Life Insurance
The information provided below is intended to be an example of the advice we offer to clients. It is intended to be accompanied by customized analysis and counsel from an Altruist financial advisor.
Why does anybody need life insurance?
There is only one reason why you might need life insurance: You want to be sure that, in the event of your untimely death, the loved ones who depend on you for financial support will have adequate financial resources for as long as they'll need it. If you don't need it, you certainly shouldn't buy it any more than you should buy auto insurance if you don't own and/or drive a car.
Basically, life insurance is a necessary evil for those who need it. For those who do not need it, life insurance is just plain evil and should generally be avoided as part of sound fiscal decision making.
How much life insurance should I get?
You should get as much as you need. To determine how much you need, ask yourself the following questions:
- Who (if anybody) is financially dependent on you right now?
- If you were to die tomorrow, would those dependents be put in distress financially? When assessing the answer to this question, you must consider the following:
- When you die, your minor children will usually immediately become eligible for Social Security Survivors Benefits. These benefits may be on order of $30,000 per year per child (subject to a family cap) tax free, with the amount rising with inflation. Social Security Survivor’s Benefits for children typically end when the child turns 18, unless they are still attending high school, in which case it ends either when they stop attending high school or when they turn 19, whichever comes first.
- When you die, if your spouse is caring for your child who is under age 16, they also get Social Security Survivor’s Benefits (subject to a family cap). If they work, they lose benefits at the rate of 50 cents per $1 earned above a threshold.
- Many workers have life insurance benefits paid for by their employer. It is also common for professional organizations, credit unions, and other organizations to whom you might belong to sponsor very modest life insurance policies for their members.
- Your dependents would generally have access to your existing assets, lessening their need for supplemental funds.
- Many families have one parent who chooses not to work. If the wage earner dies, it may be feasible for the non-working parent to re-enter the workforce to provide for themselves and/or their dependents.
- It is common for parents to provide support to their (non-disabled) children until they are roughly 18–22 years of age. So the need to support them is usually of a finite timeframe.
- The amount of your life insurance need typically decreases over time as your children approach age 22 and as your assets grow.
- If the amount of your assets, combined with other sources of funds described above, are adequate to meet their needs, you don’t require any life insurance.
If I need life insurance, what kind should I get?
The major types are whole life and term. "Whole life" includes various variations like Variable Universal Life and others. For most people, we feel that term is usually the way to go.
Should I get Annual Renewable Term or Level Term?
Annual Renewable Term (“ART”) guarantees that you will be able renew it annually without taking an additional medical exam. Because the chances of your dying during the next year are usually very low, the premiums tend to be correspondingly low. However, due to the fact that your chances of dying any particular year go up somewhat as you age, the annual premiums also go up as you age.
Level Term guarantees that you will continue to get a fixed amount of coverage for the term of the policy (e.g., ten years or twenty years) and that the premiums you pay will not change. The result is that you pay more than you would for ART the first several years of the term and you pay less than you would for ART for the last few years of the term. This may sound beneficial until you realize that your actual need for life insurance usually declines over time. Given that your need for insurance often decreases over time (perhaps to zero once your children are twenty two years old or so), it makes sense to periodically adjust your coverage to the level that you actually need at any one point in time. If you are going to reduce your coverage anyway, it makes little sense to pay more up front with a level term policy.
A better strategy may be to get ART and reassess your needs every two or three years.
However, because ART is so unprofitable for insurance companies, some will offer it only reluctantly or not at all. You may find that level term is less expensive than ART. If so, go with the level term policy of the shortest duration you can reasonably foresee being adequate (i.e., if you expect only to have life insurance needs for 15 years, get a 15 year level term policy, not a 30 year level term policy which would be more expensive). If at some time in the future you need more insurance, buy more at that time (it may entail an additional medical exam, regardless of what type you buy). If at some time in the future you need less insurance, tell your insurance company that you want to reduce your coverage at that time and they will correspondingly reduce your premiums.
What's wrong with whole life policies?
Whole life policies tend to be extremely profitable for the insurance companies. Rather than helping insurance companies to make profits, we feel that most people would be better off buying the equivalent insurance amount in term insurance and investing the difference in appropriate investments. Here's why: Let's split up every dollar that you pay into a whole life policy into three categories: the basic insurance premium, the insurance company's profit, and the cash accumulation amount. The exact proportions are irrelevant—what is important is to realize that it is broken down into these three categories. Let's assume the following proportions:
- 20% Basic insurance (i.e., essentially pays the equivalent term insurance premium).
- 40% Profit for the insurance company and/or the agent.
- 40% Cash accumulation (i.e., adds to the cash value of the account).
Unfortunately, we've found that the cash accumulation part of whole life policies tends to be a very poor performing long-term investment, when compared with long-term returns available from a prudent portfolio of diversified stock and bond mutual funds. Further, the only way of getting at the cash accumulation in general is to either cancel the policy or take out a loan against it (if you die, you get the face value of the policy less any outstanding loans—the insurance company always keeps the cash value unless you cancel the policy). So it is a real stretch to even consider it an "investment" at all.
Of course, we'd all prefer to avoid helping insurance companies (and/or agents) to get rich when the alternative is to help ourselves to get rich. We can do that both by removing the part of whole life policy premiums that goes directly to their profits and by applying it (as well as the part that normally goes to cash accumulation) all to our own cash accumulation (e.g., in a diversified portfolio of mutual funds). We will have more money working for us and what we have will, over the long run, realize better returns than if we used the "investment" portion of a whole life account. And, since we are still getting exactly the same amount of insurance coverage while we need it (by buying a term policy), we are likely to be better off in every way, on average!
