Return to the "POINTER VIEW"June 8, 2001
Return to the "POINTER VIEW"
June 8, 2001
"In youth money is a convenience, an aid to pleasure. In age, it is a necessity, for when we are old we have to buy even consideration and politeness from those about us."
Dorothy Dix
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It looks like the two teams facing each other in the NBA Championship -- the Los Angeles Lakers and the Philadelphia ‘76ers -- are different in more than just name. We’re talking showtime versus "yo" time, power versus willpower, Kobe versus the Answer, Shaq versus Mount Mutombo, Hollywood versus blue collar.
Like the distinct differences in these two basketball teams, there are distinctly different types of life insurance. After reading the last edition of Murphy’s Law, you have probably started thinking about your own life-insurance needs. Maybe your spouse even asked you why he or she didn’t have a life- insurance policy. And you, being the wise person that you are, probably admitted that the family would be in a world of financial hurt if he or she suffered an unexpected death. Fortunately, you have no doubt advised your family members that you’re simply waiting to read all three installments of Murphy’s Law on the basics of life insurance so you can understand all your options.
Different types of insurance
Basically, you can purchase three primary types of life insurance:
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Whole life-insurance policies require large monthly policy payments but, depending on the success of the insurance companies, are intended to be self-funding in approximately 15 years. After making several years of payments, your policy accumulates a cash value that you can also borrow against or cash in.n
Term life-insurance requires significantly smaller policy payments than is required by whole life insurance policies. Like your auto insurance, term life does not accumulate a cash value. Servicemembers Group Life Insurance is an example of a term life insurance policy. Most term policies, however, increase in cost as you get older, while SGLI costs remain the same for all soldiers regardless of age.n
Universal life-insurance policies have an established policy term of 10 to 20 years. A universal policy requires larger payments than term policies but allows the insured to spread equal payments throughout the term of the policy. It generally has a small cash value accumulation that the policy will eventually consume.What type of insurance to buy
Just as Larry Brown must determine which ‘Sixer to put into the game, you should analyze your needs to ensure you have the right type of insurance coverage.
You need to be very careful in first assessing your insurance needs and then finding the appropriate policy. Remember that insurance agents make money by selling policies and some may have their financial interests more at heart than your own. There are some great Internet sources that can provide you with instant quotes for all sorts of insurance. Just search for life insurance and you will find them.
Some people prefer whole-life coverage because it provides cash accumulation. While these policies do accumulate cash value, that’s not the full picture. Consider a 40-year-old, nonsmoking male who needs a $200,000 life insurance policy and compare the costs and benefits of term versus whole life insurance. In the chart below, "Term" means the cost of term life insurance. "Savings" equals the difference in cost between term and whole life-insurance policies. "Whole life" is the cost of whole life insurance. "Guaranteed cash value" means the amount the insurance company will pay if you cancel the policy. Note that there is no guaranteed cash surrender value for the first two years for most whole-life policies. Also note that each policy provides the same $200,000 in life-insurance coverage.
| Term | Savings | Whole Life |
Guaranteed Cash Value |
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| Yearly premium: | $194 | $2,962 | $3,156 | N/A |
| Monthly cost: | $16 | $247 | $263 | N/A |
| 5-year cost | $970 | $14,810 | $15,780 | $9,000 |
| 10-year cost | $1,940 | $29,620 | $31,560 | $26,600 |
| 15-year cost | $2,910 | $44,430 | $47,340 | $44,000 |
So, what are the differences? First, notice that the cost of the whole-life policy minus the cost of the term policy nearly equals the guaranteed cash value under the whole life policy. The real cost of insurance is essentially identical in either case. Now at 15 years, the whole-life policy may have sufficient cash accumulation to pay its own premiums -- i.e., it could be "paid up." With term insurance, the now 55-year-old man may have to purchase a much more expensive term policy if he continues to need life insurance. A term policy at age 55 would cost at least $650 a year or more. Plus, at some point, the cost of term insurance will simply become too expensive.
Does this matter? It depends. If at age 55 the man has paid off his mortgage and sent his kids to college, he may not have that great of an insurance need. On the other hand, if he finally married and has a set of triplets, he will have a significant insurance need -- but he could have considerable financial savings based upon his savings over the past 15 years.
If the difference between the whole-life policy and term policy ($2962 a year) were invested in a mutual fund, which earned a conservative 6 percent rate of return over a 15-year period, it would equal $71,832. That would mean nearly $28,000 more in the pocket for the man purchasing a term-life policy. If the investments earned a more ambitious 10 percent, it would equal $102,374, or $58,000 more than the guaranteed whole-life amount. If part of the money were invested using a tax-deductible IRA, there would be additional tax savings, as well.
Using a whole-life policy, the 40-year-old man would be guaranteed to have $44,000 at age 55, but the return on that amount would be used to keep the policy alive. Even though the policy has a cash value, if you take out anything from that account, it will need to be paid back or you will have to continue making payments for the insurance. Of course, whole life insurance amounts could be greater than $44,000 if the insurance company’s investments resulted in a higher rate of return.
Why do some people prefer whole-life policy to term insurance? It has a cash accumulation that sounds attractive. You’re not just "spending" money; you’re "accumulating cash." For some individuals, saving cash through insurance is the only way they can put away any portion of a nest egg. If the insured placed the savings into a bank account, they might use these savings to purchase such things as tickets to the ‘Sixers-Lakers championship series.
For individuals who are disciplined enough to bank, the difference between the whole-life and term insurance-policy premiums, the term insurance will have a much greater return on the investment. But the decision is up to you. Getting the appropriate amount of insurance is what is most important. Too many individuals who purchase whole life insurance obtain a policy that is significantly less than they need in order to afford the costs of a whole life-insurance policy.
The next Murphy’s Law will offer a few additional pointers for
purchasing life insurance and some tricks for the unwary. By then the ‘Sixers-Lakers
series will be over. Let’s just say Murphy’s Law feels that the Phillies might
not be the only Philadelphia team to shock the world in the summer of 2001.
