About the author: Lamar Watson, CFP®, is a Fee-Only Financial Advisor in the Washington, D.C., area who works with clients virtually across the country. Dream Financial Planning is a Fiduciary Financial Planning firm specifically designed to help individuals in their 30s and 40s take control of their finances and fulfill their dreams. Feel free to schedule a Free Consultation to learn how we use the DREAM Financial Planning Process ™ to help our clients achieve their goals.
Life insurance is one of those financial products that we put off thinking about. No one wants to talk about the eventuality of passing away, and we especially don’t like to talk about what would happen if we passed away unexpectedly.
But life insurance is an important part of any financial and protection strategy. For National Life Insurance Awareness Month, we wanted to share some helpful information about life insurance, including what it is, its different types, and how it can help protect your family in case something happens.
Life insurance is a vital component of a well-developed comprehensive financial plan, This can be of particular importance to individuals who may be uninsured or underinsured and need to protect their loved ones. To help guide you through an introductory life insurance conversation, we have created this checklist. It covers key considerations, including:
- Purpose of coverage
- Appropriate amount of coverage
- Types of policies
What is Life Insurance?
According to Life Happens, a nonprofit dedicated to giving users unbiased insurance information, life insurance is an insurance policy that provides cash to your family or loved ones after your death. This "death benefit" helps replace your income and supports your loved ones in the event of your passing. Your family can use this payment for funeral expenses, mortgage payments, college tuition, and other bills.1
Different Types of Life Insurance
There are two main types of life insurance: term life insurance and permanent life insurance. Let’s look at the differences.
Term Life Insurance
Term life insurance policies cover the insured for a specific period, usually between 5 and 30 years, depending on your policy. Term policies pay a death benefit only if the insured person dies during the coverage term. These policies don’t carry any cash value, but the premiums are generally significantly lower than permanent life insurance premiums.
Permanent Life Insurance
Permanent life insurance policies cover the holder for their entire life. Some of these policies also carry savings or investment components. According to US News, this cash value “grows tax-deferred over time and may be withdrawn or borrowed against while you’re still alive.” But remember that withdrawing these funds will decrease the policy’s death benefit unless the funds are repaid.2
There are a few permanent life insurance options, including whole life (sometimes called "traditional" life insurance) and universal life. Each of these policies has its own pros and cons.
When considering which life insurance policy is right for you, think about the following factors:
- Coverage duration
- Coverage amount
- Cash value
I think Permanent Life Insurance makes sense for a very small percentage of the population. However, I do get a lot of questions about it, so I wanted to mention it here. If you do have a Permanent Life Insurance Policy, I suggest asking your Insurance Advisor for an illustration and reaching out to me to see if there are less expensive options to help you and your family build wealth. There are different types of permanent life, but I'll focus on whole-life insurance in the example below, which is the most common type I see among my clients.
A Real-Life Example
A large well-known insurance company sold a young woman two life insurance policies at the same time before she became of client of mine. The first was a $1 million 20-year term life insurance policy that cost $500 a year. At the same exact time, the insurance broker sold her a whole life policy with a $350,000 death benefit that cost $500/month. Please keep in mind that your circumstances may vary greatly from the scenario I'm describing.
This client was in her mid-thirties, healthy, and single with no dependents. Since no one was depending on her for financial support, I could make the case that she didn't need any life insurance or at least much less coverage. However, I didn't make that suggestion. The recommendation I made was to terminate the whole-life policy. This gave my client the opportunity to have extra cash flow that she could spend or save and invest in a more cost-efficient way to help her build wealth. The premium on the whole-life policy was over 10% of her monthly spending.
Most insurance agents make a much higher commission when selling a whole-life policy and could receive up to your entire first year's worth of premiums as a commission. So in this scenario, that could be $6,000 commission versus $500 in commission for the term policy. With that potential difference in compensation, you can see the potential for a conflict of interest where your needs and the needs of the agent are not aligned. As a Fee-Only Advisor, I never sell insurance or receive commissions of any kind.
When evaluating whole-life insurance, make sure you ask for an illustration so you can fully evaluate the cost, surrender charges, and guaranteed returns of your policy.
I view life insurance as a tool to replace a loss of income during someone's working years. So, when I build a financial plan, I aim to have the policy expire around age 55 to 60. My hope is that when someone reaches that age, they've been able to increase their net worth to a place where expensive life insurance is no longer necessary.
Cash Value, Guaranteed Returns, Policy Loans, and Surrender Charges
Building cash value is a major selling point for insurance salesmen. Unfortunately, these guaranteed returns or the cash value are much closer to low-return conservative investments such as bonds. Relative to the fees you pay, I usually find them to be a bad deal. This may be appropriate for very conservative or older investors but not for most of my clients who are in their 30s or 40s and trying to build wealth.