What should I do if I already have a whole life policy?
If you already have a whole life policy, you are almost certainly paying as much as ten times as much as you would for a good term policy for the same amount of coverage.
Unless you are one of the few individuals who truly has a need for whole life (e.g., if you have a disabled child who will always be a dependent), or your whole life policy is placed with a good mutual insurer and has been in place for many years (i.e., it is fully paid up, at the very least), we strongly recommend that you consider selecting an appropriate term policy to replace the coverage. Once the term policy is in effect, either cash out the whole life plan entirely (you may be taxed on the distribution, to the extent it exceeds the total amount of premiums paid) or avoid taxes on it by rolling it over to a low-cost variable annuity such as those offered by TIAA-CREF (minimum rollover $250).
If you have a whole life policy but you have no need for life insurance at all, it may be generally wise to cash in the policy (and consider rolling over the cash value into a low-cost variable annuity as described above if any of the cash value is taxable). Note the exception discussed above whereby a whole life policy which has been in place for many years with a good mutual insurer may represent a good value going forward, regardless of whether you need insurance.
If you believe that you might meet the exceptions whereby keeping a long-standing whole life policy may make sense for you, we suggest that you verify that by purchasing the Consumer Federation of America's Life Insurance Rate of Return Service. This is a one-time analysis costing $150 (as of 2022).
An exception to the above advice suggesting replacing a policy applies if your health has materially declined since you bought the policy in question. In other words, if your likelihood of an early death is higher than originally assumed in setting your premiums, it may represent a good value, regardless of the issues discussed in the few paragraphs above.
How do I select a term policy?
Term life insurance policies are commodities and you first should shop by price. There is little reason even to assess the financial stability of the various insurance companies. The reason is that if the term insurance policy issuer goes bankrupt, your coverage would generally continue, compliments of your state's guaranty association. All states, Puerto Rico, and the District of Columbia have guaranty associations that generally pay your claims up to a certain limit, usually $300,000, if your insurer becomes insolvent. Here and here is more info on what happens if a life insurer goes bankrupt.
Even if the guaranty associations didn't exist, if your insurer became bankrupt, you would simply shift to another term insurance supplier and start paying your premiums to an alternative company. Of course, in that event you would be taking a slight risk that, when/if you need to shift to another company, you may fail your physical and be uninsurable. You'd have to judge whether you are willing to take that chance or not. If you are willing to take that chance, then ignore the financial stability of the insurer. If you are less willing to take that chance, then figure in the financial stability of the insurer to the degree you choose.
If you need insurance coverage higher than the guaranty association limit (which typically is $300,000), it might also be useful to consider the risk that you may become uninsurable, and therefore unable to replace coverage above the $300,000 guaranty association limit. In such a case, it may also be beneficial to figure in the financial stability of the insurer to the degree you choose.
But unless you need greater than $300,000 of insurance AND you become less insurable between when you buy the policy and when the insurer goes bankrupt (and because you aren't building up a cash value), you have very little to lose if the issuer goes bankrupt.
If you are concerned about an insurer’s solvency, you can also consider the insurance company’s financial stability as measured by the various rating services (e.g., Weiss Research, A.M. Best, Moody’s, Standard & Poor’s, etc.). Of the major rating services, Weiss Research probably has the most stringent standards.
Here's some free services that will give you the best quote from many different term insurance issuers:
- Insure.com 1-800-324-6370
- Term4Sale
It is probably beneficial to compare the best quotes from the above services with those from:
- USAA (1-800-531-8000)
- Ameritas (1-800-552-3553)
They both offer policies free of agents’ commissions. In particular, Ameritas’ ten year guaranteed level premium term policy is worthy of consideration. Its premiums are very competitive and the policy may be converted with no health questions to its attractive, no-agents’ commission cash value policies if you still need insurance after ten years and you can’t qualify for another ten year period at low rates due to deteriorating health (i.e., according to the Consumer Federation of America).
If you need to speak with an agent, the best agent-represented policies may come from Northwestern Mutual Life (according to the Consumer Federation of America).
People in states served by the Savings Bank Life Insurance company (“SBLI”) would do well to also get a quote from them. SBLI has low term rates in the several states in which they do business (as of July 2021, they did business in all states except MT and NY).
While it might seem somewhat overwhelming to have to do all the comparison shopping we advocate here, it really pays to shop around. Prices for similar products vary dramatically from company to company.
Here's a source of unbiased, objective info about life insurance.
Here's an outstanding source of unbiased objective info about life insurance.
This web page contains the current opinions of Eric E. Haas at the time it is written—and such opinions are subject to change without notice. This web page is intended to serve two purposes:
- To educate the public; and
- To provide disclosure of Mr. Haas' opinions to prospective clients. We believe that prospective clients are well-served by being made aware of what they are buying—and what they are buying is advice that is based on these opinions.
We believe the information provided here to be useful and accurate at the time it is written. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.
No investor should invest solely on the basis of information listed here. Before investing, it is important to consult each prospective investment's prospectus and consider both its risk/return characteristics and its effect on your overall portfolio.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Altruist recommends consultation with a qualified tax adviser, CPA, financial planner, or investment adviser. If you would like to discuss the rationale or support for any particular idea expressed on this web page, feel free to contact us.