In the context of life insurance marketing, you probably see far more advertisements for term life insurance than whole life insurance.  The reason for this is term life insurance is almost always the better option.  However, like most financial decisions, there are costs and benefits that come with each respective life insurance option. Term life insurance is life insurance that covers you during the life, or term, of the policy.  Terms range in length from 1 to 20 years. Whole life insurance, on the other hand, covers you for your entire life.  In this post, we are going to outline the pros and cons of whole life insurance to help you make a more informed life insurance decision.

Why Whole Life Insurance is a GOOD Idea

Assuming that you are paying your monthly premiums, a whole life insurance policy will cover you for your entire life.  The idea of ceaseless life insurance coverage comforts many customers.  Typically, term life insurance policies won’t cover you after age 65.

Whole life insurance differs from term life insurance in its provision of both a death benefit and a savings account.  A portion of your life insurance payment is set aside in a savings account often meant to serve as retirement account.  Insurance agents refer to this as “forced savings.”  You can withdraw or borrow against the cash value of your savings portion of your insurance policy.  In addition, if you outlive the life of the policy, you can receive cash back, which acts as another security feature to ease consumers minds.

Why Whole Life Insurance is a BAD Idea

It might be difficult to quantify the price you would be willing to pay for ceaseless life insurance.  However, you can guarantee that you will be paying far more for a whole life policy than a term life policy.  The whole life premiums generally cost 5 to 10 times more than the term life premiums.  They are usually paid at a constant cost on an annual basis.  The reason for this higher cost is the savings account aspect of whole life insurance, mentioned above.

Whole life insurance policies appeal to people who want insurance coverage despite their old age.  Once you think about the reason for having insurance, you realize this justification is flawed when applied to most people’s situations.  In case of your unfortunate demise, life insurance is supposed to provide for the people who depend on you.  This sounds fantastic, but as you reach age 65, you will likely realize that your kids are old enough to care for themselves and your loans or liabilities will have already been paid off.

Some insurance agents sell whole life insurance to unsuspecting customers by stressing that a portion of your premium is invested in bonds, money-market products, stocks, and other financial products that collectively serve mainly as a retirement fund.  Again, this might sound fantastic as forced savings takes the savings responsibility out of your hands.  However, maintaining these funds under your life insurance policy typically comes with large commissions and high fees.  If you prefer to invest your money in the best product for retirement, the whole life insurance policy will leave you dissatisfied.  Sure, a whole life policy bundles insurance and retirement together.  Unfortunately, that neat package will cost you dearly in retirement savings.

In summary, for the average interested party, the benefits of whole life insurance lie in its mental comfort (insurance forever!) and its offer of a forced savings account.  However, I do not believe these benefits outweigh the significant additional costs and the lost revenue from investing your retirement account poorly.  Avoid whole life insurance if possible and look to secure your family’s future with term life insurance instead.

When making financial decisions, we like to stress that circumstances matter.  Your wants and needs make one decision good for you and another decision good for me.  This is less true, though, in deciding whether to purchase term or whole life insurance.  Term life insurance is almost always the better option.  First, let’s get an understanding of each type of insurance, and then we’ll look at why term life insurance is usually a smarter choice.

What is whole life insurance?

As the name implies, whole life insurance is a life insurance policy that covers you for your entire life, assuming you are paying the premiums.  The idea that the policy has no end date is appealing to some customers.  Whole life insurance differs from term life insurance because it provides both a death benefit and a savings account.  Insurance agents like to refer to these “forced savings” as a form of retirement savings.  You can withdraw or borrow against this cash value savings account portion of the policy.  In addition, insurers sell this policy by emphasizing that the cash value grows over time.  If you outlive the life of the policy, you can receive cash back.  Since a portion of your premiums are going towards this savings account, whole life premiums typically cost 5 to 10 times more than term life premiums.

What is term life insurance?

