“Misfortune pursues the sinner, but prosperity is the reward of the righteous. A good man leaves an inheritance for his children’s children, but a sinner’s wealth is stored up for the righteous. A poor man’s field may produce abundant food, but injustice sweeps it away.” (Prov 13:21-23)
From what you’ve read so far about insurance, it is probably obvious that proper planning means insuring your HLV with life insurance. If you have a family, it’s most obvious that your sudden death would be crippling in every way. So we’ll only go a little deeper into that and will instead approach this section differently. First, let’s explain the basic types of life insurance.
With all life insurance, your premiums will be less or benefits will be greater the younger you are and better health you are in. Women also tend to live longer than men, so their life insurance costs a little less.
There are many, many different types of life insurance, but really only two major types – Term and Permanent. However, there are a number of popular policies today that try to straddle the middle ground, so we’ll cover this as well.
1) Term Insurance- The simplest to understand. Term insures your death for a particular amount of money (face amount) over a particular period of time (Term) for a certain premium. A ten year term will cost more than a one year term will cost you today, but it will stay at that flat premium for ten years. Many companies offer 1, 5, 10, 15, 20, and sometimes 30 year terms. It’s important to have a convertible policy with a solid company that you would want to have permanent insurance with.
2) Universal Life- These policies became popular when interest rates were really high because they couple a term insurance policy together with a money market fund. Such policies are more responsive to interest rates than whole life insurance (both positively and negatively). You get the same tax deferred growth of a whole life policy but with much less in the way of guarantees. The biggest problem with these contracts is that the variable factors that can be changed in the future are at the company’s discretion. If the company is having a hard time in the future with policies such as these, they may increase the cost of the insurance within the policy that you pay, thus destroying the growth potential. Also, if you take money out of the policy (which we assume you had in mind when you put it in there), the amount at risk to the insurance company goes up and thus the costs within the policy go up. This again destroys the value of your asset and makes it very different than the illustration which looked so nice when you first bought the policy.
There are two other major subcategories to Universal life insurance, Variable and Indexed. Variable (VUL) policies offer many investment fund options similar to mutual funds. These look amazing when illustrated by a gifted data entry insurance agent, but perform very differently than these illustrations. When I (Wes) was new in the business, I loved these policies (and owned one myself). The more educated I became, the less likely it became that I would ever recommend them to a client. So you will see here the reasons behind this prejudice, although sometimes they are appropriate in certain situations. When I used to recommend them, I had no idea of the gross misinformation I was giving by illustrating these policies at the “long term average” rate of return of the market. We’ll discuss in future sections the difference between actual and average rate of return, but the point is that the growth of the policy is never anywhere close to what is shown on an illustration. Also, what ends up happening is that after a bad year in the market, when your investments are down, the cost of the term insurance coming out takes a much larger portion of your assets. These assets are no longer there to grow when the next “good” year comes along. Finally, do you really want to involve market risk to the life insurance policy that you want to depend on for 50 years?
The other subcategory of universal life is indexed to the major stock markets. The idea here is that when the stock market goes up, you receive the benefit, but when the market shrinks back, your account does not change. The insurance company has a sophisticated hedging strategy that allows them to give these guarantees. Again, these usually sound great. When we first heard about these programs we got excited, but the problem with these types of accounts is that the cost of the hedging leaves little room to capture the upside of the market, so they place either caps on the gains, or only give a certain percentage, or use some other method to limit your gains.
Tomorrow, we’ll explain what whole life insurance is and does.
Photo credit: carnesteacher