Life Insurance 101
In this episode of the Mind of a Millionaire podcast, our associate advisor Austyn Garcia joins me to discuss life insurance—the different types, who needs it, how to assess your needs, and when it’s appropriate to self-insure.
At Denver Wealth, our advisors are independent insurance agents. We shop top carriers for the most suitable coverage at the lowest prices. If you need help assessing your insurance needs or comparing quotes, call our team at (303) 261-8015 or schedule a free consultation on our website.
TERM VS. PERM
When it comes to insurance, the first decision you’ll make is what type of insurance you’ll need. And while there are plenty of various policy styles, there are two main types of insurance: temporary (term) or permanent (perm).
Life insurance can be a challenging topic to address due to the morbid nature of the conversation, but it’s essential. We like to describe it as a necessary evil—you hope to never need it, but it can be crucial in the unfortunate (and unlikely) event that you or your spouse pass away prematurely.
If you’re a young professional just beginning your investment journey, you likely have some liabilities and dependents. Perhaps you have a couple of kids, a stay-at-home spouse, and a mortgage. People rely on your income. If you were to pass away, insurance is an opportunity to decrease some of the financial burden left upon your family.
Generally speaking, the higher your liabilities, the more insurance you’ll want. If you have a $500k mortgage, it may not be a bad idea to have at least a $500k term insurance policy. If you pass, your family can pay off the home.
So, how does term insurance work? I like to think of a term policy as renting insurance—again, the hope is that you’ll never need to use it.
You select a timeframe or “term” (usually 5, 10, 20, or 30 years) and a benefit amount (the amount your beneficiaries would receive if you passed within the term). You may go through some medical underwriting, and based on your health classification, you’ll receive a quoted, usually fixed, premium amount.
Let’s put that into context. We ran quotes for the following hypothetical investor:
- Insured: 25-Year-Old Female
- Death Benefit: $500,000
- Term Length: 30 Years
We explored two health classes, preferred best non-tobacco (best) and standard non-tobacco (regular). If the hypothetical insured were as healthy as possible, she might expect to pay around $23 a month in insurance premiums for the next 30 years. If she fell into a regular health class, she would pay closer to $43 per month.
That is only a hypothetical—please reach out to your qualified financial or insurance professional regarding your specific situation.
One other note on term insurance is that while many policies are fixed (you pay the same benefit for the entire term), there are different policies with increasing or decreasing premiums.
Permanent insurance—“perm” as the cool kids say—is just that, permanent. You may see it referred to as “whole” or “straight” life. We don’t sell many perm policies because they have significant drawbacks and are only suitable for a select few. Though the contract never expires, between now and age 100, the premium will continually increase.
Here’s how it works: let’s say our hypothetical investor buys a perm policy at 30 years old. He may pay $200 per month in the first year. Of that $200, $25 goes toward the actual cost of insurance, $25 is a premium charge (policy expense), and $150 goes into a savings account within the policy.
An agent may tell you, “the reason we save into a separate savings account is so the bucket will rise in value.”
Realistically, the cost of insurance goes up every year, eating into that savings bucket. For most insureds, by the time you reach 80, your rising insurance cost has depleted the savings bucket, leaving you to pay the total expense out of pocket.
None of this is to say that a permanent policy is wrong for you. Insurance should be custom and a conversation to have with your financial professional.
A PERM HORROR STORY
That scenario played out for a client of mine. Please note, I didn’t sell the policy to him but saw how it impacted him in his later years.
Let’s say our hypothetical perm customer lives to 90 years old, and he’s still kickin’! Since he purchased the policy, the premium has slowly crept up, month-over-month. Well, insurance for a 90-year-old is not cheap; think $25k-$50k per year, all of which comes out of your pocket because of the likely valueless separate savings account.
Now, at 90 years old, our investor is faced with a dilemma: does he continue to pay the significant premiums, or does he cancel a policy that he’s paid into every month for 60 years?
