Understanding Life Insurance: Part Two
Last week I talked about life insurance, defined some key industry terms, and gave some tips on how much insurance you should buy, if any. Now we’re going to look at the best types of insurance, as well as how to avoid life insurance gimmick products.
You’ve heard the phrase, “buy term and invest the difference”? Term insurance is pure insurance protection, there are no gimmicks, bells or whistles. The premiums per $1,000 of insurance are the lowest of any form of life insurance, often by 50 percent less than whole life plans. Term insurance is cheap and pays sales people far less in commissions, and therefore is rarely offered unless you insist.
There are no valid financial reasons for buying or keeping whole life or universal life policies at any age. You are always better off buying term insurance and investing the difference yourself. Unless your health is deteriorating and you are no longer insurable, you should drop your whole life or universal life policy and replace it with term, investing the difference in your RRSP, TFSA or non-registered account.
If possible, don’t set up your insurance policy to pay out a lump-sum upon your death. Set up your life insurance plan to have the proceeds invested so that income is generated for many years, rather than subjecting a lump sum to unintended mismanagement or bad financial advice.
Here are a examples of life insurance gimmicks to avoid:
- Never buy whole life insurance as an investment – They say that whole life is a plan where your money goes into a “hole” never to be seen again. Whole life policies typically have level premiums (equal yearly installments) and claim to build tax-deferred cash value. The problem is that the cash value, which is built up by your premium payments, is minuscule compared to what you could create with proper investments.
- Never buy life insurance when you’re young just because it will cost less – The only reason to buy life insurance when you are young is for financial protection for your family, not saving money.
- Never buy life insurance just to avoid the threat of being uninsurable in the future – All insurance is a bet and the odds are overwhelmingly in your favour when it comes to insurability. Future insurability is a scare tactic used by salesmen for the purpose of selling you more insurance at an early age.
- Never buy life insurance just because you recognize the company name – Just because you recognize the name from ad’s on TV doesn’t make the insurance any better. Make your choice based on lowest rates, not name recognition.
- Never buy double indemnity for accidental death – When you buy this option, twice the face amount of the policy will be paid to the beneficiary, but only if the insured dies an accidental death. It is cheaper just to top up the base amount of your policy than to pay for this expensive option.
Purchasing life insurance can be one of the most confusing financial decisions you ever make, but with a little knowledge and understanding of the type of insurance and amount of coverage you require, you’ll be prepared to buy the right policy for you and your family.
Hi Echo, I respect your opinions but do not necessarily agree with your thoughts on wholelife and Universal Life keeping in mind that I am not liscenced to sell these products. It’s very dangerous to generalize on “Buy term, invest the difference”. I have seen many applications to estate planning and business planning where permanent insurance makes sense. For a rate of return perspective, a permanent policy is certain to pay out a death benefit unlike term so there are many cases where the UL and whole life outperforms.
I also feel it is dangerous to recommend that people replace their policies with term. In some cases, if the UL and wholelife policies have been around long enough, people may actually be better off keeping the original policy.
I agree with buy term invest the difference but the negativity on UL and wholelife may be a little overgeneralized.
Hi Jim, thanks for your comments. Buy term and invest the difference is a sound strategy and I feel that everyone should strive to be self-insured later in life. I’m not sure how “dangerous” that advice is. If people don’t invest the difference, than they are doing themselves a disservice. Just like taking out an RRSP loan and then not paying it back with the tax refund.
The danger is not in promoting buy term invest the difference. I agree that is a sound strategy. The danger is advocating the replacement of these policies with term without sound analysis. I’ve done the analysis where it make sense to replace permanent policies with term but I’ve also concluded it is better to keep the permanent policy. In fact, I recommended that my dad keep his wholelife policy after my mother passed away.
Your comment “There are no valid financial reasons for buying or keeping whole life or universal life policies at any age.” is my example of a dangerous over-generalization.
