"You want to hear 'Freebird'? Yeah, we'll get right on that."

We’d never solicited requests at Control Your Cash, but then Twitter follower @JSmisko sent us the following tweet:

@CYCash If u have done a blog on life ins, plz repost for me. Thx.

Rather than ask why he didn’t spell all the words in full with the 66 remaining characters Twitter allotted him, we’re indulging him.

We don’t spend a lot of time on life insurance in the book because life insurance is a waste of money unless you* earn an extraordinarily high income or have expensive dependents (e.g. a blind and retarded daughter with spinal meningitis.)

You pay an insurer a monthly stipend, and if you die your beneficiary gets paid. There are two major classifications of life insurance – term and the less common permanent. “Term” means you buy it for a fixed period, usually 10, 15, 20 or 30 years, and pay similar monthly premia throughout. However, the premia can rise (or less likely, lower) throughout the term. If you contract HIV 4 years into a 30-year policy, your insurer will want to know. And will probably have a right to know via a medical exam, if you read the fine print in your policy (which you won’t be receiving anyway, because as we’re establishing, life insurance is a waste of money.)

If your term policy ends with you still alive, you could argue (as we do) that you wasted 10, 15, 20 or 30 years worth of premium payments. Or you could do like most life insurance customers do, and keep renewing. The older you are when a term starts, the higher your premia; which makes sense, seeing as you’re closer to death. This is why customers who are committed to the concept of term life insurance will usually buy for as long a term as possible.

If you’re a 30-year old man, chances are you’ve got half a century or so before you kick, less if you’re dumb enough to smoke. Of course your income will vary throughout any insurance term, but it’s reasonable for the insurer to assume that your income will rise throughout your work years then decrease once you retire. The insurer calculates the likely existence trajectory of someone in your position, then determines that a typical term policy for someone like you should cost around, say $100 a month. If you die via a cause approved by your insurer (who probably won’t let you, say, jump in front of a train and then have your wife and kids expect a windfall), your beneficiary will get something like $125,000.

But you’re almost certainly not going to die during the term. In any event, your wife can work. (If you don’t have dependents, you must really hate money in order to own life insurance.) Besides, well before your 30-year term elapses, your kids should have stopped relying on you to provide for them anyway. That $1200 a year can go into far better investments, ones that don’t require you to die.

And term is the best kind of life insurance.

In general, permanent coverage is subdivided into whole life insurance and universal life insurance. Whole life insurance remains in effect for…well, your whole life. A long time ago, thousands of term policyholders made it to the end of their terms without dying and wondered why they’d bothered spending all that money. Thus the insurance industry invented whole life insurance, which charges higher premia. The insurer invests the excess, creating a cash value that it offers to you should you ever want to cancel your policy. By the way, if you die while the policy is in effect, your beneficiary doesn’t get the cash value.

The problems with this are plentiful and clear. For the increase in what you pay, the insurer incurs no additional risk. That excess is pure profit to the insurer. If the cash value is the aspect that excites you about whole life, then you aren’t really insuring, you’re investing. If you’re going to invest, there are better ways to do it than with a whole life policy. Pick a mutual fund at random at Yahoo! Finance and it’ll almost certainly offer a better 30-year return than the 2% or so you can expect from a whole life policy.

Universal life insurance is similarly confiscatory for most people, except you have the option of paying more than your monthly premium and having the excess go into investments managed by the life insurance company.
Chew on that. This kind of policy only makes sense if

a) you’re rich enough to overpay for things,
b) yet you’re not rich enough to manage your own investments.

If something appears to be financially illogical, there’s probably a legal reason involved. There is. Universal life insurance investments aren’t subject to income tax, so rich people use them as shelters. When a rich person dies, the IRS will come for its pound of necrotizing flesh, which the estate will then settle using the universal life insurance proceeds. Even though the insurer ostensibly manages the investments in a universal life policy, if a policyholder is rich enough, she’ll tell the insurer what investments to “recommend” to her. And like all insurance policies, universal life policies are protected from creditors, too.

You can’t win with life insurance. Your death, while a foregone conclusion, is hard to predict the date of. In fact the more accurately you can predict the date, the less likely you’ll be to find a company willing to insure you. And the higher the premia you’ll pay. If you want to invest for your descendents, try index funds, blue-chip stocks…even something as conservative as a certificate of deposit offers you a comparable return with way less risk of losing your investment (if you buy a term policy) or way less overhead (if you buy whole life or universal life.)

*As opposed to your investments earning a high income, which your existence shouldn’t have a bearing on.