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Call me old-fashioned, but I believe as a husband and father it’s my
responsibility to provide for my wife and children should I die
prematurely. Life insurance is the best way to meet this need, but
many people get confused when buying life insurance. A recent email
from a reader will help clear up this confusion.
Richard is 26 years old and in his email he tells me, “I was getting
ready to pull the trigger on a $200,000 universal life policy for
myself. I have 2 children and I think not preparing for a pre-mature
death is irresponsible planning. I just read your article and I have
a few questions for you.” He goes on to provide the details of the
cost between term insurance and the cost of a universal life policy.
Based on his calculations, it will actually cost more to buy term
insurance over the next 60 years than buying universal life. He
wonders why the universal life policy wouldn’t be a more logical
choice. To Richard’s credit, he has taken the time to research this
decision. But there are a few issues that he is missing. Here’s my
response.
“There are several things for you to keep in mind as you make your
decision.
“First, why are you getting life insurance? If it's for income
replacement (pre-mature death) then you need to take a look at the
amount. $200,000 wouldn't be enough to cover the costs of housing,
education, etc. for your children. You may find that $1,000,000 is
more realistic based on your earnings, etc. Consider 10-15 times
your salary.
“If your wife is the primary caregiver then you should consider
picking up some insurance on her to help cover child care costs in
the event of her death, perhaps $200,000 worth.
“As for you, the difference in cost between term and universal life
on a $200,000 policy for a 26 year old isn’t that great. When the
death benefit is $1,000,000, the difference in premium can be
significant. If it’s a matter of cost, I would suggest using the
difference in cost on the $200,000 policy to buy more term death
benefit.”
Richard further discussed the difference in cost assuming he lived
to age 76. Based on the minimum guaranteed return with the universal
policy compared to the cost of the term insurance over the same time
period, it was clear to him that the universal was a better deal.
Why shouldn’t he do it?
My response continued, “Second, if you want to compare apples to
apples then you have to take into account investing that difference
in premiums over that same time period. Otherwise you are assuming
growth in the universal policy scenario but not in the term
scenario. When you do, the numbers look entirely different.” In
Richard’s example, the $70 a month he’d save with the term policy
may not seem like much. But over 50 years, assuming an annual
interest rate of 3%, it amounts to over $90,000. That’s much more
than the cash value of the universal life policy after 50 years.
Plus, he has complete control over that money.
I continued, “Third, it depends on whether you anticipate keeping
the policy till age 100. This comes back to the point about life
insurance being primarily used for income replacement. As people
near retirement and their children are grown and their wealth has
increased, they no longer need life insurance for that purpose.
“Fourth, you should take into account inflation. $200,000 won't buy
much in another 40 years. And since the underlying cost of insurance
in the universal policy increases just like term, the growth of the
cash value will slow considerably.
“Lastly, the only value associated with the cash value in a
universal life policy is that you can use it. The problem is that
when you borrow it from the insurance company (it’s really not your
money), it will dramatically affect the policy’s performance. The
‘target’ premium may no longer be enough to keep the policy
in-force.
“By the way, Richard, I don’t sell either universal or term life
insurance so I don’t have any financial incentive to recommend one
over the other. All things considered, I still prefer term life
insurance over universal. It’s what I use. Thanks for the question!”
Nationally-syndicated financial columnist and Certified Financial
Planner® Jeffrey Voudrie provides personal, in-depth money
management services and advice to select private clients throughout
the USA. He’ll answer your financial question – FREE at
www.guardingyourwealth.com. |
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