May 19, 2008

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:


Anonymous said...

Good post. Really, term life is not just a "short whole life" Basically, for young people it is much cheaper than whole life. Check term life quote Canada, it starts at some $25 monthly for $250000 policy and I don't think US prices differ much. Term life doesn't include investment tool as permanent insurance does and it's more expensive to renew it in higher age. So term is more suitable for young people, trying not to spend much...

Anonymous said...

"Whole life" is a very specific type type of permanent insurance policy, and it also happens to be the most expensive. Other forms of permanent or cash-value life insurance are often incorrectly referred to as "whole life" policies.

If you need permanent insurance (most people don't), there are low-load universal life and guaranteed universal life policies available that function a lot like term but dont end after a set number of years. You can pay the minimum premiums on these policies, so more of your money goes toward the actual cost of insurance and less toward a sub-par investment portfolio or into your agent's pocket. Most consumers are not aware of these options because they are not actively sold by agents (they don't get paid to sell them).

Chief Family Officer said...

@Dylan - Interesting! Thanks for letting me know about that, it's news to me.

Unknown said...

It is my opinion that someone who admittedly is not an expert in insurance should not be giving advice on which types are better than another. Though I drive a car, I do not feel I have enough knowledge to write a blog on why my make and model car is better than another make and model car that I have never owned, researched or even driven.

In conclusion, my only wish is that my 401k was doing as well as the cash value in my whole life policy. What's your term policy earning?


Chief Family Officer said...

@MrsTown2 - I completely agree with your criticism, which is why I put that disclaimer at the beginning. The post is simply intended as a starting point for anyone thinking about life insurance. I don't think your car comparison is really fair in that regard, unless you are saying that only car experts are qualified to write reviews about cars.

Also, your 401(k) could easily be doing better than your whole life policy if you chose the conservative options. The same could be said for mine, too, of course!

Anonymous said...

Whole life/permanent insurance and term life insurance cannot be compared in an oversimplified manner as good or bad, but rather as to the type of coverage needed, budget restraints, and purpose. Most term is good for people who need a lot of coverage for a specific period of time (like renting an apartment). The reason it is so cheap is because based on mortality tables, less than 3% of the people who own term insurance die during the coverage period. Overtime just like the rent on an apt, your premiums(rental costs) are going to go up but your coverage will not increase (as the value of your apt does not increase). Conversely, permanent insurance is like owning a home. The premiums remain fixed (30 year mortgage) and the value of the insurance policy will increase over time (as the value of your home will). Also just like when you pay your mortgage you build equity in your home, a similar occurrence happens in whole life insurance through it's cash value (CV) investment feature. The longer you intend to own something, the more sense it makes to own it rather than rent it. One may not necessarily want to own all of their life insurance as costs are certainly a limiting factor. As for the investment vehicle component of permanent life insurance, it does have many favorable tax incentives legal built into the policy. The CV of whole life is an after tax contribution, that grows tax deferred and can be accessed tax free through policy loans. Death benefits for both term and permanent are both paid out tax free, but one should definitely go with a good, financially sound/highly rated company if they decide to invest in permanent insurance. Permanent life insurance should not be viewed as right or wrong but rather a supplemental piece of the investment pie. It acts similar to a Roth IRA with regards to it's investment component, except it is not restrained by the investment or income level restraints of the Roth. I am maxing out my 401(k), investing in a Roth, a non-qualified mutual fund, and permanent life insurance through Northwestern Mutual. My policy with NML is the only investment I have that increased in value within the last six months. The argument is much more complex than good or bad. Many variables such as income, income-tax bracket, investment horizon, and age, need to be taken into consideration within this argument

Unknown said...

Bravo Anonymous! Well put