How Much Life Insurance Do I Need? – Part 2

Let’s pick up where we left off last week……..

The Downside:

Since an IUL is permanent life insurance, there is a 100% probability that a person will pass away. It is inevitable. Insurance companies charge for this inevitable outcome. IUL’s are about 10X more expensive that a term insurance policy for the same amount of coverage.

Plus, there are front-loaded administrative fees and surrender charges that are built into complex crediting rate calculations. Fees can be very high and can take a long time to recover from. Most people back out of the policy in the 1st 7 years. As the policy progresses, the fees become more manageable.

This type of policy is a long-term investment. If choosing to purchase one, assume you’ll need 10-20 years to make it worth your while.

Also, costs can also vary from insurer to insurer so make sure to do your homework.

A few fees to watch out for include:

Premium Expense Charge – deducted from the premium before it is applied to the cash value

Administrative Expenses – deducted monthly from the cash value of the policy

Insurance Costs – additional deductions taken from the policy to cover the death benefit, supplemental benefits, and riders

Fees and Commissions – some policies charge upfront fees for setting up and managing the account

Surrender Charges – the amount forfeited if the policy is cancelled or if loans / withdrawals are made. In some cases, it could potentially also reduce the death benefit.

Next, the gains on the index are capped and limited by the insurer. While the floor is protected (good for you), gains also have a cap (not so good for you). If the index goes above the cap, not only do you get paid, the insurance company keeps any gains above the cap.

Another disadvantage is the minimum health requirements. While requirements are not extreme, if you do not qualify, a person cannot purchase a policy.

Also, a person needs to keep paying the premiums to keep the policy in force. When this happens, a person risks losing all previously paid premium as well as the death benefit.

For example, when a policy holder tries to surrender the policy, the insurer might keep the entire 1st year’s premium since commission costs were already paid to the agent who sold the policy.

Lastly, be wary of policy projections. Ensure the projections seem realistic since the projections are not guaranteed and may not come to fruition. Do a worst-case analysis and ensure you understand worst-case projections to determine if the IUL policy will meet your needs, be profitable, and worth your time.

Whole Life Insurance – Pro’s / Con’s

The Benefits:

The benefits of whole life are similar to IUL.

For starters, whole life insurance has both a death benefit and the ability to build a cash value within the policy. Like universal life insurance, whole life has benefits for both the insured AND the beneficiaries.

Whole Life Insurance

First, the most significant advantage of whole life insurance is the potential for stable, extremely safe, risk-free growth in the cash value.  Gains are not as high as other types of financial products including traditional universal or IUL policies.

The interest rate is usually between 4-6% every year guaranteed. The rate is not dictated by the stock market in any way, shape, or form. This is because the rate is dictated by the insurance company and the policy is a legal contract with the insurance company.

On top of that, a lot of insurance companies also provide dividends on top of the interest rate. This is usually between 1-3% and is not guaranteed. Ensure the company has a history of providing dividends before counting this into your calculations.

Depending on the insurance company and policy signed, the overall rate of return can be between 5-9% every year. While this rate of return on the low end can be topped by investing in index funds, the rate on the top end is comparable. Plus, this rate of return is consistent, year in and year out. It is as constant as death and taxes.

Second and like IUL’s, there are huge tax advantages with overfunding a whole life policy. Like IUL’s, money already taxed at current rate (“seed”) is added to the policy. Money can be taken out tax-free via withdrawals and loans (“tree”) against the policy.

Like IUL’s, loans on the other hand have huge advantages. Loans are not taxable and does not impact the accumulation of the cash value.

Unfortunately, the loans must be paid back BUT YOU set the terms! In other words, you set the monthly payment. There is interest on the loan and is typically equal to the interest rate provided to the policy.

This opens up ALOT of possibilities especially for paying off high interest loans (i.e. credit cards) ….. more on that later.

