You Don't Need Life Insurance Until You Have This

You Dont Need Life Insurance Until You Have This

13 MIN READ

You Don’t Need Life Insurance Until You Have This, by Eric Roberge

I’ll be honest with you: I’m not a big fan of life insurance.

It’s a product you pay for with hopes that you never have to actually use it. It’s also a product that gets pushed hard by salespeople who often try to use guilt and fear to give into their pitch.

That kind of pressure can set you up to make a bad decision when you go to buy a policy, and it certainly doesn’t leave room in the conversation to explore one potential possibility for you: that you don’t even need life insurance.

A life insurance salesperson probably won’t volunteer to tell you when that’s the case. Worse, you might not even know you’re dealing with a salesperson, as many people approach 30- and 40-somethings in the guise of an “advisor” when really their main goal is to sell you the biggest policy possible.

Given all this, it’s important to understand when you need the kind of protection that life insurance can provide you — and when you can skip it.

Be Aware of Potential Conflicts of Interest

As a fee-only financial planner, I don’t sell any kind of product nor do I make any kind of commission from any work that I do.

I believe this is the best way to eliminate conflicts of interest. It’s one way I can give my clients confidence that the advice they receive from me is truly in their best interest.

But not everyone in the financial services industry works this way. Life insurance agents, for example, get paid commissions based on the policies they sell.

That’s an inherent conflict: they have an incentive to sell the biggest policies possible because that’s what allows them to make the biggest income possible.

Insurance agents also don’t have to call themselves such. They can put “financial planner” or “advisor” on their business card and offer you a free financial plan… which ends in the recommendation that you buy a pricey whole life insurance policy.

(This isn’t just hypothetical. It’s the exact tactic of a number of insurance companies.)

None of this is to say that all life insurance agents are bad people out to get you (and your money), but we need to start by understanding the incentives to make sales first and consider your actual needs much farther down the priority list.

Again, you might not need the big policy a salesperson tries to convince you to buy. You might be better off with a smaller, cheaper policy — or you might not need insurance at all.

Here’s how to know what camp you fall into.

The Purpose of Life Insurance

It’s little wonder that insurance gets confusing:

  • The people selling insurance may try to sell you on a larger policy than you actually need, because they earn a bigger commission when they do.
  • There may be periods of time in your life when you truly do need insurance.
  • There are periods of your life when you don’t need insurance.

So how are you supposed to sort through everything and figure out what you actually need, from what type of policy to get to how much coverage is appropriate?

First, let’s start by understanding what life insurance is. It is a product, designed to meet a specific need. It is not an investment. It is a utility that serves a function.

Second, the purpose of life insurance is to protect anyone who is financially independent on you should you pass away and no longer be able to provide for those people.

So if no one depends on your income for their financial wellbeing… then you might not need a life insurance policy at all.

You May Not Need Life Insurance Until You Have Dependents

In other words, if you’re single, childless, and you don’t support anyone with your income, you may be able to do without spending money on a life insurance policy.

If you were to pass away, no one relies on your income — so there’s no need for anyone to receive a life insurance payout.

You can take the money you might spend on monthly premiums and save or invest it instead to grow your nest egg.

If you’re concerned about leaving something behind for a particular individual (who doesn’t need a reliable stream of income for you to get by), they could be named your beneficiary on those assets.

Again, this all goes for you if you’re single and no one is going to be financially burdened by your passing.

Things chance if you’re married, have children, or claim other dependents. In these situations, it’s time to think about your life insurance needs.

Here’s When You Need to Start Considering Your Need for Coverage

Your policy will protect these people — your spouse, kids, or anyone else that you support monetarily– and provide them with the financial means they need should you no longer be able to do so.

Minor children are the most obvious beneficiaries for life insurance policies. Anyone under the age of 18 will likely face financial hardship should their parent or guardian pass away.

In this case, the death benefit on your policy would go to your children, providing them with financial means until they’re old enough to earn their own incomes.

Some parents want to make sure adult children receive a benefit too, and that’s an option to consider. You could consider a policy that would protect your college-aged or young adult children if planned to support them through their early 20s.

And remember, it’s not just your income you might need to replace. Your spouse may need life insurance, too, even if they’re a stay-at-home parent.

If you would need to hire help to manage all the work they currently do — housekeeping, childcare, etc — then you need a life insurance policy that would provide enough of a benefit to help you pay for help in their absence.

You may also need life insurance if you’re married — even if you don’t have kids. If you have shared debts, like a mortgage, you want to make sure your spouse could easily pay off those balances even if they could not longer depend on your income to help accomplish that.

Part of a good life insurance analysis for married couples would look at the general impact of a loss of income for one spouse. For example, would they be able to maintain their current lifestyle if the household income lost your contribution to the total?

You may want to get a policy that allows the surviving spouse to maintain the standard of living you currently enjoy, so they wouldn’t be forced to move or make drastic changes in the wake of your passing.