Term life insurance is life insurance that covers you during the life, or term, of the policy.  Terms range in length from 1 to 20 years.  There is no forced savings associated with term life insurance.  For this reason, term life policies tend to be less confusing and more convenient for policy holders than whole life policies.  Term life premiums are also significantly cheaper than whole life premiums, particularly if you are under age 50.  You usually pay an annual renewable premium that increases in cost every year.  This differs from whole life policies’ constant cost premiums.

Why is term life insurance better?

Whole life insurance is usually significantly more expensive than term life insurance.  You would assume this means your whole life policy provides a noticeable extra benefit.  One purported benefit is that you can receive life insurance beyond age 65.  Term life policies typically won’t cover you beyond age 65.  On the surface this might seem attractive, but it doesn’t really matter.  The idea of life insurance is it provides for the people who depend on you and won’t be able to care for themselves in the case of your death.  For example, life insurance is designed to help provide for young children if their parents pass away.  By the time your term policy expires—likely around age 65—your kids will be old enough to care for themselves.  In addition, most liabilities, like loans, will be repaid by that age.

So how else do insurers justify the much higher premiums for whole life policies?  They say a portion of your premiums goes towards an investment—it might be bonds, money-market instruments, stocks, etc.  You can borrow against this savings account, or you can use it as a retirement account.  This might seem like a good idea, except these policies typically come with large commissions and high fees.  In addition, there are much better ways to invest for retirement.  So with whole life insurance you are essentially paying a higher premium in order to put money into a bad retirement investment.  You would do better to take the difference in premiums between the term life and whole life policies and invest it in something like a mutual fund.

Is whole life insurance ever a good idea?

To be clear, buying whole life insurance is not always a bad idea as the high premiums are suited for wealthier people.  Whole life policy holders might benefit from using the whole life policy in their estate planning or by setting up an insurance trust to pay estate taxes.  Borrowing or withdrawing from the cash value could be a useful investment strategy as well.  However, in the vast majority of cases, choosing term life instead of whole life insurance is the smart decision.

Life insurance. To buy or not to buy? Although this is most likely a major question in the minds of many, we’re interested in how the insurance companies make money and just where our money is going if we buy a policy. Before we examine that question, however, let’s do a little refresher on life insurance. As we talked about earlier this year, basic life insurance can be broken down into two major categories, term insurance and whole life insurance which can further be divided into four types. Term insurance is insurance for which one makes annual premium payments in exchange for a death benefit. This is the least expensive type and is ideal if you do not believe you will need life insurance in your later years of life. Whole life insurance, also known as permanent or cash value life insurance is the second type of life insurance and can be broken down into whole life, universal life, variable life and variable universal.

In general, cash value life insurance offers protection throughout one’s entire life, and also includes an investment – the cash value. Only a portion of the premium payments on a permanent life insurance policy cover the actual insurance. With the other portion of the premium, the insurance company sets up an investment known as an accumulation account which is invested in interest bearing securities. The cash value reduces the amount at risk to the insurance company and thus, the insurance expense over time. The owner can access the money in the cash value through policy loans or other options which reduce the death benefit. Accordingly, premiums for such policies generally tend to be higher than those associated with term life insurance, at least in the earlier years.

It is on first blush difficult to understand how a life insurance company makes money. If you buy $500,000, 30-year term life insurance policy and pay a $1,000 annual premium and pass away after year 25, the insurance company has collected $25,000 but must pay out $500,000. How do they make this work? Do they find ways to wiggle out of paying claims? Many insurance companies do have a suicide clause for the first two years of the policy, but in almost every other instance, even if the insured was driving drunk and caused his/her own death, the insurance carrier would have to pay out death benefits. It should be noted that if you purchase a life insurance policy late in life (after age 50) you will only receive partial benefits if you pass away within the first two years of the policy period.

