Use Nothing But Term Life Insurance
Whole Life. Universal Life. Variable Life. Variable Universal. Second-to-die Life. Term Life.
There are almost as many ways to insure your life as there are ways to die. But I will make your life insurance decision easy.
There is never a situation where anything other than term life insurance should be used to insure your life. Ever.
But let’s step back and briefly describe what life insurance is available. Life insurance falls into two broad categories - term and whole life. Their names imply their definitions. Term insurance provides a death benefit to your heirs for a certain ‘term’ or period of time. Whole life provides the benefit for your entire life or age 100, whichever comes first.
Each type of insurance has certain characteristics.
Term is cheaper. It can be purchased for various increments of time. In other words, you can get coverage for 5, 10, 15 years or whatever. Premiums remain the same over the entire term. That means that, because of inflation, your premium effectively gets cheaper over the years. At the end of the term, you can typically extend the length of time your covered, but usually at ridiculous rates.
Whole life is more expensive. Over the years, it generates a cash value. In other words, whole life is part life insurance and part savings account. You can cash in your policy at any time (after the first couple of years) and receive the cash value. Of course, this means you lose the insurance benefit.
The big pitch for buying whole life is that over the years, your savings will generate enough earnings to cover your premium. The problem is it takes forever to achieve that. Unfortunately, these policies contain a ton of fees, as well.
Why term is the only way to go.
So if term is cheaper, pays out the same amount to your heirs in the event of your death, and cannot be canceled as long as you pay your premiums, why would you buy whole life? Answer: you shouldn’t. No one should. Only someone who completely lacks the self-discipline to save might benefit from whole life. If that’s you, you have bigger problems than life insurance.
The usual advice is to buy term insurance and invest cost difference between term and whole life. The counter-argument to this advice is ‘most people won’t invest the difference but spend it on current living expenses.’ To which I’d respond - fine. Spend the difference today on things you need. At least you’re not paying exorbitant fees and getting crappy returns. You’re getting some enjoyment out of your money.
What to do
- Evaluate how much life insurance you need (Calculators here, here, and here.)
- Evaluate how long you’ll need coverage (Usually only as long as you have dependents)
- Comparison shop A++ or AAA-rated insurers
- Buy term
- Invest the difference between the cost of term and whole life. Or don’t.
June 4th, 2007 at 11:51 am
Cheers for this article! Term insurance does exactly what you need and is super cheap. No bells or whistles (you always have to pay for bells and whistles!).
You make alot of salient points - this site is a must-read for me.
June 5th, 2007 at 5:10 pm
[…]Advanced Personal Finance says term insurance is the only kind of insurance you need. […]
June 5th, 2007 at 9:07 pm
June 13th, 2007 at 8:18 am
[…] posted in the past about the need to have adequate term life insurance. I also post quite a bit about inflation. The two discussions intersect in an important […]
June 15th, 2007 at 4:22 am
I’m 10 days late in replying to your BEST POST EVER!!!
The ONLY people that will argue with you here are:
1) Those that sell whole life insurance
2) Those that have sold whole life insurance
3) Those that have been sold life insurance and are too deep into it to pull out and admit that they got duped so many years ago.
I did some quick calculations (which anyone could easily do with an investment calculator), and I figured out that if I (a healthy, 30-year-old male) could make 8.8% after tax annual return on my money, I could self-insure the value of any life insurance policy within 20 years by investing the difference in premium between a whole life policy and a 20-year term policy. This difference in premiums WOULD NOT CHANGE with my health or my age (they’d both be more expensive).
So cash-value, schmash value. Here’s what happens if you buy term and invest vs. buying whole life:
Starting at age 30, if I die 1 year later: Term - death benefit 1 year of premium difference. Whole life - death benefit plus probably $10 of cash value.
If I die 5 years in: Term - death benefit 5 years of premium difference (probably around 10% of death benefit). Whole life - death benefit plus not much more.
10 years: Term - death benefit 10 years of of premium difference (probably around 40% of death benefit). Whole life - death benefit plus maybe 5% of death benefit.
20 years and one day: Term - 20 years of premium difference (equal to death benefit). Whole life - death benefit plus maybe 15% of death benefit.
