Long Term insurance

Long term insurance is basic, inexpensive and easy to understand. It gives you all the coverage you need and none that you don’t. That’s why it’s the best choice for almost everyone.

As the name implies, a term insurance policy is good for a specific period of time; that can be one year, 10 years, and 20 years or even up to 30 years. Given that you generally need life insurance only until you’ve managed to save up money elsewhere, just pick the term that dovetails with the time you need coverage. If you die during that term, your beneficiaries get a payout, known as the death benefit. If you die after the term expires, there’s no payout.

Term policies typically have maximum issue ages. If you’re past age 80, you’ll have a hard time getting term insurance. (You almost certainly won’t need it at that age anyway.)

What are the different types of term insurance?

There are two kinds. There’s “annual renewable term,” which gives you one year of coverage at a time that you renew annually, and “level premium term,” which you buy for a specific multiyear period – say, five, 10 or 20 years.

Annual renewable term usually has the lowest annual premium to start, but the premium rises as you age. If your main concern is keeping your initial costs down – for example, because you think your earnings will rise significantly in the future – consider going with annual renewable term.

Level premium term lets you lock in the premium for that period; the annual premium is guaranteed never to change, from the first year to the last. That can be a smart way to insulate you from any premium increases. It’s like the peace of mind you get from a fixed-rate mortgage compared to an adjustable-rate one.

How much will life insurance cost me?

That depends on your age, your health and the size of the death benefit you want. No surprise that the younger and healthier you are, the lower your premium will be.

Just as a ballpark, a healthy 40-year-old man who buys a 20-year level term policy, which has a fixed annual premium, might pay $350 a year to secure a $500,000 death benefit. A healthy 50-year-old man who buys the same policy might pay $1,000 a year. If he waits until he’s 60, the policy will cost about $3,000 a year.

Premiums for cash-value policies are much higher. For example, the healthy 40-year-old man who pays $350 a year for a $500,000 term policy would pay about $3,000 a year for a $500,000 universal life policy – in part because a portion of that $3,000 is going into the investment component of the policy. That’s a huge difference.

What’s wrong with using insurance as an investment?

Agents may try to sell you a cash-value policy as a way to invest for retirement. They’ll tell you that the investing component serves as “forced savings.” (Sure, but retirement plans like 401(k)s force you to save too, once you’ve taken the initiative to sign up for them.) They’ll say the money you have building up in your cash-value policy can grow tax-deferred, but money in IRAs and 401(k)s does too. What they won’t tell you is that cash-value insurance is generally a poor investment.

It is a very costly way to invest. There’s the cost of the insurance protection itself – which, by the way, is usually more expensive than what you would pay for a regular term insurance policy. There are the marketing and sales commissions. There’s also the “surrender charge” that may be levied if you decide to drop your policy within the first 10 years or so. The amount of a surrender charge varies by insurer and type of policy, but it is not uncommon for it to exceed the total amount of your first-year premium.

And, on top of all that, there are annual investment fees. Those are not broken out in all policies, so it’s often hard to determine how much you’re paying. In policies where they are disclosed (typically variable life or variable universal life policies), however, they can be substantial: 3% or more, year end and year out.

What makes up that 3%? Most of it is the investment management fee, which can run as high as 2% a year. Added to that is an annual fee called the “mortality and expense” charge, which also goes by the name of “M&E.” This is essentially a fee thrown in to assure the insurance company a profit, even if all those other fees somehow don’t.

The heavy fees involved with cash-value life insurance can really drag down your returns. Especially when you consider that index mutual funds often have annual expenses under 0.5%, and many actively managed mutual funds charge 1% or so. That’s a lot less than the 3% or more you’ll pay for the investment component on a cash-value policy.

The lesson: If you need life insurance, get term insurance. If you want to invest for retirement, invest in IRAs, 401(k)s or similar retirement plans.

How big should my life insurance policy be?

One basic rule of thumb is that the death benefit on your policy should equal seven to 10 times the amount of your annual salary. But, like any rule of thumb, that isn’t always particularly accurate.

Another way of looking at it: You need to figure out what income you want to provide for your spouse or other beneficiaries when you die. From that sum, subtract all the other income sources they will be able to tap: retirement accounts, pensions, Social Security (for your spouse). The resulting number is the shortfall you’ll want to fill with life insurance. This interactive calculator can help you arrive at a number.

Let’s say the shortfall is $25,000 a year. A standard insurance principle says to buy a life insurance policy that is about 10 times that amount, or $250,000 in this example. That might be just fine. But such estimates can be misleading. Ideally, you should make the decision based on your specific circumstances – or give yourself a big margin for error. For instance, you might want to buy coverage worth 20 times the annual amount you need to replace.

 

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