Do you need life insurance and are not certain what kind you need? If you have read my blogs in the past you know I, am a firm believer that the term is a much better value for a permanent policy. While I still believe, a term policy is better for most people provided they invest the difference of the two premiums in a low-cost mutual fund or exchange traded fund. But there is a point for some high net worth people where a permanent policy does have its place in someone’s financial plan.
First, let me explain my preferred method of buying life insurance and explain some of the numbers. If you are a non-smoking male age 40 and in good health you can get a $500,000 30-year term policy from a major insurance company for about $152 a month. The same person could get a universal life policy for a monthly premium of $502. That is a difference of $350 a month that could be invested in a low-cost fund that is almost guaranteed to outpace the accumulated cash value of a permanent policy. In the policy, I quoted in the example above the guaranteed interest return on the policy was 2% that does not even outpace inflation that is currently at about 2.2%. That means the value of your cash value is not going to outpace the inflation rate, and you will, in essence, lose money. But if you were to invest the $350 difference in premiums in an indexed fund in something similar to the S&P 500 it would have a pre-inflation return of about 8.5%. That means the adjusted return would be 6.3%, and that invested $350 a month would grow to be $367,000. And if you invested that $4,200 a year in a ROTH IRA that is money that would be tax-free for you or your heirs. And to be honest with you, most people in their 70’s do not need large life insurance policies as their homes are paid for, and there is no income to replace.
As you can see for younger people who are healthy there, is little incentive to purchase a permanent life insurance policy when by using a term policy and a smart investment plan the same objective can be achieved with much more flexibility for the insured. Regardless if you buy a term policy and invest the difference or purchase a permanent policy, it is all pointless if you do not or cannot pay the premiums for the policy for the life of the policy or the insured. Now we will take a brief look at some instances where a permanent policy may make sense depending on the time in which it is maintained.
If the permanent policy is kept, less than five years it is basically a waste of your valuable resources. As many insurance agents will sell a permanent policy as a hybrid of insurance and an investment that is simply not the case. For the first year or two about all of the premiums, go to pay the commission to the agent that sold the policy and will build very little in the way of a cash value. In reality the cash value of a policy less than five years old will be minute in nature as during that period most of the premiums go to pay commissions, fees, and the insurance portion of the policy. So if you cannot pay for the policy for at least five years it is a much better proposition to purchase a term policy from the beginning.
In the sixteenth year of the policy is to the breakeven point. This means that the cash value and the value of the life insurance provided to that point are about equal to what was paid into the policy. This is the earliest you can cancel the policy and not lose the vast majority of what you have paid into the policy. Again, if you do not think you can afford the higher premiums for at least this period, it is better to go with the cheaper term policy.
If you can maintain the policy for twenty years and are wise with the use of any dividends paid by the issuing company, a permanent policy can be advantageous. Dividends will be the subject of a the future blog as they can be somewhat complicated but if you reinvest them they can actually make the death benefit and cash value an attractive vehicle for financial planning. If a permanent policy is held long enough and dividends are reinvested, the cash value portion of the policy can compete with similar risked investments.
Now the term policy would have expired at age 70 and taking out a permanent or another term policy at that age may be prohibitive for most. However, if you had the term policy and invested the difference in premiums, you would have a sizable amount of money at your disposal. And yes it is also true that you would no longer have any life insurance death benefits that will be paid upon the insured’s death. But as I stated earlier a large death benefit might not be needed if you invested wisely, have paid off your house and are not replacing lost income. And in many instances the value of the investments can replace a large portion of the death benefit. A positive of a permanent policy is that they will continue to insure the person anywhere from 100 to 121 years of age provided the premiums are paid on the policy. Depending on at what age a permanent policy is taken out it is apparent that this type of insurance can be extremely expensive depending on the longevity of the insured.
Term policies and permanent policies both have their advantages and disadvantages so it is wise to consult an expert when deciding what is best for you and your family. If you need more information or have any additional questions feel free to contact me.
