"Those few inches of air between your underbody and the road can MURDER a car, lemme tell ya..."
Life insurance is supposed to keep your survivors’ financial lives operating without interruption should you buy the farm. If you’re rational enough to acknowledge that you might die and leave dependents, but not so rational as to compare the likelihood of you leaving your family destitute with the price of insurance, then perhaps a term policy is for you. You pay fixed amounts on a regular schedule, and if you fulfill your part of the covenant by dying, your family is covered.
With a term policy in effect for a fixed number of years (hence its name), the term expires and you buy another policy. If you survive the term, you spend thousands of dollars and receive nothing of value except the intangible quality of “protection”, which it turns out you never needed. Incredibly, it’s easy to make the argument that this type of policy, the one that gives you a -100% return, is the best type of life insurance. Beyond term insurance, sometimes people looking for coverage kid themselves into seeing life insurance as an investment, rather than a financial fire extinguisher that will probably spend its entire existence mounted in a bracket in your kitchen.
Over time, financial instruments always increase in complexity proportional to their profit margins (a recently discovered economic law, temporarily dubbed “McFarlane’s Shift”.) In that spirit, the insurance industry created classes of “investment” policies that went beyond term life insurance. These (in chronological order of invention; whole life, universal life and its variants) claim to foster your money’s growth, something term policies don’t do.
“Whole life” policies aren’t in effect for a fixed term, but rather – appropriately enough – the holder’s whole life. They carry a cash value that’s accrued throughout the duration of the policy. Not that there’s anything wrong with cash values in and of themselves, but investing and insuring are different objectives. To confirm that, if you die while your whole life policy is in effect, your beneficiary doesn’t get the cash value. Just the death benefit.
It’s sound financial advice to look at each transaction from the other party’s perspective. Is this exchange value-for-value, or is someone getting the short end? An insurer who moves you from a term policy to a more expensive whole life one incurs zero additional risk. That excess is pure loss for one party, pure profit for the other. Most mutual funds will almost certainly offer a better 30-year return than the modest percentage points you can expect from a whole life policy.
Understand opportunity cost. The money you invest in a whole life policy is money you now can’t spend elsewhere. Investing is one thing, protecting your family is another. If it’s protection you want, then it’s protection you should pay for.
A universal life policy is similarly pricey, one major difference from a whole life policy being that with the latter, you can modify the death benefit (and thus the premia) through the policy’s duration. If you increase the premium, the surplus goes into investments that aren’t subject to income tax, but that must be approved by your insurer. And the holdings are protected from creditors. In other words, only use this if you’re a rich person looking for a tax shelter. When you die, your polo-playing granddaughters can settle the tax bill with universal life proceeds.
But even with a basic term policy, the young father who thinks he’s prudent by “taking care of” his stay-at-home wife and bevy of offspring can easily forget that time progresses. Your kids aren’t always going to be financial drains. (Hard to believe, but it’s true.) Your earning power will likely increase throughout your career. And your investments, if you choose wisely and start early, will increase too. If life goes like that, according to something resembling a plan, then any money you’ve spent on life insurance has been wasted. This despite what any insurer might tell you.
If you’re retired, or getting there, life insurance is likely a losing proposition regardless of your net worth. Your family should depend less and less on your income as the years progress. Which is a cause to rejoice, not to buy insurance. And of course the older you get, the greater your monthly payments. Your cardiologist might care that you’re running 30 miles a week. Your insurer, less so.
There are even people who buy life insurance policies for their children, which is the equivalent of issuing a formal declaration of war on your money. The rationale among some parents who buy such policies is that were the child to die, the parent would be so distraught that she couldn’t bring herself to ever again function at a job. Tabling the ethical question of why suffering a tragedy would disqualify someone from being productive, why would you spend disposable income on something that pays a return only if your child dies? There are cheaper ways to tempt fate.
It’s hard to win with life insurance, especially the investment class of life insurance. If you want to leave a legacy for the succeeding generations, there are Dow stocks, index funds, blue-chip stocks…even the most conservative investments give you less risk of loss (if you buy term) and far less overhead (if you buy an investment policy.)
This article is featured in:
**Baby Boomers Blog Carnival One Hundred Thirty-eight Edition**