Third and like IUL’s, riders can be purchased to benefit the living such as critical illness protection (i.e. heart attacks, cancer, stroke, kidney failure, etc.), accelerated death benefits, overloan protection, terminal illness protection, waiver of premium, child riders, long-term nursing home care, etc. Investigate not only the policy rates charged by the insurance company but also what other riders and perks are available. These may be even more valuable than the policy itself.

Fourth and like IUL’s, when a permanent insurance policy is purchased, an asset is being purchased. It builds equity over time. This asset can be bought and sold like any other commodity.

There are several websites offering to buy whole life policies from individuals. Also, the policy holder can also cash out the policy with the insurance company (called cash out surrender value) This offers options later in life if a person decides to opt out of the policy. The policy can be cashed out one way or another and you get the cash value from the policy.

The Flip Side:

Now for the other side of the coin. Whole life policies are very expensive. Like IUL’s, this is permanent insurance so insurance companies will price for it.  In general, whole life is about 15x more expensive than term life insurance for the same amount of coverage.

Second and like IUL’s, there are front-loaded administrative fees and surrender charges. Fees can be very high and can take a long time to recover from. Most people back out of the policy in the early years.

This type of policy is a long-term investment. If choosing to purchase one, assume you’ll need 10-20 years to make it worth your while.

Third, whole life policies only pay on the death benefit. A person will lose any cash value leftover upon demise to the insurance company UNLESS a special rider is purchased. Ensure you know the policy details before purchasing.

Fourth, there are minimum health requirements to qualify for the policy. While requirements are not extreme, if you do not qualify, a person cannot purchase a policy.

Lastly, a person needs to keep paying the premiums to keep the policy in force. A person risks losing all previously paid premium as well as the death benefit if the policy is not kept current.

What Should I Do?

With all these choices what’s a person to do? Well, let’s first figure out how much coverage is needed before we make any decisions.

The rule of thumb is to have 10X a person’s salary in life insurance. I question this logic. For starters, everyone’s needs are different.

For example, if single, a person will not need as much coverage as a person who is married with kids. For a single person with no kids, 10X salary would be enough to meet their needs of covering funeral expenses and provide some extra income for family members.  This type of person can probably get by with term insurance only.

If married with kids, the needs are totally different. You must think about ensuring there is enough income to protect the kids and provide for them throughout college. If both parents work, then both parents should have insurance coverage. Plus, coverage should be based on the combined income of both parents.

For example, assume the combined annual income for both parents is $100,000 and that 95% of this income goes toward living expenses. If they follow the 10X rule, they would get a combined $1M in coverage. Sounds like a lot, right? Wrong.

Assume the kids are currently 6 and 8 respectively. Getting $1M in coverage only provides sufficient income for the kids until ages 16 and 18 respectively. What about getting them thru high school?  What about college or vocational training? What about leaving them something to get started on their own lives? A $1M in coverage won’t cut it.

In this case, getting 20X in coverage would equate to about $2M. With $2M in coverage this would be enough to payoff the house, get them thru college, and started on the right path in their adult lives. The downside using term to cover the entire $2M is it will only last 20 years, maybe 30 years if you can find a good policy. Could IUL or whole life help with the coverage?

A third scenario is what about a person looking to get insurance coverage for when they may need long-term care in their later years? What about protection against critical illness if there is a history of cancer in the family? For these people, IUL and whole life policies have merit.

A fourth scenario is what about protecting your assets in case of stock market crashes? As I wrote previously here, protecting your assets against market crashes is a must. Utilizing IUL’s and whole life policies can help with that. If designed properly, an IUL can provide consistent payment that acts like a pension AND provides death benefits for your loved ones.

The choices are endless… what if still confused? Let’s use my life situation as an example.

Here’s My Strategy

Here is my situation, I currently am the sole income provider in the family and have been for most of the last 15 years. I have 2 of my 3 kids in elementary school and the 3rd is an adult with special needs who currently lives in a group home.

So here is my strategy:

I started by maxing out my company provided term insurance which was equal to 10X my current salary. This allots about 60% of my target coverage.

