How One Decision Can Secure Your Financial Future Today.
Wait! Life Insurance is really important and not as boring as you think it is.
Not sure why... but this is the image that came to mind for the most part when I heard "Life Insurance". Some guy who hates his sales job and shows up every day to scare people into giving their money over to this big company for something they never benefit from.
Then I got some for myself.
Turns out, life insurance is an interesting multi-purpose financial product that, if set up correctly, can be extremely beneficial to you in the short to medium term.
Didn't we go over this literally the other day?
On Monday, we introduced the concept of insurance and the fact that there are many different factors that change the risk of the insurance company having to pay out money in a given year - and thus the price you pay.
Today, I want to take a deeper dive into life insurance and explain why getting some sooner rather than later is a very good idea for people younger than 30.
Types of Life Insurance.
Today, we'll talk about both: Term Life and Whole Life. Within these categories, there are different types, including Mortgage, Accident, and Participating, that we will touch on briefly.
How are Premiums (Policy Costs) Calculated?
The insurance company adds together the cost of operating the business (Cost of Goods Sold for any business majors in the room) along with the dollar cost of risk associated with insuring the individual buying the policy. This is normally charged on a monthly or yearly basis.
Term Insurance.
As the name suggests, this type of policy covers your life for a limited amount of time (term). These can last for any amount of time but most commonly 5, 10, 20, and 30-year periods. Policies with longer terms are more expensive per month because at the end of a longer term, you will be older and, therefore, have a higher chance of death.
Term insurance is for people who have debts or other major expenses they are responsible for. For example, a parent who wants to sponsor their child through university may have a term life policy that ends when the child turns 18-24 (the time when you should have enough saved or they can take care of it themselves).
Another example is people with mortgages. No one wants a huge debt outstanding on their house that they can't pay, so it's common to have another term policy running until the time when payments should theoretically be finished (usually corresponding to a 20-30-year term).
Scam Alert.
One important thing to note at this stage is that people at banks who sell mortgages (yes, they are sold; "Wealth Advisors" get commissions on them) will almost always try to sell you Mortgage Insurance. I need to warn you that this is categorically a SCAM.
Mortgage insurance is usually far more expensive than regular term insurance over the same time frame. Additionally, as you pay your mortgage, the size of the policy shrinks. If you die before you pay your mortgage off, the bank will (theoretically) cover the rest of it, but no more. HOWEVER, YOU KEEP PAYING THE SAME PREMIUM THE WHOLE TIME.
Another reason it's a scam: when you get insurance from a licensed broker (which banks are not, and neither is anyone who works there usually), your health gets checked when you apply for the policy; not so with a bank! They check your health whenever they need to pay out the claim. This means that even if you applied for the policy at 30, the banks are checking your health at a much older age to see whether they will pay the claim, meaning they often won't.
You are much more likely to have developed a chronic issue or had an accident that makes you uninsurable.
I will have a full edition dedicated to why you should not trust people at banks.
Accident/Sickness Insurance.
Another type of term insurance is called Accident and Sickness Insurance. For the most part, it is unavailable after age 70, but that changes depending on the insurance company.
This insurance kicks in when you have a temporary or permanent sickness or injury that prevents you from working. It usually pays out every month until you have recovered or no longer need it.
This type of insurance is really important for people whose work requires that they not be confined to a wheelchair.
The cost of the insurance and the payout amount depend entirely on the person buying the policy and their personal circumstances, but generally, the cost increases with the danger of your job. People who repair high voltage power lines will pay more than a web developer.
You can often buy Accident/Sickness as optional extra when you go to buy a Life policy.
Whole Life Insurance
As the name suggests, Whole Life insurance provides coverage that continues until the insured person's death, regardless of when or why it occurs. However, this type of insurance has both benefits and drawbacks.
Firstly, it's important to note that Whole Life insurance never ends and pays out upon your death at any age. You often cannot buy or renew term insurance after age 75.
Whole Life insurance is expensive. Since it is guaranteed to pay out at some point, the insurance company needs to generate more funds than the eventual payout. As a result, the premiums for Whole Life insurance are typically very high compared to the lower death benefit they eventually yield.
On the other hand, Whole Life insurance is asset that you own. It accumulates a cash value, which you can access in emergencies or use as collateral for a loan.
Additionally, due to the higher premiums paid, policyholders are treated like they have a stake in the insurance company and receive dividends. These factors alone may not justify the purchase of this type of insurance.
However, there is a way to structure the policy so that the dividends received can be used to make one-time purchases of additional life insurance. Importantly, these additional purchases do not increase the size of the regular premium. However, since the size of the dividends is proportional to the size of the policy, they can lead to an increase in the overall coverage, and thus increase the size of the next dividend.
Wait at minute! This sounds like one of those too good to be true infinite money glitches…
The premiums you pay for Whole Life insurance are high enough that the insurance company treats them somewhat similarly to an investment (it is crucial to note that it is not legally considered an investment, you do not receive shares, and you are not taxed). As a result, the insurance company pays dividends to Whole Life policyholders based on its yearly performance, including revenue growth and profits from its investments.
In essence, the concept is similar to receiving dividends on a stock purchase and reinvesting them into another share of the same stock (although, again, you are not acquiring shares in the company), this has the same effect of increase the next divided payment you receive.
Final Thoughts.
It’s true that all the compelling reasons to invest in life insurance are far away for many of us. Realistically you could hold off on buying it until there is a spouse or child the RELIES on your income.
As discussed in our last edition however, life insurance gets more expensive every year starting at about age 24-25. Biological males need to be especially aware of this as the rates increase significantly faster than for biological females.
Additionally, many ways of passing down money to your generations are taxable or subject to attacks by creditors (banks or other groups to whom you owe money) while life insurance benefits are not.
You can get bigger policies at lower rates the earlier you start. I personally began investing in a Whole Life policy as described above at at 18 and have yet to regret it for the reasons above.
I hope this primer on life insurance has been valuable!
Sincerely,
James R. Davies