CHAPTER 10 Financial Planning with Life Insurance “Buy Term and Invest the Difference!” The Wealthy Barber
An Introduction to Life Insurance • Life insurance is obtained by purchasing a policy, with the insurance company promising to pay a lump sum at the time of the policy holder’s death • Some types will pay while the policy holder is still alive if they live long enough • (Whole life policies for stupid people) uninformed
An Introduction to Life Insurance (continued) • The purpose of life insurance is to protect someone who depends on you from financial loss related to your death – Other reasons are… • To make charitable bequests upon your death • To leave as part of your estate / avoid estate taxes • Careful! The IRS often looks unfavorably at some of these tactics (only affects the very wealthy) • Usually promoted by unscrupulous insurance agents • To save money for retirement or children’s education • (Whole life policies for uninformed people)
An Introduction to Life Insurance (continued) “People should buy life insurance so that when they die, their assets combined with their insurance proceeds can allow for the proper winding down of their financial affairs, and provide the desired standard of living for their dependents.” “Really, life insurance is better termed financial protection for dependents or income replacement insurance.” The Wealthy Barber
The Basis of Life Insurance • Mortality tables provide odds on your dying, based on your age and sex • Your premium is based on your life expectancy and the projections for the payouts for persons who die • You are essentially betting the insurance company that you will die • It is a bet that you hope you lose • And so does the insurance company • They have a very good idea how many people will die and how many will live – Actuaries Let’s Play The Longevity Game!
Two Types ofLife Insurance Companies • Stock life insurance companies are owned by the shareholders • 75% are of this type of company • Sell non-participating policies • 79% of policies are non-participating • Amount of premium stays the same 2010 American Council of Life Insurers www.acli.org
Two Types ofLife Insurance Companies (continued) • Mutual life insurance companies • Owned by the policyholders • 25% are of this type of company • With participating policies the premiums are higher than non-participating policies • 21% of policies are participating • However part of the premium is refunded to the policyholders annually • This is called the policy dividend • Not the same as dividends from stocks or credit unions that are taxable • They are non-taxable transactions since they are simply not charging you what they said they would charge you
Determining Your LifeInsurance Needs • Do you need life insurance? Ask Yourself… • “Are there any people who depend upon my income for their living expenses?” • If the answer is, “Yes,” then it is not a question of whether or not you need insurance • It is how much life insurance you need! • If the answer is, “No,” then you do not need life insurance! • No matter what the life insurance agent says!
But Even If You Are Single, You Will Be Told By An Insurance Agent… • “Of course, you need life insurance!” • “Your policy is acting as a savings vehicle” • “Insurance is cheaper when you are younger” • “You should buy insurance now while you are healthy and can get it” • Your response to each of these should be… • “Nonsense!”The rate of return is awful • “Nonsense!”Why buy something you do not need? • “Nonsense!”Only 2% of people are turned down
And Do Not Ever Buy Life Insurance for a Child! • Would you be devastated emotionally if your child dies? • Yes! • Would you be devastated financially if your child dies? • No! • Excuse me for being callous, but you will be better off financially if your child dies • Do not ever buy life insurance for a child!
But If You Have Children… • Young married couples or single people with one or more children almost always need life insurance • The question for them is not, “Do we need it?” but rather, “How much do we need?” • Often the answer to that is, “More Than You Think!” We will discuss how much in a bit…
And Do Not Forget the Non-wage Earner Spouse… • Normally, it makes sense to have some insurance on a non-wage earner spouse (a.k.a. stay-at-home mom or dad) • Have enough to pay off the debts, and • Replace the services that the non-wage earner provided • Men usually remarry quickly, women do not • Married Men • Single Women • Married Women • Single Men
Some Examples… Who needs life insurance? • A young married couple with no children • A young married couple with two children • Single adult or an unmarried couple • Single adult who is a partner in a business • A married couple with children • Both parents are high-wage earners • A middle-aged couple • Children gone and house paid off • Same middle-aged couple taking care of one or more of their aged parents
Estimating Your LifeInsurance Requirements Da’ Book sez… • The Easy Method • Typically, you will need 70% of your salary for seven years while family adjusts • The DINK (dual income, no kids) Method • The “Nonworking” Spouse Method • Multiply the number of years until the youngest child reaches 18 by $10,000 • The “Family Need” Method • More thorough because it also considers employer provided insurance, Social Security benefits, and income and assets
Estimating Your LifeInsurance Requirements The Wealthy Barber sez… • Get out your Financial Statements • Use your Net Worth Statement to total your debts • Start with at least this much life insurance • The surviving spouse & family will be debt-free • Create a second Cash Flow Statement without the person’s income and without the person alive • This will tell you how much income the surviving family will need • Determine the principal needed to generate that income • We’ll learn this later when we get to investments • Add the first amount (debt) and second amount (principal) to get how much life insurance you need • By the way, the rule of thumb is 7 to 10 times your annual salary depending upon the level of debt
Types of Life Insurance Policies • Term life insurance– The Only Type of Life Insurance! • Protection for a specified period of time • If you do not pay premiums, coverage stops • A renewability option means that at the end of the term you can renew the policy without having a physical • Conversion option allows you to change your policy from term to whole life without a physical • If you are uninformed enough to actually buy a whole life policy…
Types of Life Insurance Policies (continued) • Whole life insurance(a.k.a. straight life, ordinary life, cash-value life, adjustable, variable, universal, etc. etc. etc. They keep changing the name! Why?) • You pay a premium as long as you live • Amount of premium depends on your age when you start the policy • Provides death benefits and accumulates a cash value • You can borrow against the cash value or draw it out at retirement • Look carefully at the rate of return your money earns– It is almost always abysmal!