Most People Need Term Life, Not Whole or Permanent Life Policies

Now you know when you likely need a policy, and when you can probably skip it. But how much insurance do you need? And what kind of policy makes the most sense?

As far as what type, most people who need life insurance need termlife insurance.

Yes, there are exceptions. If you are ultra-super-wealthy, whole life may be a good product to use because it can play a role in reducing your estate taxes. In some circumstances, families with special needs family members might also benefit from something like a whole life policy.

But for almost everyone else, term probably makes more sense. Whole life insurance or permanent life insurance is expensive and you can get a better solution for a lower cost through a term option.

Again, insurance is not an “investment.” It is a product. Whole life will get you a life insurance with a built-in savings account that comes with extra fees.

Any cash inside it really isn’t accessible for many years down the road (and you’ll probably get a better return on your money by simply investing it in a diversified portfolio anyway).

Finally, whole life does not expire unless you stop paying the necessary premiums. This means that whole life policies stay in place until the day you die (and you’re paying for them along the way).

Why is this a factor? Other than the cost, most people don’t need this kind of protection because most of us don’t have dependents for our entire lives.

Children grow up and become independent; we pay off mortgages and debts so there are no more liabilities; we start building assets that will also be distributed to heirs when we pass.

As that list alludes to, you don’t need a whole life policy to accomplish those kinds of goals.

Term life covers you for a set period of time, like 10, 15, 20 or 30 years. The life insurance expires at the end of the term — and you also get to stop paying monthly premiums.

It covers you for the period of time you need coverage, but then is something that can drop off your list of expenses once it’s no longer needed.

For example, a 20+ year term policy might make sense if you have young children, especially if they plan to attend college. This way you can ensure that they will have the proper financial support until they are able to support themselves after school.

Or maybe you get term insurance that matches up with the number of years left on your mortgage payment — this way, your spouse could use the death benefit to pay off that loan should something happen to you (and your income).

Insurance Serves an Important Purpose – But Don’t Get Oversold

The bottom line is that life insurance is important — but most of us cringe when we hear that phrase because we associate it with pushy salespeople who are seeking their next commission.

You can have a better experience by educating yourself first. Ask questions, do some research, or talk to a fee-only financial planner about what you need to look for when it comes to a policy.

That “fee-only” phrase is important, because it means that planner won’t sell you products or make a commission based off what they recommend which reduces the financial conflicts of interest.

The next step is to seek out only the amount of insurance you need, which will be based on things like your current expenses, your goals, and the needs of the people who would benefit from the policy. Finally, look at how long you need to protect those people for to help determine the term length of the life insurance you choose.

 

The Problem with Whole Life Insurance, by Nathan Schorsch

A common theme seems to run through most doctors lives as they progress through residency, and that’s being pitched by insurance salespeople.  The “cream of the crop” insurance product that they are all pitching is whole life insurance as it not only provides life insurance for you but also gives you a way to invest and comes with tax advantages.  This is the dream product for insurance salespeople because it sounds good to those who haven’t spent much time learning about investments or life insurance and the policies are generally very expensive. That means that the agent’s payout will be quite high as they take a commission on the sales they make, so why not try to sell the most expensive product they can?  This post will look at why you should avoid buying a whole life insurance plan from the completely biased view of someone who used to work for a large company that pushed insurance sales.

Better Uses for Your Money

This is particularly true of young doctors, but the chances are astronomical that you have better things to spend your money on than a whole life policy.  Most young doctors have student loans to repay, malpractice insurance premiums to deal with, term life insurance, a house to save up for, retirement accounts to fund, and emergency funds to set up to name just a few of the ways in which money will be spent.  Any and all of these expenditures and investments should be much higher on your priority list than a whole life insurance plan.

I have often talked about creating a strong financial foundation from which to build the rest of your goals and plans, and whole life insurance is almost the last thing I would I would recommend adding, after the space under your mattress has been filled with money.  That is a bit of an exaggeration but, as you begin to build your financial foundation is the worst time to add a whole life policy as paying off debts, building up your retirement accounts, and saving for big purchases is a far more important use of your hard earned money.  If you are in the market for life insurance, get some cheap term life insurance that will cover your needs and not affect your budget in the same way that whole life does.

Things Change

One of the constants of life is that life changes, and I don’t say that to seem deep or like I took a philosophy class in college, it is simply the truth that not everything will remain constant.  Whether that means spending 5-10 years as a pediatrician and then changing courses to go into psychiatry or it could mean that after 15 years you are simply burned out and want to completely change careers.  Whatever changes you make or end up happening, you will need to adjust your budgeting to account for the new level of income.