Have no fear, the insurance companies have done their math. First, the insurance company goes through a very detailed underwriting process to ensure that the proposed applicant is eligible for the insurance policy and to determine what the appropriate premium would be. Rates charged for life insurance increase with the insurer’s age because, statistically, people are more likely to die as they get older. Some insurance companies, depending on the year, can make money from underwriting income. For example, Insurer “A” collects $10,000,000 in premium for polices issued or renewed in a given year. If Insurer A pays less than $10,000,000 in claims, they have made a profit. If they pay more than $10,000,000 in claims, they suffer a loss. Even with the best underwriting it is still possible for the insurance carrier to pay out death benefits equal to the premiums collected. That is why insurance companies invest the premiums in stocks, bonds and other interest-bearing accounts. From this investment income, an insurance company can pay claims, commissions, administrative costs and finance its operations. During the year, an insurance company collects huge sums of cash and may not have to pay on claims on those policies for many years. In the interim, the money is invested and hopefully earning a sizable return.

When the stock market does poorly, insurance companies take a hit; however, they should have enough income in reserves to cover their claims. If need be, insurance rates may be raised to make up for stock market losses. On the flip side, insurance companies can knowingly charge too little for insurance policies and plan for an underwriting loss if they believe they can make a profit from investing the money they receive before having to pay claims. In the early 2000s, when the stock market was booming, this very practice was taking place.

Additionally, as it pertains to whole life plans, cash values built up through dividends are very enticing to people who don’t manage money well. Therefore, when they glance at their statement and see thousands of dollars just sitting there teasing them, they can’t resist cancelling the policy and buying that big screen TV or new car. Et volia. The liability ends for the insurance company; they keep all the premiums paid, pay out some of the interest and pocket the rest.

Finally, there is another way that insurance companies win as well. It has to do with something called a “lapse.” A lapse is when a policy expires without a death benefit being paid. This can mean the end of the term of a policy or more specifically, when people abandon their policies because they no longer can afford to pay the premiums. The company gets all the premiums and makes no payout. Since the abandonment occurs earlier than the length of the policy, it is a huge statistical win for the insurance company. According to industry experts only 2-3% of term policies actually pay out; the remainder lapse because the insured outlives the term or cannot afford the premiums and the policy is canceled.

As is evident, the insurance companies are doing just fine. The decision is whether life insurance is the right choice for you!

Life insurance rates are relatively straightforward. They typically correlate with age, health, and lifestyle. The older you are, the more you pay. The healthier you are, the less you pay. Smokers pay more than nonsmokers. There are, however, a few fixes you can apply to potentially lower your premiums. Before buying your next policy, give these ideas a shot and see if your quoted rates drop.

First, take a good hard look at your finances and determine exactly how much coverage you need. Consider the expenses your spouse or other dependents will be left with if you were to pass away unexpectedly. If you’re trying to cut costs, there’s no reason to buy more coverage than you need. Apply the same principle to the term length of the coverage you purchase. If your mortgage will be paid off in five years, you may not need the same huge payout for a ten-year term.

Once you have a number in mind, you may find that you can save money by rounding up. Premium rates for certain levels of coverage often drop when you certain thresholds of coverage are met. Paradoxically, a $490,000 policy may cost less than a $500,000. But remember, this is no time to fall victim to an up sale. If you only need $250,000, don’t let an agent talk you into $300,000 for “just a little bit more each month.”

If you have a condition such as diabetes or heart troubles, start your shopping with a friendly insurance company. Many insurers offer competitive rates for persons with such conditions. These companies are able to do so by employing specially trained underwriters who can review each policyholder on a case by case basis. The next step in reducing the premium of your life insurance policy is kicking costly, redundant riders to the curb. Some riders may be warranted. Members of the armed services should make sure that their policy covers death due to war or terrorism, for example. But you’ll find that many riders are just costly measures that cover events with little to no shot at happening, or that they duplicate existing coverage.

As you’re shopping for policies, make sure you check the hidden fees. Americans have grown accustomed to checking credit cards for too-good-to-be-true offers, but insurance policies are another area where seedy sellers can try to gouge consumers. Some insurers charge extra fees if you pay on a monthly basis rather than up front. As with any product, make sure you read the fine print and enter the policy with a full understanding of the terms and costs.

