Thinking about buying life insurance sucks, which is why so many of us put it off for as long as we can or until there is some scare like a close call, medical event, or a close friend dying unexpectedly. There’s also some pretty intimidating decisions you need to make when you are buying a policy, such as how much coverage to buy, how long you want to be covered for, and what type of policy to get.
In this article we will cover the differences between whole-life and term insurance policies, why we think term policies are the better choice, how much coverage you should have and what the duration of that policy should be. We’ll then wrap up with a short summary for those who want to skip to the punchline.
One note on insurance up front – many people see the big face value of a policy, for example a million dollars, and think, “Wow, I’ll leave my family rich!” That’s not the point. The point is to make sure you don’t leave them starving and homeless. It’s to make sure they have time to get on their feet after your death.
What is Term Insurance
Term life insurance is a policy that pays out a fixed amount upon your death with coverage lasting for a defined period of time (the term). It generally gets more expensive as you age and must be renewed if you want to extend coverage beyond the term. In some cases it can be converted to whole life insurance. The benefits of term insurance are:
- Less expensive than whole-life policies
- Higher payouts than whole-life policies
- Very transparent and easy to understand
With term policy there are only three things you really need to understand: How much is the coverage for (e.g., $500,000), how long is it for (e.g., 20 years), and what are the exclusions (e.g., no pay out for suicide or base-jumping).
What is Whole-life Insurance
Whole-life policies, as the name implies, covers you for life. It provides both a death benefit and has a cash value. The costs are typically fixed over the life of the policy and you can withdraw or borrow against the cash value of the policy. The benefits of whole-life insurance are:
- Whole-life is a forced savings plan
- It will build (some) value over time
- They guarantee that you’ll have coverage into very advanced age
The downside with whole-life policies are that they are more expensive, it can often take a long time to build any real cash value, the return on investment is not guaranteed, and it can be very hard to understand how the cash value will be, what the fees are, and what the conditions of withdrawing cash can be.
Which is better?
Many insurance agents will make it sound like buying whole-life is an investment that will build equity just like your home. I suspect much of this is because they receive much higher commissions on selling whole-life policies to you. Here at Caveman Cash we believe that term policies are the significantly better choice for almost all people. There are three main reasons that we suggest term policies over whole-life policies:
- You get more bang for your buck, and they can allow you to build wealth over time (see graphic below). With term policies you’ll often get the same face coverage for about 10% of the cost if you are relatively healthy. For example, a 35 year old man might get a $200k, 20 year term policy for $15/month, while an equivalent whole-life policy might be $200/month. You could argue that the whole-life will build cash value, and you’d be right, but it only builds at an average of 1-2% per year. You could put that money in the market, and via the magic of compounding returns you’d come out much wealthier in the end.
- If you get your finances in order you don’t need coverage for your entire life. Life insurance is about making sure that your spouse and kids don’t end up starving and homeless should you die. If you don’t have any debts, have maxed out your 401(k), and have built an investment portfolio then they’ll be okay. The time you need insurance for is when they are dependent on your working income. So, if you’re 35, you only need that coverage for 20-30 years in most cases.
- Whole-life policies are too dependent on the companies that manage them, have too many fees, don’t have guarantees on the cash accumulation value, and usually don’t provide you with enough coverage should you die young to really make a difference.
Check out this chart below:
How much and how long?
In terms of how much a good ball park estimate, depending on your financial situation, is about 10 times your annual income (with each spouse having their own policy). You both need your own policy because both of you contribute to the house. Even a stay-at-home Mom contributes because you’d need to replace the childcare she provides.
With respect to how long, the term on the policy should cover you until your kids are out of the house or until you are in your mid-50s. The reason for basing it on your children’s age is because, let’s face it, kids are expensive and you still want to make sure that they can go to college without having to take out a fortune in student loans. The reason we target the mid-50s, as a minimum, is that is about when most people will start to get in solid financial shape, and usually before then a spouse without dependent children would like need help.
Term life is the better value, is easier to understand, and is easier to tailor to your needs. Furthermore, with all the money you can save on term instead of whole-life you’ll be able to make significant investments elsewhere that will likely grow to become their own wealth guarantee.
Here at Caveman Cash we believe that everyone can achieve personal financial independence, and we’re dedicated to helping you along this journey. If you haven’t already done so, please consider signing-up for our newsletter which will bring some great deals to your inbox every week and let you know when we are running our Financial Freedom courses.
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