Term Life Insurance Versus Cash Value Life Insurance
By G.E. Miller • Apr 10th, 2008 • Category: Life Insurance
photo credit: Laurel Fan
Earlier this week, we discussed who may or may not need to be covered by a life insurance policy, and how much you might need to be covered by. For those of you looking to purchase life insurance, you’ll quickly realize that there are many options available to you - term, whole, universal, variable, and so on.
The Two Categories of Life Insurance
Forget all the fancy names out there to confuse you, there are really only two types of life insurance policies:
Term: Term life insurance is simply paying a set annual premium each year to cover you for a set dollar amount that you select. If you are to pass away, your beneficiaries will collect on the amount that you selected. Your annual premium will not change, nor will the value of your policy unless you change it yourself or your policy expires. Policies typically run 10, 15, 20, 25, or 30 years in length.
Cash Value: Cash value life insurance policies include universal, whole, variable, and any other trendy name other than term life insurance that you may encounter. These policies involve paying for premiums, much like term insurance, but also include a contribution of a portion of your premiums towards a separate account that accrues value over time. Getting insurance coverage, and getting cash back if you don’t need to use it. Sounds great right? Let’s take a closer look .
On average, you generally will pay a premium of about 7-10 times what you do for the same amount of term coverage (it’s more than irony that salespeople make a significantly higher commission on cash value policies than term). Salespeople are great at talking these policies up and appealing to your emotions. Don’t let them do it! Essentially, cash value policies are meant to be held for life. A small portion of your premium goes towards your insurance coverage, while the large majority goes into a forced savings account.
You can think of holding your cash in a forced savings cash value account much like keeping your money in an old 401K from a previous job where you only get a few investment options. Not to mention that your fees probably will be much higher. With a little homework you are better off converting that 401K to an IRA and investing in just about anything you like. In my humble opinion, the better choice is clearly term insurance in EVERY situation.
How Much will this Cost?
My wife and I went life insurance shopping a few years back after we got married and bought our first house. At the time, we were both covered by 1 times our annual salary at work, which would have been enough to cover our smaller debts, but not our mortgage (and neither of us would have been able to foot that bill on one salary). We were both in our mid 20’s and in good health, so we were able to get ‘preferred plus’ (best) rates. We each purchased a term plan worth $250,000 from AIG (enough to cover our mortgage and any debts). We both ended up paying less than $12 each per month. Essentially, for the price of a cheap dinner out each month, we had the peace of mind knowing that the other was safe in the unfortunate circumstances.
Where Can I Get the Best Price on Term Life Insurance?
My first recommendation would be to check a few of the many term life insurance comparison sites out there. Don’t buy anything that doesn’t require a medical screening, as you can pay up to twice as much for these plans. Also, if you are in good health, choose ‘preferred plus’ or whatever their best health category is. Don’t lie about anything, these companies have ways of finding out if you’re telling the truth.
Here are a two sites that you may want to explore to get quotes from (you can remain completely anonymous on both of these sites to get your free quote and not get spammed later):
Once you get your price quotes, I would then recommend checking with your HR department at work to see if they have an option for you to purchase a higher amount of coverage than they are currently giving you. Compare your employer’s offer with your previous quotes. You may also want to check with whatever company covers your home or auto insurance to see if they have a good offer as well. Go with the best deal you can find, but make sure that it is a legit company with a good reputation (so you’re assured that they will be able to pay off your policy in the event that they have to).
Where did you find the best deal on your life insurance policy?
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Life Insurance: How much Coverage do I Need, if Any?
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Good post. Some policies are essentially both. Term life pays a sum to the beneficiary when the insured dies during the coverage period. Cash value life provides a variety of features and benefits in addition to the death benefit of a term policy. Cash value life insurance policies have a savings element built into the policy that accumulates over the life of the policy. The insured usually has the option to withdraw, invest or borrow money against the value of the cash value life policy. Term policies are usually less expensive than cash value life policies.
I am having trouble getting a consistant opinion from financial minds on what retirement options are best if you make too much money to fund a Roth IRA. I already max out my 401k, I already have my cash reserves and I am ready to grow my retirement further and fast to retire earlier.
I’m stuck between going towards a tradtional IRA where I have the freedom to invest where I want, but im capped on age… Versus… A cash value policy where my returns are fixed. BUT, I get the benefit of a life policy, and I get the cash value plus interest earned at any point regardless of age.
Could you please provide some thoughts on this matter…
@ 30 something - I have actually chosen a traditional IRA over a roth, so I’m not sure that I would consider it a downgrade, if anything it allows you to save on your taxable income now (and it sounds like you have a decent income).