Now, a life insurance salesman would say, “Look, you’ll earn more money with Whole Life if you die at the expiration of your term insurance. Lots of people die at 50. My dad died at 50 and it was the saddest day of my life. My mother needed that money to keep the house. Blah Blah Blah.” Well, the fact is that the insurance companies (and the IRS) and a whole bunch of other people called actuaries have figured out that most people will be around (and will be paying whole-life premiums) until about age 80. Yes, could you die at 50? Sure. Should you bet on that? Heck NO!
Guess how much longer it takes to save that tiny cash value amount after you no longer have to pay any term premiums at all because you are now self insured? Well, let’s just say that by about age 65, you have DOUBLE the amount of your death benefit. If you live to 80, the age all these companies think you’ll die at, you’ll have 4 TIMES the death benefit of that whole-life policy your sucker friends bought back when you were all 30.
So, you can leave your relatives 1-million dollars tax-free via a whole-life policy, or you can leave them 4-million dollars that MIGHT be taxed (if you’re unable to move it to hem other ways or in a tax-sheltered vehicle). Either way, 4 million taxed is WAY better than 1-million tax-free. PLUS, if you’ve raised them right and they’re independent and have their own wealth, you can SPEND all that big pile of loot on fun stuff instead of them waiting for you to die so that they can get paid. Don’t even get me started on the life insurance ploy of “if you leave them money, they’ll have to pay taxes on it and won’t be able to afford it.” That’s a bunch of complete crap.
One more thing about life insurance: Insurance salesmen, term or whole-life, say “if you die, don’t you want your family to be protected?” Well, guess what? If I die, my college-educated wife can get her butt off the couch and get a damn job! There was nothing in our vows that stated that I was going to hand her money as long as I was living and she could just sit at home and mourn me. She stays at home as a mom to little ones now, but once the kids are in school, she’ll probably go back to work. Lots of single parents do just fine in the work force. My family will be sad enough that I’m gone. The last thing they need is a big pot of money to make them fight, buy a bunch of junk, or sit around and be lazy. I’ve provided for them by working and saving. If I die, they can work and save for themselves. Maybe she’ll even remarry some rich dude. All this talk about how much life insurance you need has some VERY antiquated assumptions built in, namely that the wife stays in the home and that finding another mate after the death of your spouse is taboo.
June 25th, 2007 at 10:47 pm
I have done a couple posts on this subject. Rather than re-write it again here can I ask you to read http://www.momentonmoney.com/2007/06/the_great_debat.html ?
Also, what about Universal Life with secondary guarantees? I am posting about that tomorrow.
July 2nd, 2007 at 6:25 pm
Nice click-generating reference, but paying now for “when you die” insurance (which may be as much as 80 years from now for some readers) is silly. If you want your family to have money to pay for stuff when you die, save it for yourself and then give it to them. “If you die” insurance covers you while you self-insure. Funeral costs are small in the big picture and one way to avoid having debts to pay when you die is to pay them off NOW instead of paying all those extra insurance premiums!
I guess there could be some hypothetical example where whole-life is better, but term is better enough of the time to make it the “rule”. “Universal Life with secondary guarantees” is just industry dress-up for the same old junk.
June 30th, 2008 at 11:37 pm
C’mon. People that cry ‘only term’ make the same mistakes as whole life proponents. You’re both wrong.
Term insurance is absolutely right ‘for most of us, most of the time’. But it does not cover off everyone.
Let’s say you have an asset like a business, that’s going to get passed down to your dependents. Let’s say that asset is taxable on your death (not uncommon in many countries, for many assets). How are you going to pay those assets? If the tax bill is large, in some cases the solution is to sell the asset to pay the government - not what was intended.
In that case, permanent insurance fits the bill - because if you live to age 85 your term insurance is long gone. For that need (or any need where there’s a need for money at death, irregardless of age) permanent insurance is definitely the answer.
Term fits well with most people because covering dependents through the mortgage and child rearing years is a ‘temporary’ need so we can dump the insurance when we get older. Fair enough - and that’s what most of us need.
In terms of ‘how much insurance do I need, here’s another calculator that calculates the present value of your income over a period of time:
http://www.insurecan.com/life-insurance-calculator-canada