Understanding Insurance - Part 2

Our 6th Type of Insurance is

Life Insurance

I always thought it was odd that they call it life insurance since it insures your death, but in any case, it is definitely an insurance that most people do not understand. In fact, most people have no idea what kind of life insurance policy they own, which violates our last class to not buy anything you don’t understand.

Now this is probably going to tick some of you off, but that’s okay because I’m giving you the best information from the best sources, and I’m interested in telling you how you can win with money.

There are 2 Types of Life Insurance: Term Life (for a specified number of years) and Cash Value (for your whole life).

Cash Value Insurance

75% of people in America have this type of insurance. Why? Because it is what the insurance agents push the most. Which should throw up a big red flag right there, but for some reason it didn’t.

The premiums are higher because it covers you throughout your entire life and because the policy has a savings account attached to it. It builds cash value, thus the name "Cash Value Insurance." Part of your premiums are invested to gain cash value that you can take out. Many people see this as a way to save for retirement.

Often you will hear, "Term life is like renting, but cash value is like buying a home." Of course, the people saying this are the agents who want you to buy it…but hey…

There is a big myth floating around out there that we need do debunk right now.

Myth: The need for life insurance is a permanent situation and is ever growing.
Truth: The only ever growing and permanent situation is the agent's need to make more money.

Nothing is permanent about insurance! If you get a 20 year level term life insurance policy, just think about where you will be in 20 years. In 20 years, when the kids are grown and gone, the house is paid for, you're debt free (because you've been doing this plan), you're sitting on a nestegg for retirement plus your emergency fund....you are then self-insured. There is no need for life insurance at that point.

Don't believe me? Well, I'll use my family as an example. My husband and I are 28. We have 3 kids (ages 3 1/2, 2, and 9 months). In 20 years our children will all be adults and will hopefully be out of the house. We will be debt free next year, the house will be paid for by 2012, and we'll have approximately $250,000 invested by 2029 (not including our fully-funded emergency fund). If my hubby dies after the next 20 years, I think I'll be able to muddle through life debt free, no kids at home, and a nestegg.

In 20 years, we will be self-insured.

So, let's compare apples to apples:

For $100 a month, Jon can buy about $125,000 of cash value life insurance. It builds cash value that he can take out. In 20 years, it'd be worth about $22,000. That sounds pretty good.

However, Jon can buy $125,000 of term life insurance for about $9.00 a month. He can invest the other $91 and have about $47,000 in 20 years. That sounds a lot better.

Now there are 2 problems with his example. 1. No one is going to want to write a $9.00 a month life insurance policy, and 2. He does not have enough insurance. If he dies, and his wife invests the money (and let's just make it easy and say she can get about 10% in a good growth stock mutual fund), the she would only have $12,000 a year to live on without draining the nest egg. I don't know many people who could do that. I could probably come close, but even then it'd be VERY VERY difficult and we'd REALLY have to sacrifice and scrape by.

HOW MUCH DO YOU NEED??

You need 10 times your annual income, so if you make $40,000 (which is what we’ll say Jon makes), then you’d get $400,000 of life insurance.

A full time mom brings economic value to the home, which is why she needs life insurance as well. She needs to have close to what her husband would have, as it would need to offset the things that she does. If I were to die, my husband would have to bring in Marry Poppins to take my place…and I hear she doesn’t work cheap. So, the husband would have daycare expenses, higher grocery expenses (because he’s not used to doing the shopping, couponing, cooking, etc), and he’d have to find ways to pick up all of her jobs too. So, a stay at home mom brings economic value to the home.

Now, don't get so much that you have to sleep with one eye open. My BIL brags about his $1 Million policy (in whole life) and says that he’s worth more dead than alive. He makes about $40,000 a year, and his premiums for that $1 Million policy are beyond outrageous. He is beyond over-insured. Do not get caught in that trap.

So, let’s give Jon the right amount of coverage.
$400,000 for Jon of Term Life Insurance is about $25.00 a month. He can take that $75 a month he’d be saving in not paying whole life or cash value insurance and invest it. In the event that he dies before the 20 years are up, his wife gets $400,000. At a 10% investment return (as I said earlier) she'd be able to live on $40,000 a year - which is what he makes. Ooops, looks like we just replaced Jon.

