The insurance industry makes it very easy for us to separate ourselves from our money. If you’re not careful, you can easily find yourself with far more of the wrong type of insurance than you need. If it’s any consolation though, you will have made your insurance broker really happy.
I’ve been through this question for my own family. My priorities changed when I entered new phases like fatherhood and growing in my professional life. I’d like share my thinking and walk you through the issues I considered when making my insurance decisions.
Let’s start by understanding what types of life insurance there are and why you might need them.
Term insurance and permanent insurance
A term insurance policy is a policy that you pay for a set number of years, and it expires when that number of years is up. It is the cheapest type of insurance you can get and it sells typically in 10- and 20-year terms. You can also buy shorter or longer terms if you want.
This type of insurance is good for protecting your family from risks that will eventually go away. So, what you’re really protecting against is the risk that you pass away before having saved enough money to put your kids through school, pay for your family’s lifestyle and retirement, and pay off your debts. Once you’ve saved enough to pay off all your debts, put your kids through school and pay for your retirement, you won’t need the insurance anymore! That’s why you buy it for a set number of years or for a specified term.
Now, a permanent insurance policy on the other hand will essentially have you paying premiums for life, so that you are covered for life. These are commonly known as whole life or universal life policies. You are guaranteed to collect on this type of insurance, so long as you always make your payments. As a result, these policies are more expensive than term policies.
Permanent policies can also have an investment component. You can accumulate an investment value inside these policies over time, which will increase the eventual pay-out of the policy, over and above the original face value. With a whole life policy, you have no control over the accumulation of the investment value, it’s baked into your premiums and you get whatever you get. You surrender the investment decision making to the insurance company. With universal life insurance, you get to choose how much you want to accumulate in the investment component, and how it is invested.
Permanent policies are often sold as great investment vehicles, because the investments grow tax free. I don’t like the idea of accumulating investment value inside an insurance policy, mainly because the costs on the investment component are so high, that they offset the tax benefit.
So why might you need permanent insurance? Primarily to keep the peace in your family once you’re gone! Policies like this are used to protect your heirs from having to sell assets in your estate that they may prefer to keep. Let me give you an example: you and your spouse have a house in the city and a cottage in the country, but you don’t have much of an investment portfolio. When the last of you or your spouse passes away, there will be a big tax bill on one of the two properties. The properties aren’t likely worth the same amount either. If you want to make sure there’s enough money in your estate to pay the taxes and equalize your children for the un-equal values of real estate they will inherit, permanent insurance can be a really helpful tool. Your heirs get to keep the houses and everyone receives the same value from your estate.
Discretion is another big plus with permanent policies again, to help keep peace in your family when you’re gone. Think of this scenario: You have children from your first marriage and would like them to be treated equally with your current spouse. One of my favorite clients extolls the virtue of his permanent insurance policy, because it equalizes his kids, who are a result of his first marriage, with what he will leave for his current wife. Often times, particularly in second marriages, situations can arise where insurance can be a very helpful way to manage these challenges and keep things balanced.
Do you have any experience or questions about insurance? Please comment below to let me know your thoughts!