Types of Life Insurance Policies (continued) • Whole life insurance (continued) • Every 5 to 10 years or so, the insurance industry changes the name of whole life insurance • Why? Because eventually consumers get hip to how they are being screwed • To confuse the issue, they just change the name • (Heaven forbid they stop selling the cursed things!) • The newest spin is “permanent life insurance” • Wouldn’t you rather have “permanent” life insurance instead of just “temporary” life insurance? • Hint: Do you have “permanent” car insurance? • How about “permanent” home insurance?
Whole Life Policy Options • Limited payment policy • Pay premiums for a stipulated period, usually 20 or 30 years, or until you reach a specified age (65) • Your policy then becomes “paid up” and you remain insured for life • Such a deal! You overpaid for 30 years so that now you can have life insurance even though you don’t need it any more! • Single payment policy • Allows someone to pay for the entire policy in one single payment • Popular form of compensation for some high-end executives
Whole Life Policy Options (continued) • Variable life policy • A minimum death benefit guaranteed, but the death benefit can rise above it depending on yield of the dollars invested in a separate fund • Meant to give policyholders better returns (They lied) • Universal life • Lets you pay premiums in almost any amount • Combines term insurance and investment elements • Variable universal life • Combines the odious(uh, I mean, best) parts of both variable whole life and universal whole life
Term versus Whole Life Review: • Term life insurance • Life insurance without a savings component • Whole life insurance • Life insurance with a savings component So what is the big deal, Paiano? If the insurance company is offering to provide you with life insurance and a savings plan, why not let them?
Term versus Whole Life (continued) • $500,000 Term Life Insurance Policy • 32-year-old male, preferred • 20-year term life policy • $250 per year • $500,000 Whole Life Insurance Policy • 32-year-old male, preferred • $250 per month! Starting to see the difference yet?
Term versus Whole Life (continued) • If a company came up to you and said, To save at our institution, you must buy life insurance. You must pay for it even if you don’t need it. We’ll take everything you deposit in the first few years for ourselves. In future years, we’ll charge you to deposit money into your savings account. You can borrow the money at any time, but we’ll charge you interest. If you happen to die while this loan in outstanding, we’ll decrease the amount we were to pay your beneficiaries by the outstanding amount of the loan. If you don’t borrow from this account and you die, we’ll pay the beneficiary the face amount of the policy – we’ll keep your savings for ourselves. Oh, and finally, we don’t offer the greatest rates of return. Usually between 1% and 2%. See any difference yet?
Term versus Whole Life (continued) • Insurance companies are regulated by the states • For the last 50 years, virtually every Insurance Commissioner’s Office in every state has publicly stated that term life insurance is a better deal for consumers than whole life insurance • Virtually every consumers group recommends term life insurance over whole life insurance How ‘bout now?
