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  • Going against the grain: When to get a whole life insurance policy

    Let me start this article off by noting that I am by no means an expert on life insurance. What I state here is simply my own opinion, based on what I’ve read and learned over the years. Always do your own research and make your own informed decision based on what is best for you and your family.

    As I mentioned the other day, I’ve been thinking about life insurance since my friend lost her husband. They have two young boys also, so her loss has really got me wanting to make sure we’ve done everything we can to prepare for the unthinkable in case it happens. Because sometimes it does.

    I’ve already discussed how to figure out how much life insurance you need, but I didn’t really talk about the difference between term and whole life insurance.

    Term insurance is very simple to understand. Your policy is for a set term (usually between 10 and 30 years). You pay a monthly or annual premium that’s based on your age, gender, health, and personal and family medical history at the time you obtained the policy.

    Whole life insurance is a little more complicated. The policy isn’t for a set term but rather it’s for the rest of your life. Partly because of that, the premium is considerably higher than the premium for a term policy. But (and here’s where things start to get confusing for me), unlike with term insurance, part of the premium of a whole life insurance policy goes toward an investment component. Generally, the return on the investment portion of a whole life policy is such that it’s not considered a good investment, i.e., you could get a better return on your money elsewhere.

    There are other types of life insurance also – universal and variable – which are similar to whole life in that they also have an investment component (and these are all often grouped together as “whole life”). The differences between these types are related to the investment component, i.e., what types of investments are available.

    So how do you know if you should get term or whole life insurance?

    Generally, you always want to go with term. It’s much more affordable and it’s all most people need.

    But there are times when you need life insurance for your entire life. For example, if you have a disabled dependent who may outlive you but will be unable to support herself, you may want to consider a whole life policy.

    If you think you’ll need some life insurance but not that much when you are older, you can purchase a small whole life policy and get the rest of your coverage as a term policy. The advantage of doing this is that the premium on the whole life policy will be significantly lower than if you wait to get a new policy when your term policies expire. And if you keep your whole life policy for 20 or more years, eventually you will end up with a pretty good cash value in the investment portion of the policy. (Although some experts would recommend that you simply invest the money you would have paid toward the premium instead.)

    If you decide a whole life policy is right for you, you still have other decisions to make. Within whole life policies, there are variables that I don’t quite understand that need to be taken into account. You’ll probably want to talk to an expert to help you decide exactly what kind of policy is best for you.

    If you want to learn more about whole life insurance, check out the following articles:

    How much life insurance do you need?

    The sudden death of my friend J.’s husband a couple of days ago has got me thinking about life insurance again, and specifically, whether my husband I each have enough coverage. As much I hate paying the premiums, thinking about how much worse J.’s situation would be if her husband didn’t have adequate life insurance is making me wonder if we should add a policy.

    But how do you decide how much life insurance is enough?

    I remember struggling with this question after our oldest was born. I knew my husband and I both needed to purchase additional policies (we already had policies that we’d purchased after we bought our house) but I wasn’t sure how much coverage to add. I used various online calculators, but I felt the same way about them as I do about retirement calculators: there are too many uncertain variables.

    For instance, perhaps our biggest expense in the next 15 to 20 years will be paying for a private school education for the boys. (We might still send them to public school, but I have a lot to learn about the exemption system in LAUSD before we make a final decision.) The calculators take college expenses into account, but not private primary and secondary education expenses. That’s not really a problem, since there’s almost always a miscellaneous expense category, or the expense can be added into college expenses. The real problem is that it’s hard to predict how much private school tuition will run 10 years from now. It’s equally difficult to predict how high college expenses will be in 15 to 20 years.

    If I assume that tuition will increase at 6% per year, a top private school will cost nearly $480,000 by the time our oldest graduates from high school. A less expensive but still reputable private school will cost nearly $200,000. If our son were to attend USC, says it will cost $524,000 without aid. Attending UCLA will still cost over $250,000. So we’re talking anywhere from $450,000 to $1 million just for educational expenses for each child. Probably. (I figure if the kids have lost a parent, the least we can do for everyone is eliminate these expenses as a source of stress and worry.) At this point, before our oldest has even started kindergarten, it’s simply impossible to know which number is more realistic. For me, this kind of uncertainty is what makes life insurance calculations so difficult. (Ditto for retirement calculations.)

    Another equally important and yet tenuous area of calculations is living expenses. How do you estimate your living expenses for 10 or 20 years from now? The calculators require you to input your current living expenses, and then use a formula to project expenses. But a family’s expenses change through the years. Right now we pay for daycare and an occasional activity. But in a few years, we’ll probably be paying for private school, sports teams participation and maybe lessons of some sort. I’m expecting our living expenses to rise considerably in approximately three years, when both boys are in school and participating in organized sports/activities, yet it’s hard to predict exactly how much those things will cost. Or what if we decide to move? The mortgage, insurance, taxes and utilities would all change. But all I can do is guesstimate.