Say that you decide to go down to working part time in order to pursue a passion that you had not been able to indulge in previously.  With part time income comes a reduction in expenses and reduced ability to save for retirement. Being able to adjust those expenses to account for new levels of income should be part of everyone’s financial plan, and luckily most expenses can be reduced fairly easily.  However, one major expense that cannot be reduced is the premiums you pay on whole life insurance. These premiums are far higher than you would be paying for term life insurance and stay with you for life. What about if you keep your job and nothing changes on that front, but you realize that in your haste 10 years ago you bought a far larger whole life insurance policy than you needed?  Well, you will be paying the premiums on that amount of insurance regardless of how much insurance you actually. Committing to something fixed that comes with that large of a price tag simply does not make sense in a world where things can change in an instant.

Negative or Low Returns

Remember in the beginning when I said that part of the pitch is that whole life insurance also utilizes an investment component?  Well it absolutely does and that investment component can help supplement your other investments and provide great cash value for not only you but your heirs as well, or so the pitch often goes.  The problem for those who read the small print in the illustrations (and especially for those who don’t read the small print) is that the returns you’ll be getting from the investment accounts inside the whole life policy will be either negligible or negative for the first 10 or so years.  Because the cash value will be less than the premiums paid in, as the insurance company has expenses and needs to pay out that fat commission to the insurance salesperson. So, you will be in the red for a long time as you put your hard earned money into this product.

But when you cross that threshold where the cash value is more than the premiums you pay in, you’ll be set right? Well, no.  The problem is that most people are misled or confused by the numbers they are looking at and see the dividend rate as the rate of return for the investment account.  Many whole life products generate a rate of return of about 2% for the investment account which means that for years of being in the red and exorbitant premiums you paid you’ll be making slightly less than inflation.  To put that in perspective, it is almost better to put the money under your mattress because even though you won’t earn that 2% you also will not have spent tens of thousands of dollars on the product that you’ll never see again.  

The Benefits

To close out this post I wanted to take a look at some of the benefits that are pitched for a whole life insurance plan and break down what they actually do for you.  Many insurance agents are happy to tell you about all the great tax advantages that whole life insurance provides, but I want to put those in context of what else is available on the market.  

  1. Death Benefit: One of the features of the whole life insurance policy is that your heirs receive the death benefit tax free, which is admittedly very nice.  However, unless you are looking at an irrevocable trust, most inherited assets like a house or investments come with a step up in cost basis, which is a fancy way of saying tax free.  So, do not be fooled by thinking this will provide something that’s unique.

  2. Protected Growth: One of the most trumpeted benefits of the whole life plan is that your dividends/interest has tax protected growth.  This is absolutely true because the dividends/interest represent an overpayment of those expensive premiums you have been dumping into the policy.  While this does sound good, you get this in plenty of other types of accounts like a 401k or a Roth IRA.

  3. Tax Free Borrowing:  This one probably makes me the angriest because of course you can borrow money tax free, you can do that your 401k and most other accounts.  You cannot borrow the money interest free however, just like in every other situation in life. If I borrow $500 from a friend, I’m not paying taxes on that because it’s not income.  But I will likely have to pay some amount of interest on that loan.

Now we will take a look at some of the things you will miss out on by funding a whole life policy over other investment accounts.

  1. No Reduction in Taxable Income: Those with higher levels of income want to max out their retirement accounts so that it reduces the taxable income they have to pay on.  However, a whole life policy does not provide that advantage because you are paying premiums on a policy, not investing in retirement.

  2. No Loss Harvesting: Usually when you sell an investment at a loss you can use that to offset taxable gains you accrued through tax loss harvesting.  However, if you surrender a whole life policy at a loss that does nothing to offset gains, you have just lost money.

  3. Non-deductible Interest: Remember that money you borrowed from this policy that was tax free but not interest free?  Unlike most other assets you can borrow against, the interest is not deductible to you.

From my time at the large financial firm, they were insistent on pushing whole life insurance policies.  This was the best way for us to get paid as it resulted in a big payday initially and we would get what were called trails, so we could keep profiting off your insurance policy years after it had been in place.  If you are a young doctor or other medical professional and get approached by a salesperson who wants to buy you dinner and pitch whole life insurance then get the free food and pass on the policy.

This article originally appeared on Head to Toe Financial Planning

2eaa4689-36dc-41a1-b082-6cbe4292fe57-attach_headshot-eric-robergeAbout the Authors
Eric Roberge is a CFP® and founder of Beyond Your Hammock, a fee-only financial planning firm that helps professionals in their 30s and 40s use their money as a tool to live well today while still planning responsibly for tomorrow.

 

 

 

 

 

 

 

Nathan SchorschNathan Schorsch was raised by two doctors and this has helped give him a basic understanding as to how hectic life can be in the healthcare profession. Now as the spouse of a nurse, he has an even better understanding of what that means. Nathan started Head To Toe to serve young practitioners with a focus on their most relevant planning needs, such as student debt management, financial planning, and investments. By helping his clients organize, prioritize, and automate, their focus can remain on what matters most: their patients, their families, and their well-deserved recreational pursuits.



 

 

 

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