Taking a loan from your policy is another major selling point I hear from those who sell insurance. I've never understood the appeal of essentially taking a loan from yourself. Surrender charges are another problem with these types of policies. They're usually hidden in the fine print of a policy. Surrender charges are fees of up to 10% in most cases that you must pay to get out of your policy if you don't hold the policy for a long enough period of time.
In the example above, the client actually lost money after having the policy for over four years because of the high hidden fees, surrender charges, and the low return on the cash value of their policy. My client asked me how they could have lost money, so I explained to them the problems with these policies that I just outlined for you.
If you'd like to evaluate your current whole-life or other permanent insurance policy to ensure it's not slowing down your financial progress, feel free to schedule a free consultation or send me an e-mail.
Do You Need Life Insurance?
For most people, the answer to this question is “Yes.” Life insurance can help protect the people you care about if something happens to you. This could include a spouse, children, disabled family members, aging parents, or any other dependent. There are a variety of coverage limits, and depending on your household expenses, you may not have to purchase an enormous life insurance policy. Even modest protection could help your family pay the bills and make arrangements.
A simple way to calculate how much life insurance you need is to consider all your immediate, ongoing, and future expenses, as well as the financial resources that your loved ones already have. This is how you may need to make up with a life insurance policy. Forbes lays out the DIME method: debt, income, mortgage, and education.3
Ready to review (or begin) your life insurance policy for National Life Insurance Awareness Month? There are plenty of websites where you can sign up for a policy, or you can talk to a financial professional for help.
Review Your Current Policy
Life insurance is a complex topic, and it often leaves many people confused about what they should do with their existing policy. With this checklist, you will be better prepared to understand their life insurance policy and determine whether it is still appropriate for their financial situation. This checklist covers the key issues to consider when reviewing your existing life insurance policy, such as:
- Understanding their policy’s in-force illustration, contract, riders, and other important information.
- Exploring the different options for, as well as the pros and cons of, replacing, surrendering, or selling their policy.
- Reviewing their policy’s cash value accumulation and death benefit and any potential tax consequences that may arise.
- Seeing how their policy fits in with any health and/or estate issues that may be present.
I hope we get the opportunity to work together. Read below for a list of the different ways you can work with me. If you'd like to see if any of these services are a good fit for you, feel free to schedule a free consultation or send me an e-mail.
Work With Us
Wealth Management - Combines ongoing financial planning and investment management. The financial planning fee is waived if we manage at least $500,000 in investments for you. Tax Preparation will be included.
Ongoing Financial Planning - Our most popular program now includes tax prep. This is a good fit if you have several goals and want the option to manage your investments. We'll cover everything from spending, insurance, taxes, investments, retirement planning, and estate planning, just to name a few. Our goal is to give you and your family an easy-to-understand comprehensive plan to provide you with confidence you're making the right financial decisions.
One-Time Financial Plan With Ongoing Support - An accelerated version of the service above with additional support for one year after your start date. This service requires prepayment for the year and is offered at a significant discount from the annual pricing for ongoing planning.
Estate Planning - If you're looking for a cost-effective solution to get your estate planning documents in place, we can help. We have partnered with a leading Estate Planning platform to deliver high-quality Estate Planning documents for a fraction of the cost of working with an attorney.
Revocable Living Trust-Based Estate Plan
- Individual - $1,600
- Couple - $2,100
Will-Based Estate Plan
- Individual - $900
- Couple - $1,400
Tax preparation is now part of the ongoing financial planning program. This will be in addition to the Tax Report we already generate for clients and our work with the IRS Withholding Calculator to help prevent our clients from getting a surprise tax bill.
Three-Hour Ask Me Anything - This is a good fit if you have 2-3 goals you want help with. These three one-hour meetings need to be completed within three months. The fee for this service is $2,000.
Financial Coaching - Our financial coaching program starts at $99/month. This is ideal for someone who is looking to simplify and automate their finances. We'll also serve as an accountability partner and help you overcome obstacles that may be stopping you from accomplishing your goals. You can learn more about our coaching program here. If you think this program might be a good fit for you, schedule a 15-Minute Demo.
Paying for College
This service is an ideal fit for parents of high school juniors and seniors with a standardized test score (ACT/SAT) and a list of colleges they're considering. This is included as part of ongoing financial planning or as a stand-alone package. This service includes:
- A college affordability assessment
- How Much Colleges Think You Can Afford (EFC)
- If You Qualify for Need-based Grants
- If You Qualify for Merit-based Scholarships
- Help you search for scholarships
- 1 Year Out of Pocket Cost (For Each College)
- 4 Year Out of Pocket Cost (For Each College)
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