As with any product, you’ll want to shop around for the best bargain. Thankfully, most insurers make policy quotes available online. You can hop on the web and shop for a policy that suits your needs. As you’re shopping, make sure you’re comparing like policies with like terms. While one company might offer a policy with a lower premium for the same coverage, it may have exclusions that make the policy differ in important ways.  Finally, there’s one way you might be able to lower your premiums before you even start shopping: get healthier. Quit smoking, and start exercising. Insurers are known to charge smokers up to double the regular rate and lying to your insurer is a bad idea. If you die of a smoking related illness, and claim to be a non-smoker, it’s very likely that your insurer will opt not to pay your death benefit.

When my wife and I first had children, one of the big questions I asked was a familiar one: How much life insurance do I need? While nobody likes to think of their own demise, it’s prudent to consider what financial ramifications your death could have on those you leave behind. It gives me tremendous peace of mind to know that if I die, my wife will have enough to pay off all our debts and take care of our family. While it’s hard to dispute the sensibility of life insurance in general, many people disagree on how much life insurance you should have. So if you are asking How much life insurance should I buy, here are some things to consider.

1. Rule of Thumb

When it comes to buying life insurance, there are some rules of thumb to help you determine how much you need. While no rule of thumb should be followed blindly, they can represent a good starting point for further analysis. So here are several widely used rules of thumb when it comes to buying life insurance:

• 17 times salary: Take your annual salary and multiply by 17. So if you make $75,000 a year, with this approach, you’d buy $1,275,000 in life insurance. With this amount of life insurance, your beneficiary should be able to replace your income with interest and dividends earned from investing the life insurance proceeds. In effect, the 17 times salary rule of them an income replacement for life model.
• Sliding Scale: Some refine the multiplier based on your age. The younger you are, the higher the multiplier. For example, a 20-something would multiply their annual salary by 20, while somebody nearing retirement would multiple their income by just 5.
• 5 to 10 times salary: If you are not looking to replace your salary for life, many suggestion 5 to 10 times salary. The idea with this rule of thumb is to help your loved ones pay off debt and to have some time to grieve without the added stress of financial worry.

2. What can you afford?

Regardless of how much coverage you need, think you need, or someone says you need, a critical financial consideration is how much life insurance you can afford. Exceeding a balanced budget isn’t in keeping with sound financial planning, no matter the line item. Admittedly, adjusting your spending in other areas to increase the premium you can afford may be prudent. Bottom line: don’t ask your family to live like paupers now so that, in the eventuality of your death, they can live like kings.

Make this your first order of business. This will help you to explore your maximum coverage without being stressed or tempted to buy more than you can afford. Find your maximum monthly payment, and stick to it as you seek quotes.

3. What is your minimum coverage?

None of us would mind making our family comfortable for the rest of their days. But before we tally up a $10,000 payoff for every second cousin, let’s consider the bare minimums needed. Typically, the most important factor people consider is liabilities. Is there a car payment? A home mortgage? A serious desire to provide for your child’s college education? Evaluate what debts and costs your family will have to face without you. Burial costs are another expense to consider.

4. What do you want to accomplish?

The bulk of your baseline coverage amounts should be dictated by your minimum coverage requirements you just tallied, but there are those who do want a considerable amount more than what will meet their family’s financial obligations. Many people evaluate what it would take to enable their grieving spouse to mourn for a year or two before returning to work. Others want to replace their income for life, so that a spouse never has to return to work. Again, this depends almost completely on your individual lifestyle. So give thought to what you’ll want the money to cover over and above paying off your debt.