Term versus Whole Life (continued) • “Buy Term and Invest the Difference” • But Mr. Insurance Salesperson will tell you… • “But with our whole life policy, you get ‘Forced Savings.’ Most people don’t have the discipline to ‘Buy Term and Invest the Difference.’ Even with the best of intentions, they will not do it.” • “Nonsense!” • If you have the discipline to make the payments to the life insurance company, surely you have the discipline to make the payments to your own savings or investment plan! • Use an automatic contribution from your checking account
Term versus Whole Life (continued) • So do you see why we call term life insurance, • “The Only Type of Life Insurance?” • It does not matter which type you buy, you are still paying for protection for your dependents in the event of your death • With term, you are only paying for that protection • With whole life, you are paying far more for that protection plus you are being tapped for an awful savings plan that you may not even get to use • Lastly, if you do invest the difference, by the time you are nearing retirement, you will not need life insurance any more–You will be self-insured!
Types of Policies Issued – Surprised? 2011 American Council of Life Insurers Fact Book www.acli.org
Amount of Insurance Issued 2011 American Council of Life Insurers Fact Book www.acli.org
“Huh? I Do Not Understand…” • The number of whole life policies is far greater than the number of term life policies • Mostly because life insurance salespersons get far greater commissions from whole life • But the amount of insurance in force for term life is far greater than whole life • Because term life is far less expensive than whole life, you can buy the amount you actually need So after the insurance agent convinces the poor slob that she needs whole life, the agent sells her far less insurance than she needs because the poor slob can not afford to pay the huge premiums for the amount of insurance her family really needs! Personally, I believe this behavior should be criminal because if the poor slob actually dies, her family suffers. Whole Life Illustration
Other Types of Life Insurance Policies • Group life insurance • Always term insurance • Often provided by an employer or professional association – Usually a very good deal (not always) • Sometimes free (SWC employees get $50,000) • No physical is required • Credit life insurance • Debt is paid off if you die • Mortgage, car, furniture, credit cards • By the way, it protects the lenders – “What?!” • Very expensive protection – Do not buy it • Accidental Death or Double Indemnity • “Is he dead? Oh, how sad… How did he die? Good!”
Life Insurance Contract Provisions • Name your beneficiary and contingent beneficiaries • Update it when necessary (example: divorce) • Suicide clause during first two years • Misstatement of age provision • Accelerated benefits, viatical settlements • Waiver of premium disability benefit • Loan provision • Premiums paid from cash value • Return of Principal for Term Life policies • Sometimes a pretty good deal, often not
Choosing Your Insurance Agent • “Life insurance is sold, not bought” • Get a good referral • Is the person willing to take the time to answer your questions and find a policy that is right for you? • Are they available when needed? • Do they ask about your financial plan? • Do you feel pressured? • Most importantly, are they still trying to sell you whole life when you have already told them three times that you want term life insurance?
Obtaining and Examining a Policy • The first step is to apply • The second step is to provide medical history • Usually no physical for a group policy • Read every word of the contract • After you buy it you have ten days to change your mind • (Whole life policies for uniformed people) • Give your beneficiaries and your lawyer a photocopy
Choosing Settlement Options • Options are the choices for how you want the money paid out • Lump-sum payment is most common • Almost always the best choice • Limited installment plan • In equal installments for a specific number of years after your death • Life income option • Payments to the beneficiary for life • Proceeds left with the company • Pays interest to the beneficiary
Payment of Insurance Benefits • No matter what the life insurance company says, Take The Lump Sum and Invest It! • Leave a letter of instruction if you are the insured • By the end of this class, you will have a rudimentary knowledge of investments that will give you a rate of return that is at least 2 to 5 times better than anything the life insurance company will offer you • The life insurance companies love to prey upon the surviving spouse • “We’ll give you an income for the rest of your life” • “We’ll screw you for the rest of your life”
Should You Switch Policies? • Switch a term life policy if the benefits exceed costs of getting another physical, & paying policy set up costs • Are you still insurable? Don’t cancel the old policy until the new policy is in force Normally, the only reason people switch whole life policies is because a life insurance salesperson convinced them to switch. Why did they want them to switch? Because if they were uninformed enough to buy a whole life policy in the first place, they’re probably uninformed enough to switch to another policy. And the salesperson gets a ton of new commissions! Several years ago a few insurance companies got into hot water for pushing elderly folks to switch policies.
Financial Planning with Annuities • An annuity is a financial contract written by an insurance company that provides you with a regular income, often for the rest of your life • Further discussion of annuities will take place when we get to investments and retirement planning While annuities are insurance products, they really belong with investments and retirement planning. We will revisit them in the next chapter. The book includes a section on annuities in this chapter because the insurance companies often try to get the beneficiaries to purchase an annuity with their life insurance benefits instead of taking the lump sum. (Usually a bad idea!)
The Bottom Line Need Life Insurance? “Buy Term and Invest the Difference!”