We are sailing in choppy seas. Between the Coronavirus pandemic, the rising unemployment, civil unrest, and political chaos, it may feel like everything is out of control. Back when moneyman (that’s me!), laid out some themes for this year’s blog entries, this month was envisioned as a focus on “what happens when the unexpected happens.” That was the plan, at least. And then… the unexpected happened.
We’ve discussed a lot in the last few months about the unexpected. We reviewed what to do when you have a loss of income or a change in circumstances in a post on Professional Judgment, we’ve discussed the changing situation of what to expect for the Fall semester, we examined the changing job market, and we’ve spent a LOT of time reviewing the changes (oh, so many changes) which came with the CARES Act and the HEERF Grants.
With that in mind, it is time to tackle some of the subjects which moneyman had planned to discuss in the month of June. Let’s start with life insurance.
You might say, but moneyman I am too young to think about that now. And you would be… completely wrong. The right time to think about life insurance is now, when you are young. Life insurance is the perfect way to plan for the ultimate in unexpected situations. By purchasing life insurance at a young age, you get two important benefits: a much lower monthly rate for your premiums, and the chance to qualify for insurance (hopefully) long before you have developed or suffered from any long-term health complications.
Life insurance is basically a bet on behalf of the companies who provide it. They are betting the likelihood of having to pay out a benefit and they base this generally on your age, gender, smoking status, and health condition. If you seek insurance as a 22 year old who is healthy and doesn’t smoke, your cost is going to much less expensive than that for a 60 year-old smoker with a history of diabetes and cancer.
Also keep in mind that life insurance premiums are monthly payments and the longer the possible length of payments before the company may need to pay out on the insurance, the lower the monthly payment will be. Also the more you ask for in insurance, the higher the monthly payment, so it would not be unreasonable for the same monthly payment to buy much more in insurance coverage for our hypothetical 22 year old above than it would for our 65 year old.
What about the different kinds of life insurance? There are many different kinds of life insurance, but we are going to cover the main two – term insurance and whole life.
Term insurance covers you for a specific period of time, and then ends. Under term insurance you can buy coverage for a specific dollar amount over a specific number of years and as long as you continue to pay the monthly premiums you are covered for the amount you have contracted. One of the downsides of term life insurance coverage is that after the coverage ends, you lose any money you have spent in premiums (so if you don’t use it, you lose it). One of the upsides of term life insurance is that it tends to be pretty inexpensive in comparison to other insurance types.
There is even a special kind of term insurance called permanent life insurance. Like it sounds, this is similar to term life except that the term is forever. So again as long as you pay the premium monthly, you will be covered for the amount you select, but the program never ends until you pass away (or stop paying your premiums). Again, the benefit here is the lower cost (slightly more than term life, but less than whole life). The drawback again is that if you cancel it, you lose your investment.
Then there is whole life insurance. Whole life insurance allows you to make a monthly payment, but there is no expiration date on the insurance. Your monthly payment is invested for you by the insurance company and builds cash value. Yur monthly premum is usually withdrawn form your payment, or is taken as a percentage fee on your earnings, but your investment remains yours. This means you can borrow against this if necessary (for emergencies) or if you cancel your program will receive a cash settlement. When you pass away, your insurance will pay the amount of the death benefit you have chosen minus any outstanding loan amount. This is a great choice if you can afford the monthly premium (which tend to be higher than term life).
It is true that you might earn more in returns if you invest on your own and direct your own investment choices, but for those who do not have time or inclination to make these kinds of decisions, whole life might be a good choice.
So why should you look at life insurance now? And how much should you choose to insure? And should you choose whole or term? This is really dependent on your monthly income and expenses. If you can afford whole life, you can consider your monthly payment into this program as your monthly savings amount as well (because you will eventually be able to access it, one way or another). You want to purchase as much of a death benefit as you can afford, because whatever amount you think you might need now will look very small when you ultimately need it. Imagine that right now you purchase what looks like an unimaginably high $200K death benefit, and then in 8 years you buy a house for $300,000 (right now the average home price in Orlando is $260K). You will kick yourself for not having a higher value when the premiums were cheap. Price it out and see what is affordable!
And don’t forget one other important kind of life insurance; the free kind. When you get hired by an employer ask if one of the benefits of employment is life insurance. Many employers will provide free (or significantly reduced cost) life insurance for you at 1X, 2X, 3X or more than your annual salary. Some employers will even waive the health screening for the higher levels of this insurance, but only if you take the benefit when you first are eligible for it; if you choose to take advantage of this in later years, you may have to go through a health screening first.
If you want to read a lot more about all of the different kinds of life insurance and the pros and cons of each type, check out this Investopedia page which has TONS of good information. Life insurance is the ultimate example of preparing for the unexpected, but we should all be prepared.
Oh, and the best news yet? Like retirement assets (401Ks or IRAs), life insurance plans are ignored as assets on the FAFSA. So you can save lots in your whole life plan, and never have to report it as an asset when you apply for financial aid.
Great advice on term life insurance from employers.
I disagree with your statement that whole life insurance “is a great choice if you can afford the monthly premium (which tend to be higher than term life).” From what I’ve read, the difference in cost between term and whole life insurance is better spent in investments the invester controls.
My advice is to make sure you max out your 401k matching and then additional 401k contributions beyond matching.
Here’s one article that discusses this issue.
FOM (Friend of Moneyman)