5. Rules of thumb revisited

As described above, most rules of thumb for life insurance involve multiples of your salary. If you’re looking for minimum coverage, I’d say stick with the tally of your basic liabilities and goals. This will be more realistic and likely more affordable than blindly following a rule of thumb. However, if you ARE looking for your family to continue receiving the equivalent of your monthly paycheck for x number of years, then a multiple of your salary is a good approach to choosing the amount of life insurance to buy.

6. Don’t forget about terms!

I’ve made the assumption that your search for life insurance will likely bring you to the conclusion that term life insurance will meet your needs. To get a sense for the differences in life insurance (term, whole, permanent), check out our article discussing permanent life insurance.

At the same time you’re deciding on how many dollars of coverage you’ll need, you’ll also be faced with the question of how many years you’ll need the coverage. Ultimately, most financial gurus advocate self-insuring during the latter half of your life. Self-insuring simply means that you have enough money and assets to achieve the same financial goals you have identified above.

Summary:

• In the event of calamity, some life insurance is better than none. Don’t put off the decision.
• You can always layer coverage using multiple policies, meaning if you didn’t buy enough coverage the first time, you can get additional coverage through another policy.
• People joke that you want to have enough coverage to make your spouse comfortable, but not enough to make them too comfortable with the idea of living without you. There might be something to that.
• Perks and rewards are obviously secondary to premium amounts and coverage, but different insurers offer different benefits and features. Check to see if you receive any premium back at the end of your term, additional accidental death payouts, and terminal illness payouts.

Permanent life insurance is a form of life insurance that lasts for the entire life of the insured person. It’s distinct from the more typical term life insurance, the sort an individual purchases for a fixed term, typically for one year, five years, or sometimes in terms as long as 30 years. In term life insurance, the consumer pays a premium and the payout is paid in the event that the insured passes away during that term. Permanent life insurance varies from term life insurance in a few key ways.

First, since a permanent life insurance policy lasts for the insured person’s entire life, a payout is guaranteed. Your permanent life insurance premiums are invested, so the policy accrues cash value. Term policies on the other hand, accrue no value and pay nothing unless the insured person passes away during the policy’s fixed term.

Next, premiums for the two forms of policy differ sharply. Buy a permanent policy today, and you’re guaranteed to pay a much higher premium than you would for a term policy. However, the premiums for that term policy tend to rise as the insured person ages. Those extra dollars paid in the early years of a permanent policy get invested and grow. That growth is tax-deferred if the policy is cashed in during the insured persons lifetime. Proceeds are usually tax-free to the beneficiary upon the insured person’s death.

So, which insurance is right for you?

The answer depends on what you need your insurance policy for, and how long you plan to keep it.  If you only need a certain amount of coverage for a short amount of time, then chances are that a term policy will best suit your needs.  For example, let’s say that you are a worker married to a working spouse, any children you have are now financially independent, and that you and your spouse have five years of mortgage payments remaining.  After discussing it, the two of you agree that neither of you would be able to afford your mortgage payments on only one income, should one of you tragically pass away before you’ve finished paying for your home. A short-term policy in the amount of your remaining mortgage debt is probably best for you.

If, on the other hand, there are expenses you will leave behind, then a permanent policy could be the  wiser choice.  These kinds of expenses include debts owed that will survive you, taxes that will be owed against your estate, etc. Should a permanent policy be  right for you, there a few types to consider:

• Traditional Whole Life Policies are the simplest, and offer the most guarantees. The premium is guaranteed, as are certain death benefits and cash values.
• Universal Life Policies have varying premiums (with a guaranteed maximum) and minimum guaranteed cash values and death benefits. Instead of the dividends paid to traditional whole life policyholders, universal policies accrue interest at a credited rate determined each year.
• Variable Life Policies offer the fewest guarantees, and the highest possibility for increasing in cash value.

Don’t feel daunted by the berth of available permanent life insurance policies.  They vary so widely because of the vast needs of consumers. If you’re unsure what type of policy is best for you, speak to an insurance professional. Better yet, speak to multiple insurance professionals.  Do your homework, shop around online for life insurance and make an informed decision.