I think it’s good to promote buy term invest the difference, and I think you have good information in the post. I just hope people use caution and don’t avoid permanent policies when they do make sense. I own both term and permanent policies myself.
Yes, the non-permanent insurance stance is a bit simplistic. It’s a knee-jerk reaction to the days when whole life insurance was sold improperly as an investment. There are some people that want/need life insurance forever, and these days some variations on universal life insurance are perfectly viable options.
Buy term invest the difference is often touted as the way to go for those with permanent insurance needs to go, but I’ve never seen any ‘consumer advocates’ do a hard hitting analysis of some potentially very fatal flaws in the scenario. (the buy term invest the difference scenario again is a holdout from the 1980’s when the insurance industry was flogging whole life cash values, and really isn’t worth near as much as an idea today). I’ve promised an online site to do an article on this, I need to get my butt going and write that :).
Two of the points talk about future insurability, and quite frankly, are way off base. It’s not ‘never’. It’s ‘weigh the risk’, are you prepared to self insure? If you follow the login in the blog post, the final point should be ‘you should never buy life insurance because you’re unlikely to die’. So why do people buy life insurance? Because the cost of the insurance is lower than the perceived cost of the risk. When it comes to buying insurance now, to cover off the possibility that you can’t buy insurance later when you decide you need it, that’s not a ‘never’. The risk of not being able to buy life insurance in the future has a specific cost – the premium for the policy between now and when you need the insurance. That’s the cost of guaranteeing your future insurability. Most people won’t want to pay those premiums, but using the word ‘never’ is too much. Example 1) everyone in your family has diabetes, you don’t…..yet. You may decide that the risk of you becoming uninsurable is large, and worth the premiums. Example 2) You have hereditary conditions in your family that don’t show up until later in life. Maybe it’s worth getting some type of insurance on your kids now, to guarantee they can get insurance later. If you’re uninsurable, and it’s only going to cost $5 a month to guarantee your kids future insurability, is that still a ‘never’? It’s a ‘no’ for most, but not for everyone.
The final point should be ‘never’ use the word ‘never’ in life insurance. There’s too many variables and people are different.
@Glenn
Thanks for your comments. First off, if you read the points in my post I don’t say “never buy life insurance” or “never buy Universal Life”. I agree there are so many variables to account for and everyone’s situation is different.
What I suggest is that you never buy life insurance “as an investment”. You can get much better returns investing on your own. I also suggest to never buy life insurance early in life “just to save money”. In my opinion you should only buy insurance when you need it as part of your financial protection plan.
Here’s another example of where you’re missing things by generalizing. When you compare your investments with life insurance , you’re comparing guarantees with non-guaranteed projections. Where does that come off as being a valid comparison?
Your disability insurance article glosses over some very important points as well. You should seriously consider running these articles past an insurance expert of some type before publishing, to work out those kinks. Otherwise you’re doing your readers a disservice.
The word ‘login’ in the previous post should be ‘logic’.
Term insurance is likely to be the best choice for most people, but there are a couple of situations where permanent insurance would be appropriate:
1. If you expect that you’ll want to hold life insurance well into old age, perhaps because you want the death benefit to help settle estate taxes, or because you want to leave a lump sum to an heir. Buying permanent insurance now is likely to be cheaper in the long run than buying term insurance and renewing it every time term expires.
2. I recently interviewed a woman who has an blood disorder that her children have a high probability of inheriting. They are too young for the disease to be detectable now, but if it shows up later in life, they will almost certainly be unable to get affordable coverage when they will need it most. She bought permanent insurance for them now to relieve that anxiety.
@Canadian Couch Potato makes great points. I think the objections here are mostly related to the term “never”. Using heuristics in the light often spawn more ignorance than enlightenment.
When I’m discussing life insurance options with my clients, my goal is to make them understand their options, not blinding follow overly stringent rules of thumb. The truth is, exceptions arise all the time. People just need to know where they fit in the spectrum.