As far as where you should go beyond that, I’d consider taking a look at index or mutual funds and buying them through a discount broker. Cash value life insurance is rarely a good investment in any way.
In all this discussion, there’s no hard numbers, that’s great that both of you maxing out the 401k, but what percentage is the real “free money” from the company?
Take for example: my company puts 15% of my salary: 80,000 (12000 into a 401A, 403b, 401k, pick the IRS code, it doesn’t really matter). The point is, they put away company money, I don’t need to contribute. I do have to stay with the company for 6 vesting years, so if I quit, I get percentages of what they’ve contributed. Well anyways I’ll be retiring with them. So regardless what they’ve put in, I’ve been with the company for 7 years not, so with a 3% increase for the past 6 years: my salary is 92k plus change, the money put away into my retirement account is 77k, with the growth of the moderate 8%, it should be about 101k, but in reality because of the market, it’s actual number is 90k, it’s alright.
By year 20, hopefully, my salary is about 140k, company contributed 322k into my account, and projected growth is 737k.
Now if I retire, the 737 will not last for me if I’m comfortable living on 100K +, that’ll only last me for 8 years plus that’s all taxable income.
My plan that my financial advisor from New York Life, proposed that I do the same thing for myself. Put away 15% of my salary into a income-tax free generating account. Roth IRA is good, but not enough for me to fund to what I want. So I put into a life insurance policy, he designed a policy that costs are coming back to me over the long term. I’m starting out with 15k for years, then at 67 I’m taking out 67k for the next years, thereby taking out 40k from my taxable income, only having to pay 40k in taxes instead of the full 100k, wow great tax incentive.
How’s that for planning?
At current tax rates (through 2010), it actually makes sense to build up more money in a Retail account after you have maxed the 401k. (In Jan 1 2011 the current tax laws sunset and we are going back to higher tax brackets). Cash on hand is definately usefull especially as you plan for a home and family. I like real estate investing myself.
As for insurance, there are different Cash Value insurance options, but you can also look at using annuities to grow assets on a tax defered basis. Annuities can be tricky, but today you can find good variable annuities with low costs, some even have costs lower than retail mutual funds with similar returns. Annuities are nice because when you annuitize them you are GUARRANTTEED money for the rest of your life. Ask a retired person if they want to take a lot of risk, or if they’d rather have solid predictable income.
The important thing is to realize that different people are in different situations. It is unwise to suggest that one way is the best for everyone. In fact many banks and major holding companies use Cash Value life insurance to produce stable ongoing returns. (If major financial institutions are doing this to hedge risk, would it make sense that some educated Americans would want to do the same?)
One thing that wasn’t mentioned about traditional cash value insurance is that the cash value does not drop. It grows at different rates, but you won’t loose your money like you can with investments. (And legally, we aren’t allowed to call traditional cash value insurance an investment because it doesn’t fluctuate negatively.) There are Variable Cash Value policies which invest in mutual funds inside of the life insurance and have become quite popular also, but this is another topic….
The most important thing to realize is that not all cash value insurance, or annuities are the same. One must do research on the company and ask the salesperson or agent or financial advisor to give not only historical references but also a current day evaluation of the financial strength of the life insurance company they are presenting.
While Buy Term invest the difference is great, but it has several flaws. What happens if you outlive the term? What is the cost of insurance after the term period? Can the advisor put in writing the future gains of a mutual fund? If an Advisor says he can GUARANTEE future returns on a mutual fund, then run away! What happens if I want to add MORE money to my IRA on an annual basis? How much do I need to have at retirement? When will I run out of retirement money? Will my 401k/IRA contibutions be enough to get me to the goal? How about my estate tax, how much will go to the IRS? Cash value insurance can answer these questions with Authority in spades. Buy Term Invest the difference crusaders can’t answer these questions with any authority because they only look at on small aspect of the huge financial planning picture: the cost of insurance. They miss the lost opportunity cost of Triple compounding, Tax-Free Income, Estate Taxes, Increased Premium rates AFTER the Term period on Term Insurance, and the instability and inherent risk of Investing in Mutual Funds. They get you focused on the Insurance Agent’s “GREED” instead of focusing on the greed of the IRS, Brokerage Houses, and the people who promote these simpleton concepts. Buy Term invest the difference crusade was excellent in the 70s, but it is over. There are TOO many excellent products and concepts to locked into just this ONE financial plan. Buy Term invest the difference is a EXCELLENT starting point, but I would not want to finish there.