are crucial in determining if the product is right for you.
Universal Life Insurance - If you want to purchase permanent insurance, universal life insurance is typically a better investment than whole life ("guaranteed" universal life in particular). Old(er) universal life insurance policies need to be reevaluated; clients often expect these policies to last their entire lifetime, when in fact they end prematurely due to the internal cash value earning lower than anticipated interest rates. Insurance companies solved this problem by issuing guaranteed universal life insurance policies. These policies will stay in force even if interest rates aren't as projected (as long as certain conditions are met). There is a subset of universal life insurance called variable universal life insurance, which is simply "gambling" with your life insurance.
Q: I've heard that whole life can be a type of investment. Is this true?
Mr. Carroll: Yes and no. It can be a type of "investment," but often not nearly as lucrative as the salesperson leads the buyer to believe. As referenced above, this becomes problematic with whole life insurance and even more problematic with universal life insurance policies, so you really have to read between the lines or seek unbiased advice from a fee-only financial planning firm that acts as a fiduciary like Rockbridge Investment Management.
Calculator: How much life insurance do I need?
Q: Do some life insurance products work better for different people? Could you give a few examples?
Mr. Carroll: Absolutely. For example, a 30-year term policy for a family where one spouse receives employment income and the other spouse stays at home is typically a much better decision than a permanent life insurance policy. The term policy will be much more affordable and provide a greater death benefit than the whole life insurance. A life insurance salesperson may suggest that a $100,000 whole life policy is "better" than a $500,000 term policy because the whole life policy will last the buyers whole life. I would challenge that idea and argue that the majority of clients will have no need for a $100,000 life insurance policy late in life. Usually their children are out of the house, most debt is paid off, and they have a good amount of financial assets since they have been saving for the last 30+ years. What they do need, however, is the most amount of life insurance in the period of time they are most vulnerable. This is when their children are young, when they are early in their careers and don't have a lot of financial assets, and when they have a lot of debt (college loans, mortgage, etc.), just to name a few reasons.
Q: What are some things people tend to forget as they begin looking to purchase life insurance?
Mr. Carroll: People often forget that costs absolutely matter when purchasing term life insurance. I strongly suggest shopping for life insurance at term4sale.com as it compares all the insurance companies in your zip code and the prices. (note: The Dollar Stretcher has no relationship with term4sale.com) With term life insurance (unlike many other things in life), you get what you don't pay for. Use term4sale.com as a resource to find the most competitive carriers in your area.
Life insurance is complicated and there is no need to try and figure this out on your own. If you have any questions, do not hesitate to email David Carroll at email@example.com or seek for a fee-only advisor in your area for unbiased advice. For more information on life insurance or visit the RockbridgeInvest site.
Paige Estigarribia is a writer for The Dollar Stretcher who enjoys writing about food, frugal living, and money-saving tips. Visit Paige on Google+.
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