Next, my company also provides, for an additional fee (though VERY cheap), up to $250K in term insurance for my wife. Even though she does not work, if she were to pass, I would need to provide day care, nanny services, and college. This doesn’t cover the complete bill and we’ll get to that in a bit.

Next, I wanted coverage not only for life insurance but also long-term care and critical illness. This is where IUL and whole life come into play. I purchased both IUL and whole life policies to obtain this coverage and purchase additional life insurance. From both these policies, I obtained about 30% of my target life insurance coverage plus living protections against major illness and elderly care coverage.

The other great benefit of the IUL is that I designed it with minimal insurance coverage and maximized the cash value. In 20 years, I’ll have enough cash value built up to keep it self-sustaining the rest of my life PLUS develop a steady tax-free payment stream that will act like a pension.

For the whole life policy, I designed it to be similar except, I treat the whole life policy like a “super piggy bank”. I’ll use the loans on the policy to payoff my high interest debt and accelerate my journey to financial independence. I am following a strategy called Cash Flow Banking. I’ll write about my experiences with this in a future article.

The remaining 10% of my target insurance coverage I purchased using a term insurance policy from the same company that I purchased the IUL from. The great thing about this policy is that it is convertible.

This means that when the term expires, I can convert this into the IUL. This converts it to permanent coverage, and I do not lose out on all the years of premiums I put into the policy.

Finally, my wife also bought an IUL policy with a convertible term policy just like I did. This completes our coverage. Combined, we have over 20X income coverage, long-term illness protection, and retirement / savings instruments to augment our financial plan.

Below is a visual of how I structured my policies. At the core is whole life because of its many benefits especially Cash Flow Banking capabilities followed by IUL to supplement retirement with term insurance providing most of the coverage because well, it’s cheap! 😊

Life Insurance

Final Thoughts

Whatever insurance policy decided, ensure it is with an A+ (or higher) rated mutual company (key!!) that has been around for at least 100 years. Reason for this is you want to work with a company that has been through all the tough times and thrived (i.e. Great Depression, WWII, Great Recession, etc.).

Next, understand what your goals and intentions are for the life insurance. Do you want pure coverage? Is long-term care a priority? Do you need protection against market pitfalls? This drives what types of coverage that is acquired.

If single, buy at least 10X salary and investigate using IUL’s / whole life to supplement your retirement portfolio.

If you have a spouse and family, buy enough coverage to cover kids going to college and maybe even some of their wedding expenses. Buy a minimum amount of coverage that is equal to 20X of your combined salary. If can afford it, ideal situation is 30X combined salary. Don’t go short on coverage because this is the lifeline the family needs to survive and thrive.

Make sure to have coverage on spouse even if they do not work. You will need to cover daycare expenses, payoff mortgage, summer camps, college, nanny, etc. Use this to take pressure off yourself. You’ll have enough on your plate so give yourself some financial breathing room.

Ensure you have up to 70% of total coverage in term insurance. It’s cheap! If offered, max out work term insurance (SUPER cheap!). If there is still a shortfall, buy a term policy outside of work that can be later converted to IUL when term expires. This way you can still take advantage of the premiums paid later in life.

Next, have 20% of total coverage in IUL. Get small amount of coverage and overfund it.  It will allow you to save tax-free money towards retirement and create a steady tax-free income stream much like a pension. Also ensure you have riders attached to cover unexpected life events (i.e. long-term care, cannot take care of yourself, kids born with malady, etc.)

Lastly, have 10% of total coverage in Whole Life. Get small amount of coverage and overfund it. Because of the lower yet super reliable interest rate, set it up like a “super piggy bank”. Use Cash Flow Banking to payoff debt faster, take out tax-free loans to invest in hard assets (real estate, businesses, etc.), and make it count!  It will build up your net worth faster and more efficiently. Ensure you have riders in place to have beneficiaries get cash value benefit and to cover your unexpected life events.

So what do you think? Agree? Disagree? Let me know what you think…….

Live the Life You Love, Want, and Deserve! 😊