With our education, background and decades of experience we keep coming back to our original thought about permanent insurance or term insurance: The reason there are different kinds of life insurance is because people have different needs.
Let’s discuss this as an overview before we get into specifics that might relate to your own situation.
Definition of Life Insurance
Let us define “life insurance.” In this context, the word “life” means a person. “Insurance” means financial protection against a known risk of loss. Accordingly, “life” insurance is financial protection against the known risk of a loss of a person. So, term life insurance is temporary financial protection against the known risk; and permanent life insurance is long-lasting protection which is expected to last as long as needed.
As a financial advisor I have no predisposition in favor of one type of life insurance over another. And they stated, the reason there are different kinds of life insurance is because people are different kinds of needs. And, as a financial advisor, the best interest of the client is the only interest to be considered.
The best life insurance is that which is in force when you die. To help you get a handle on this so you can make an intelligent decision the way you’d do about other things in your life, here are a few things that are “permanent” — long-lasting, not expected to change:
While you’re contemplating what type of life insurance to acquire, permanent insurance or temporary insurance, compare and contrast those images of things that are long-lasting and not expected to change with these images of things that are temporary and not expected to last:
Note there is nothing wrong with any of these items in the server purpose for the time that we have them. And, like term insurance, these things are temporary and not expected to last forever.
Now that you understand the concept of term insurance compared to permanent insurance we can ask the most relevant question of all: “when are you going to die?” Or, perhaps to be a little less blunt, we might ask instead, “how long do you want this protection to be in force?” If your family is expecting an inheritance of several millions of dollars for your four years from now, you may only need life insurance in force as an income replacement mechanism for the next three or four years. Maybe you really do have a rich uncle
If you’re likely to need your life insurance protection remain in force for more than a few years, you probably should consider a permanent life insurance policy. To use a real estate analogy which most people understand, term insurance is a lot like paying rent; permanent insurance is a lot like owning the property. Term insurance, like other things that are rented, typically go up in price at the end of the lease. And, one day, the tenant will be evicted.
Permanent insurance tends to have a higher premium than term insurance and the premium is usually level. Because this premium is higher than that for term insurance, a reserve of dollars is built up in favor of the policy owner because they paid a level premium instant of increasing premium. Insurance companies call this reserve “cash value.” If it any time you decide to cancel policy, the reserve cash value fund is returned to you along with any interest and dividends it has accrued. Over a long period of time — like the length of time you will probably need life insurance — this can be a difficult concept to beat. All the leverage is in your favor as a policy owner. More on this later…
Now let’s talk about the price difference. If the purpose of your insurance protection is income replacement, you probably need 15 to 20 times your annual income in life insurance. This is demonstrated elsewhere on this website. For now, suffice to say that an adequate amount of permanent life insurance can be expensive, too expensive for most people even though most of what you’re paying in premiums is going into a safe, tax favored, and liquid cash reserve surplus account for your use. Most young people simply can’t afford to save that much money. For them term insurance, perhaps with some modest amount of permanent insurance blended in, is the best option.
In addition to this though we have to remember that life insurance is not a financial plan; it’s a part of a financial plan. One day you’re going to need money even more than you needed today. You may be planning to pay for children’s her grandchildren’s college educations. Who knows, you may even want to retire one-day! When either of those events happens, it’ll be nice to have either an education fund or retirement fund available for your use. (This is an insurance policy that allows you the ability to use the cash value within the policy for such things.)
Remember, it’s not the insurance that costs the money — it’s the education and/or retirement that are expensive. Cash value life insurance is, in this context, a dual purpose financial vehicle which will provide for your family if you die and for yourself if you live. The tax-free compounding of dividend and interest earnings in a cash value life insurance policy over a 10 or 20 or 30 year time period is a remarkable mechanism, in possible to replicate in any other financial product. You will probably have to save money somewhere, so the question is: do you want your interest earnings taxed or not taxed?