If Jon takes out that $125,000 cash value insurance and pays $91 too much every month, and 20 years go by and he has $22,000 of cash value on his policy and he dies. Then what happens to the cash value? Does Jon’s wife get $147,000?

Nope…she still gets $125,000….the company keeps the other $22,000. Doesn’t seem very fair, does it????? That's what I call a RIP-OFF! Since none of us know when we're going to die, how often do you think people actually take out their cash value? I'd venture to say that more often than not, the company gets to keep the cash value. After all, look at their big beautiful buildings. Those aren't cheap and I'm sure they've had a lot of cash value to buy them with.

Cash Value (whole life) is the worst financial product on the market today, but the companies are getting sneaky so they've come up with 2 newer models called Universal Life and Variable Life. They claim that Universal Life yeilds about a 4.5% return on the cash value, and that Variable Life yields about 12-14% on the cash value. And they do; however, these policies walk down a hallway and people take out fees left and right. Fee, fee, fee, fee...it sounds like a french poodle there are so many fees. So, after all the fees, you can expect about half of what they say you can get - IF you are lucky. And that's only if you happen to cash out your cash value before you die.

If you have these types of policies, cash out their value and invest the money elsewhere. Dave Ramsey says, "You are always better to stick with a 20 year level term life insurance policy, and do your investing outside of the insurance company." Money Magazine, Newsweek, the Wall Street Journal and more agree with him.

Life Insurance Summary

Never buy cash value: returns are low, cash value is kept by the company if you die, premiums are too high, and only agents think it is a good idea.

Buy Term Life Insurance: low rates, invest the difference in premiums so that you can become self-insured.

Now if you are over 45-50, and you have a whole life policy, then I’m not saying you need to go out and cancel it. I’m saying that you should pull your cash value from it, and invest elsewhere – maybe a good growth stock mutual fund. That way, your cash value won’t be forever gone when you die.

If you are debt free, have no house payment, have no children at home, have a substantial nest egg, have investments, and are self-insured….then drop the policy.

If you have debt and are over the age of 50, then you may have to stick it out with your whole life policy until you can be self insured.

But for those of us who are younger, the time is not to get some quotes on some good 20 year level term. If you are doing everything I’m teaching you and that Dave’s telling you to do, and you’re really doing it….then in 20 years, you will be self insured and you will not need to pay for life insurance for the rest of your life.


Avoid These Types of Insurance

Cancer Insurance - healthcare covers cancer too.

Accidental Death Insurance - You're not double dead because it was an accident.

Life Insurance on Children - You know, those Gerber policies. Avoid them….they are not a good investment. Instead, put your child’s money away and invest it yourself. They will have a much better return and won’t be sucked into buying cash value life insurance. As I mentioned, we do have a $15,000 rider on our life insurance policies to cover the burial costs of our children, should it be necessary. It’s not very expensive at all – since it’s a term policy, and we know that everyone in the family is taken care of, until we can be self insured.

Credit Life & Credit Disability - it's 90-100% more expensive than regular term life insurance.

Credit Card Protection - seriously, you want to protect your credit cards??? It's just another way to rip you off.

Pre-Paid Burial Policies - invest the money instead of parking it at the funeral home.

Mortgage Life Insurance - the face value decreases as time goes by because your mortgage goes down. Instead, put a sticky note on your life insurance policy that says, "Babe, pay off the house."

Duplicate coverage - it's never a good idea because the 2 will fight over who the primary provider is and no one will ever pay.

Pet Insurance - that's what an Emergency Fund is for, and seriously, if fluffy is going to cost you $10,000....it might be time to put fluffy to sleep. It's a pet.


One last thing I want to talk about insurance is that you cannot convince someone who has already made up their mind about it. There is no telling my Brother in Law that his policy sucks because he's being ripped off.

And you cannot go into your agent's office and try to convince him that he ripped you off, or that he should switch to term life insurance. Why? Becuase him realizing the truth of this would not only make him have to re-evaluate the way he thinks, but he'd have to look for a new line of work. So, just fire him and move on.