No, you don’t need permanent life insurance
Just because you have a need for life insurance, does not mean you need a permanent life insurance policy.
If you have anyone, like a spouse or child, who depends on your ability to generate income or provide services, you likely will have a need for life insurance.
If you are no longer here, your ability to generate income stops.
Your family's expenses, on the other hand, do not.
The amount of insurance you would need is dependent on the deficit that arises from your income no longer supporting your family (& your current & future debt).
For example, if you have $6,000/mo in expenses you’re responsible for, you will need about $1,120,000 to invest assuming a 5% after-tax rate of return with 2% inflation.
Since many individuals don’t have $1,120,000 lying around, they choose to purchase life insurance to cover this risk to their financial plan.
The two ways to cover this risk are term insurance or permanent insurance.
Term insurance covers a specific time period (or term) with a promise to pay if you die. After the term period ends, the insurance premiums stop (& with it, the insurance benefit).
This is the cheapest & most cost-effective way to insure the risk of premature death.
Using our example above, a 30-year $1,120,000 term policy for a healthy 30-year-old would cost roughly $49.5/mo.
Insurance is meant to cover a specific risk, for a specific period.
Outgrowing your need for life insurance is expected.
The highest need for life insurance is at the beginning of your adult life.
High expenses + low financial capital = increased insurance need
Your insurance need steadily falls to near 0 as you transfer your working human capital into investment capital (or your savings).
Lower expenses + high financial capital = lower insurance need
Based on this trend, it’s important that you choose the appropriate type of insurance to cover this risk.
For 99.99% of individuals looking to cover the risk of a premature death, term insurance makes the most sense.
On the other end of the spectrum, there’s permanent insurance.
Permanent insurance does not expire and provides both a guaranteed death benefit and a cash value.
When you pass, assuming you’ve consistently made your premium payments, the policy pays out the death benefit upon your passing.
The cash value inside the policies accumulates over time. From which, you can loan against to fund new investments or current lifestyle (but must pay back with interest).
There are various types of permanent insurance. The most common are:
Whole life
Most basic permanent insurance. Pays a death benefit plus accumulates cash value.
Variable life
Pays a death benefit plus cash value is invested in a separate account to be invested in stocks, bonds, etc.
Universal life
Similar to whole life but with more flexibility of premium payments.
Variable Universal life
Pays a death benefit plus cash value is invested in a separate account to be invested in stocks, bonds, etc. and offers flexibility of premiums payments.
The concerns arising from permanent insurance policies are as follows:
Commissions paid to salesperson are high.
Your monthly premium is significantly higher with permanent insurance.
The returns on your cash value are meaningfully lower than you could receive elsewhere.
Commissions paid to a salesperson on a permanent insurance policy range from 50%-105% of the first year’s premium on the policy (compared to 30%-70% for term).
If you purchased $1,120,000 in whole life insurance your costs would be roughly $1,033/mo or 95.2% more expensive than term.
Commissions paid to who sold it:
Whole life = $6,198 - $13,015
Term = $178.2 - $418.8
There isn’t anything wrong with commissions but knowing there’s an incentive to sell a larger permanent policy is good to keep in your back pocket.
What if you invest the difference in cost savings ($983.5/mo) from choosing a term policy relative to a permanent policy over the life of the term?
$983.5/mo earning 7%/yr for 30-years turns into $1,199,841.47.
For comparison purposes, the average growth on a cash value policy is ~2%/yr (depending on the provider) which yields you $484,595.42 of cash value.
Total savings?
$715,246.05
But what about the cash value? You get to access that, right?
As your permanent policy grows, you’re able to take a loan against your cash value.
If you fail to make premium or interest payments and the policy lapses, you’ll owe ordinary income taxes on the loan amount and on the remaining cash values (minus the amount of premiums paid during the life of the policy).
There are alternatives to access similar loaning capabilities.
If you own a brokerage account, you can open a securities backed line of credit (SBLOC) which provides similar loaning capabilities as a whole life policy.
Is this to say permanent life insurance is never a good idea? No.
Is this to say permanent life insurance is rarely a good idea? Yes.
In the rare case you have an estate tax concern, meaning your net worth is greater than $12,060,000 in 2022, then permanent insurance may make sense for you.
Reason being individuals with a net worth over the estate exemption limit are taxed at 40%.
To mitigate this 40% estate tax, many wealthy individuals may purchase a whole life policy titled in the name of an irrevocable life insurance trust (commonly called ILIT) so the death benefit is free of estate taxation.
When making decisions, always look through the lens of conflicts of interest & biases.
When someone is giving you advice, ask, what’s in it for them?
Someone can give you advice and it comes from the best place. They could REALLY want to help you.
But if they don’t have the education or their scope of work is limited - so will their advice.
Who you get your advice from matters.