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"You need to protect yourself and your family with life insurance that you won't outlive."
This is one of the common selling points for whole life or universal life rather than term
life insurance. At first glance, it seems to make a lot of sense. Of course you don't
want to outlive your life insurance. Having it pay benefits upon your death is the reason
you buy it. This statement, however, misses one essential
fact. Many people don't need to worry about outliving their life insurance, because they
outlive their need for life insurance. We don't all need life insurance throughout
our entire lives, any more than we do auto or homeowners' insurance. If you no longer
drive a car, you don't need auto insurance. If you no longer own a home, you don't need
homeowners' insurance. In circumstances like the following, you may
no longer need life insurance: First, when you and your spouse have accumulated enough
assets and income streams to independently care for yourselves. Second, when your children
are self-sufficient adults. Third, when your estate is too small to owe estate taxes or
liquid enough to pay the estate taxes. The primary purpose of life insurance is to
replace the future income of a primary breadwinner. Two groups most likely to need it are middle-aged
couples saving for retirement and parents of minor children. Ideally, most young families
should have over $1 million in life insurance to provide for the children if either parent
should die prematurely. Yet many of them are unable to afford the higher premiums for this
much "permanent" insurance. Their choices are to underfund their needs with a smaller
permanent policy or purchase an affordable 30-year term policy.
As we age, the probability of dying becomes greater. Therefore, a $1 million life policy
costs much less for a 25-year-old than a 75-year-old. It doesn't matter if the policy is cash value,
whole life, universal life, or level term, the cost of providing the life insurance component
increases every year. Yet most human brains have a psychological
aversion to price increases. In order to please their customers with life insurance premiums
that didn't increase every year, insurance companies came out with level term policies.
Essentially, the premiums are averaged out by overcharging in the early years of the
policy and undercharging in the later years. Whole life and universal life insurance policies
don't have that same averaging. To be "permanent," the premiums must be much higher in order
to fund a savings account that grows over time and is often used to offset a significant
portion of the death benefit in the later years of the insured's life. Usually, if the
insured cancels the policy, a portion of the premiums will be refunded.
A cash value policy may occasionally be a good estate planning tool, generally for those
with substantial wealth. It might be used to fund an irrevocable life insurance trust
upon the second spouse's death, perhaps to pay taxes on an illiquid estate like a family
farm or other property. It also can be used for those wanting to leave the bulk of an
estate to charity and still provide income to their children. These strategies rarely
apply to those whose primary goal is basic income replacement for their families.
One of the ironies of insurance in general is that we all know it's essential and we
all hope never to need it. For most people, life insurance is not really an exception
to this. Its primary purpose is not to provide us with investment income, but to provide
our families with income if we aren't there.