At this point, one option may be to purchase a “paid-up” policy. Let’s say our hypothetical investor has $50,000 in his policy’s savings, and he’s on the brink of substantially rising insurance costs. He can reach out to his agent and ask how much coverage he could afford with a one-time payment of $50,000.
Depending on your age, that paid-up death benefit may be less than your current policy; however, it may be worth avoiding the substantial monthly premiums.
BORROWING AGAINST YOUR POLICY
Yes, you can borrow against the cash value of your perm policy—something you may have discussed if you’ve explored whole life insurance options.
Though that’s true, it’s a very cumbersome way to access cash. You have to make payments on the borrowed principal plus interest. And since you’ve taken money away from the cash value, you won’t have as much going toward the increased insurance cost.
WHO NEEDS INSURANCE AND HOW MUCH?
Anyone with dependents.
If you’re the breadwinner in a household, your spouse may depend on your income. If you have minor kids, they likely depend on you. If you’re a “key person” in a business, your employees depend on you.
On the other hand, young single investors usually aren’t financially responsible for others, so we probably won’t recommend insurance. However, some folks are concerned at the prospect that they may become diagnosed with an illness or disease, precluding them from receiving insurance in the future. That is a risk, and one to be taken especially seriously if you have a family history of illness.
When it comes to calculating an amount of appropriate coverage, we like to use a field goal analogy (below). The left upright represents our minimum amount of recommended coverage: your total debt plus one year of income.
If you were to pass away, the minimum amount would help your family pay off any debts and offer a 12-month cushion to get back on track, whether that’s looking for a new job or perhaps exploring day-to-day childcare options.
The opposite upright represents the maximum—10-to-15-times your human life value (HLV). Put bluntly, HLV measures your economic value to your family. Add your income, insurance benefits, and retirement match, and inflate it over the life of your career to calculate your HLV. It’s a big number.
Dave Ramsey suggests ten times your earnings. We recommend a little higher than that; however, the appropriate amount of insurance is subjective. Ultimately, it’s your surviving spouse who should feel comfortable with the death benefit. As a financial advisor, I’m happy if you kick between the uprights.
LISTENER QUESTION OF THE DAY
Our listener question of the day is par for the course: how can I best prepare for an insurance medical exam?
To answer this, I want to start by addressing tobacco and marijuana use. Our quotes earlier reflected premiums for a hypothetical non-smoker. Tobacco or marijuana use can drastically alter the cost of insurance; however, not all insurance providers view the two substances the same. Some insurance providers consider marijuana use similar to tobacco while others view it as an illegal substance—I recommend first speaking with your agent about the various providers’ viewpoints.
On the day before your medical exam, do things to decrease your blood pressure. I don’t recommend misrepresenting your lifestyle; however, if you’re like me, you’re heart rate will increase at the very idea of having a stethoscope on your chest.
Avoid caffeinated beverages. Avoid intense exercise. Drink plenty of water. Limit salt intake. Limit alcohol consumption. And get a good night’s sleep.
FINAL THOUGHTS AND OTHER OPTIONS
I gave you a lot of information today, so I’ll leave you with a few parting words and alternative insurance options.
One thing we spoke more in-depth about in the podcast was self-insurance. Our goal is to grow our clients’ assets to a level where conventional insurance is no longer needed—another reason we like term policies. If our 30-year-old hypothetical investor buys a 30-year level term policy, at 60 years old, their home should be paid off, and they should have significant retirement and non-retirement savings.
Assuming your children are no longer financially dependent, your savings and investments should suffice to cover your spouse’s expenses if you were to pass away. That’s self-insurance.
If you have any insurance questions, please call our office at (303) 261-8015 or schedule a free consultation on our website. We are happy to help you explore your options, assess your needs, and run quotes.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Denver Wealth Management, Inc., a registered investment advisor. Denver Wealth Management, Inc. is a separate entity from LPL Financial.
This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. Please keep in mind that insurance companies alone determine insurability and some people may be deemed uninsurable because of health reasons, occupation, and lifestyle choices.