    And that’s really what it comes down to – your best guesses.

    In the end, the best way to figure out how much life insurance you need is to come up with a range based on your best guesses. And then try to buy as much life insurance as you can afford.

    One thing to note is that if your children are very young, a typical 20-year term policy may expire before your child’s school years are over. You may want to consider a 25-year policy instead.

    Life insurance, like wills, is one of those topics that’s no fun to think about but absolutely necessary to have. Especially if you have family counting on you. Just think of what life would be like for them if you didn’t have life insurance. That should be all the motivation you need to make sure you get those policies in place . . . before it’s too late.

    Interesting Health Insurance Alternative: Discount Warehouse Plans

    I just learned from Getting Green that Sam’s Club is going to offer a health insurance plan and that Costco already does. So I went to the Costco web site and sure enough, it’s there under “Services” (along with a separate dental plan), though it’s only available to California residents with the Executive level membership. The Executive level is $100 per year, so only $50 more than “regular” (Goldstar) membership, and presumably you’ll more than make that up with just one doctor’s visit if you weren’t insured to begin with.

    I didn’t want to enter my personal information to get a quote for an idea of the rates, but it appears that they keep costs low by accepting healthy people only (there’s a pretty long list of disqualifying conditions, including pregnancy). The length of the disqualifying conditions list gave me the impression that they would be stingy about paying claims – I have no idea if that’s the case, but it would certainly give me pause if I were thinking of signing up for the plan. After all, what’s the point of an insurance plan that doesn’t pay out?

    Nevertheless, if I wasn’t covered under an employer’s plan, I would definitely look into discount warehouse plans as an alternative. Does anyone have any experience with them?

    Gerber Life Insurance: Is it Worth the Money?

    Even before my oldest was born, I’d see those ads for Gerber Life Insurance and think how absurd it was. After all, children don’t need life insurance because no one’s depending on them – especially not term insurance. But I recently received a solicitation for Gerber’s Grow-Up Plan, which is a whole life policy. Since we’d recently increased our own life insurance policies to provide for our new baby, I was intrigued.

    A whole life insurance policy covers you for your entire life, unlike term insurance, which only covers you for a specified period. A whole life policy also builds cash value – the insurance company takes a portion of your premium and invests it. A whole life policy is considerably more expensive than a term policy, which is why most finance experts don’t recommend them.

    The Gerber Grow-Up Plan got my attention because the premiums start low, due to the young age of the insured, and stay the same for the duration of the policy. But when I calculated the cost of a year’s premium on the maximum $35,000 policy for our two-year-old, it came to $305.76 (the monthly premium is $25.48). The policy would increase to $70,000 at age 21 and $350,000 at age 28. $305.76 per year for $350,000 of whole life coverage is a pretty darn good rate. Estimated quotes for a comparable policy from this aggregator are all over $1200 per year. And at least one expert feels that Gerber’s rates are generally competitive.

    However, the bottom line seems to be that the amount you’d pay out over the years to get to a $350K policy for just over $300 per year makes this investment a poor choice. As this Smart Money article points out, $100,000 in today’s dollars isn’t going to have the same value in 30 years. Additionally, whole life policies are generally not a good investment vehicle – in other words, the money paid for the premiums could be invested in other vehicles with a much better return.

    As an example, if I were to buy a $35,000 policy at $305.76 per year for our two-year-old right now, I’ll pay a total of $7949.76 over the next 26 years. Gerber doesn’t say on their website how the cash value will be calculated or what the rate of return is, only that “The plan accumulates cash value and will continue to do so as long as premiums are paid. After 20 years, the cash value is equal to or greater than 100% of premiums paid.” So that’s a cash value of at least $8,000 after 20 years. I’m guessing this is a generous estimate, but I’ll assume the money doubles in the next 6 years and that after 26 years, when our son is 28 and the policy value increases to $350,000, the cash value would be $18,000.

    But if I took the $305.76 and instead of buying the whole life policy, made monthly contributions of $25.48 to a mutual fund with a conservative annual growth rate of 8%, I’d have over $26,000. If the mutual fund grew at the S&P 500’s historical growth rate of 12%, I’d have over $54,000. (And I’d definitely invest the money in an S&P 500 index fund.)

    My conclusion: Gerber’s Grow-Up Plan is not worth the money.

    But don’t forget to take the money you might have spent on a life insurance policy for your child and invest it in a tax-advantaged education account like a Coverdell ESA or 529 plan instead!

    Read the updated 2012 review of the Gerber Grow-Up Plan.