By Stephen Kyne, CFP
Life insurance can be an important part of your financial plan, but do you know what kind of insurance is right for your needs? Insurance comes in many forms, and many people have the wrong type of insurance, and aren’t insuring their need in an efficient way. That means they may be needlessly overspending.
There are two basic types of life insurance: permanent and term. We’ll discuss each of these, how they may be best used, and how not to use them.
Term insurance is temporary, and is intended to cover a temporary need. You can buy a policy which covers a duration from one to forty years. These policies typically include a level premium for the duration of the policy, so they are easy to budget since the premium will not increase during the term.
Believe it or not, most needs for life insurance are temporary. Whether you need insurance to provide protection in the event you die before your children are grown, or you need insurance to replace income during your working years, these needs are both temporary since your career will one day end, and your children will, eventually, one hopes, leave the nest.
From a purely economic standpoint, once you stop earning money and your children are grown, the risk that your death poses to your family may be none, meaning your need for insurance may end.
Most term insurance is also convertible to a form of permanent insurance at some point so, if your need becomes permanent, you can convert the policy to fill the changing need.
Permanent insurance includes whole life and universal life. You may also have heard them be referred to as “cash value life insurance,” because they include a savings component in addition to the death benefit. These policies are intended to cover permanent needs.
Permanent needs for insurance are far fewer, but it is important to recognize and cover them.
A common need for permanent insurance is an instance in which one spouse elects a single-life only pension. In other words, if that spouse dies, the pension would end. In this case, it may be necessary to buy life insurance policy to replace the lost pension, and since we don’t know when that spouse will die, the risk continues indefinitely, and term insurance would likely be insufficient.
Creating a legacy at the death of you and your spouse can be another use of permanent insurance. In this case, we utilize a special type of insurance called second-to-die insurance, which pays out at the death of the second insured.
Since the policy pays after the second death, this type of insurance is less expensive than insuring a single spouse alone. A permanent policy is important here, again, because we don’t know how long you both will live, and you need the insurance to be in-force whenever death occurs.
For both the pension and estate needs, your concern is primarily surrounding death benefit, so consider utilizing a permanent policy that provides a guaranteed death benefit, but no real cash value accumulation, since you’ll likely never want to access it. Just as with term, you want to pay for the utility of death benefit, since that is what life insurance is first and foremost—the only difference is duration of need.
As a financial advisor, too often I see clients with the wrong type of insurance to meet their needs. Most often, this means clients have permanent insurance policies when they only have a temporary need, sold under the premise that the cash value will be available to fund education or retirement goals.
Adequately funding the “cash value” portion of a permanent policy can be very costly, leading many people to eventually underfund their policy. What may have been initially illustrated as a great vehicle for future savings, usually ends up an emaciated waste of premium dollars. Unless you have exhausted all other savings vehicles for retirement and education planning, it may be unwise to consider permanent insurance as a reasonable avenue for savings.
As the saying goes, and unless you have a permanent need, “buy term, and invest the rest.”
The best piece of life insurance advice is to work closely with your independent financial advisor, and be sure that any life insurance strategy is based on a thorough understanding of your needs and budget. Keep it simple, and buy life insurance for its utility, first.
Kyne is a partner at Sterling Manor Financial in Saratoga Springs and Rhinebeck.