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Questions about Insurance
I am in my twenties and I am looking into life insurance, but I am confused as to what my options are. Could you please explain the pros and cons of whole life insurance and the pros and cons of term life insurance. I live in California, I am married with a one year old, and we bring home after taxes $5000 a month. Much thanks!
First off, congrats on your choice to learn about life insurance and make that investment. Once there is a wife and child relying on you, life insurance becomes very important. Congratulations as well on your desire to learn about these things rather than taking a salesperson's statements (or anyone else) as fact. In fact, you should compare what I say here to whatever else you hear or learn. There are plenty of hidden agendas in the world of financial services so being informed and careful is very important.
A Whole Life policy (or any cash-value policy) has two components: an insurance component and a savings component. Each year as you get older, the cost of the insurance component for that year increases. As long as you continue to cover that cost-of-insurance, the policy remains in force. You can cover the cost with new premium dollars or if there is any money saved up on the cash-value component, you can use that money.
The Whole Life policy is constructed so that your premium is fixed. In the early years, most of those premium dollars go into a "cash value" account because the cost-of-insurance is low. Money saved in "cash value" is credited interest by the insurance company (and allowed by law to grow without immediate taxation). As you get older, the amount of the premium going towards the life insurance costs goes up while the amount going into the savings component goes down. Eventually, the cost-of-insurance exceeds the premium, but by then the cash value is supposed to be big enough to cover those additional costs indefinitely. (It often doesn't work out that way, BTW).
A Term Life policy gives you a designated amount of life insurance coverage over a designated "term" (period of time). The premium is fixed to cover the cost of that insurance over the life of the term and divided evenly among each year-long period in that term. Once you are in a term-life contract, the premium will not change. There is no cash-savings component to a term-life policy.
Each type of insurance has different uses for different people ... and I'm afraid I don't know enough about your situation to tell you which is more appropriate for you. Many finance "gurus" say to "buy term and invest the difference" because term insurance is inexpensive and they feel you can make more money by investing the extra premium dollars (that would be going into the savings component of a whole life policy early on) in the stock market yourself. This is because the insurance companies all charge high fees for the privilege of using their products.
Insurance advocates will talk up the tax-deferred qualities of money growing inside the cash-value policy. Those tax savings can be significant, especially if you superfund the policy by buying the least amount of insurance allowed by law for whatever premium dollars you are willing to invest. That said, the way these policies are sold by the majority of insurance people would indicate that the gurus are probably right.
One other note - you have a very young child and you will need to save for college. For that purpose alone, a superfunded cash value policy would be appropriate. Wealth built up inside one of these policies is invisible to FAFSA (the universal college financial aid form). I would strongly recommend you work with a fiduciary advisor (like a CERTIFIED FINANCIAL PLANNER) if you wish to implement such a strategy. If you choose to go the term-life route, most life agents should be able to help you find a good rate from a solid company that will pay out the benefit should something happen to you.
I hope this helps. Let me know if you need more details.
John
Posted 9 months ago by John Buerger CFP (view professional profile)
Whole life vs term insurance, what is the difference?
Posted by Anonymous in: InsuranceI am in my twenties and I am looking into life insurance, but I am confused as to what my options are. Could you please explain the pros and cons of whole life insurance and the pros and cons of term life insurance. I live in California, I am married with a one year old, and we bring home after taxes $5000 a month. Much thanks!
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Best Answer - Chosen by Asker
A Whole Life policy (or any cash-value policy) has two components: an insurance component and a savings component. Each year as you get older, the cost of the insurance component for that year increases. As long as you continue to cover that cost-of-insurance, the policy remains in force. You can cover the cost with new premium dollars or if there is any money saved up on the cash-value component, you can use that money.
The Whole Life policy is constructed so that your premium is fixed. In the early years, most of those premium dollars go into a "cash value" account because the cost-of-insurance is low. Money saved in "cash value" is credited interest by the insurance company (and allowed by law to grow without immediate taxation). As you get older, the amount of the premium going towards the life insurance costs goes up while the amount going into the savings component goes down. Eventually, the cost-of-insurance exceeds the premium, but by then the cash value is supposed to be big enough to cover those additional costs indefinitely. (It often doesn't work out that way, BTW).
A Term Life policy gives you a designated amount of life insurance coverage over a designated "term" (period of time). The premium is fixed to cover the cost of that insurance over the life of the term and divided evenly among each year-long period in that term. Once you are in a term-life contract, the premium will not change. There is no cash-savings component to a term-life policy.
Each type of insurance has different uses for different people ... and I'm afraid I don't know enough about your situation to tell you which is more appropriate for you. Many finance "gurus" say to "buy term and invest the difference" because term insurance is inexpensive and they feel you can make more money by investing the extra premium dollars (that would be going into the savings component of a whole life policy early on) in the stock market yourself. This is because the insurance companies all charge high fees for the privilege of using their products.
Insurance advocates will talk up the tax-deferred qualities of money growing inside the cash-value policy. Those tax savings can be significant, especially if you superfund the policy by buying the least amount of insurance allowed by law for whatever premium dollars you are willing to invest. That said, the way these policies are sold by the majority of insurance people would indicate that the gurus are probably right.
One other note - you have a very young child and you will need to save for college. For that purpose alone, a superfunded cash value policy would be appropriate. Wealth built up inside one of these policies is invisible to FAFSA (the universal college financial aid form). I would strongly recommend you work with a fiduciary advisor (like a CERTIFIED FINANCIAL PLANNER) if you wish to implement such a strategy. If you choose to go the term-life route, most life agents should be able to help you find a good rate from a solid company that will pay out the benefit should something happen to you.
I hope this helps. Let me know if you need more details.
John
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Posted 9 months ago by John Buerger CFP (view professional profile)
