An Estate Planning Attorney’s Perspective on Life Insurance

Some say “yes!” life insurance is critical. Others say “no!” life insurance is a waste of money. Which one has it right? Well, that’s a complex question and depends on your individual circumstances and how the policy is written!

Who is right and who is wrong?

Common Objections to Life Insurance

Most Common: When you pay a “premium” (that’s the payment to fund the policy), you are just throwing your money away!

Common: Your life insurance agreement won’t perform like other investments, and you could make more money by investing the same amount!

Less Common (because it sounds selfish): Getting life insurance won’t benefit you at all…just someone else!

I agree. These objections are all (potentially) valid. Let me flesh these out a little. The most common objection is based on the reality that many people who enter into an insurance policy drop the insurance later on. This indeed would be a waste of money. Additionally, “term” insurance, which is life insurance for a specific period of time, expires at some point. When the policy expires, generally the premiums simply belong to the insurance company. There are other nuances, but that’s usually the gist of it. A policy that is written somewhat like an auto insurance policy would certainly seem to be a waste of money if the subject of the policy lives beyond the expiration date.

How about investment growth? Well, this is also true. Life insurance contracts generally cannot compete with raw investments in the stock exchange. For example: If you pay $500 for 360 months and get 3.5% on your money, its maturity value will be around $320,000 in thirty years minus the cost of insurance during that same period. In the alternative, if you invest $500 for 360 months and average 8.5%, its maturity value will be over $830,000 after thirty years minus taxes. Certainly, the investment would outperform the life insurance contract to the tune of roughly a half million dollars. Yikes!

Yeah, but I want more in my account!

The last objection is sort of selfish sounding… “What’s in it for me?” While it’s easy to justify getting an RV or a sports car due to the enjoyment that one could derive from owning it, a piece of paper that only pays out upon one’s death is a much more difficult sell.

Alternative Thinking About Life Insurance

Is the most common objection really accurate? Well, not necessarily. Many insurance companies offer a “return of premium” rider. (A “rider” is a supplemental provision to the general life insurance contract…sort of like an addendum.) Return of premium allows an insured to get back all the premium paid for the life insurance if they stick with the policy until the end. It also requires a higher premium, but on the other hand, nothing is “wasted” except for the potential growth that money could have made during the term of the policy. Still, the value of any insurance policy is the immediate liquidity that is provided in the event of an insured passing away. Its value is not really in the growth of cash value…because life insurance isn’t actually an investment. Coverage against unexpected or inevitable events is its purpose.

For example: I attended the funeral of a client who had unexpectedly passed away in his mid-forties. His surviving spouse and children were devastated, and I noticed that the “bills” had already begun to pile up. Their life insurance agent showed up at the family viewing. He provided her with a checkbook and explained that she could draw on the policy immediately for the whole amount or any smaller amounts she might need. He explained that there were no taxes due which brought a small, trembling smile to my client’s face. She accepted the checkbook gratefully, and I observed some of the tightness recede from her expression. Even though the family had other assets, that immediate liquidity really helped reduce her sudden financial crisis on top of the loss she was experiencing.

Tragedy shouldn't be exacerbated by financial stress.

Yeah, but what about growth? An investment professional might point out again and again that “You might be losing half a million dollars!!!” Are you really? Maybe if the policy was term life insurance…and there was no return of premium. But what about a permanent policy? After all, you can count on a policy paying out since none of us are going to avoid eventual death, right? If you hold onto the policy, it will be valuable at some point. In other words, your payments will always pay off.

Permanent life insurance falls into three basic categories: Whole Life, Variable Life, and Hybrid Policies.

Whole life policies are essentially fixed contracts that determine your cost insurance at the outset, require a fixed premium payment and increase the cash value over time at a fixed interest rate like up to 3.5% typically. (The cash value is the amount of premium left over once the “cost of insurance” has come out so you should be aware that your whole premium payment isn’t going to cash value.) That being said, if the premiums are paid by “post-tax” money, then the eventual pay-out of the death benefit will be tax free…and the growth in the policy will be tax free also. Generally, over time a policy will generate enough interest from the cash value to cover the cost of insurance and will “pay for itself” without additional premium payments.

Variable life policies are generally indexed to stock market growth and offer a much higher interest rate. The downside is market volatility that can fluctuate up and down and another consideration that is not generally mentioned… Your “cost of insurance” is calculated anew every year of the policy. As you age, your cost of insurance goes up, so a larger and larger portion of your premium will go toward that rather than cash value. In some cases, if the policy doesn’t perform well enough, substantial premium payments may be required down the road so there is some risk in an indexed policy.

Hybrid life policies are just what they sound like. One could be a mix between term life insurance and whole life or an indexed, variable, policy. Term covers the insured for the early portions of the policy and is slowly replaced over time by a fixed or variable policy as time goes on. These can be very efficient price wise but may have other restrictions that more traditional policies do not have.

Can you risk it?

So, back to the objection about growth… The first consideration is coverage against unexpected death. The investment person might be right about eventual value but not if an unexpected situation occurs. If a person has been investing for 120 months at an average return of 8.5%, they’ll have roughly $95,000 in their account. If they’ve been paying on a term life insurance policy, they’ll have a death benefit of roughly $2,000,000 or more. If the policy was permanent life insurance, they would likely have a death benefit of $250,000 or more. In either case, the death benefit outweighs the investment value…and the growth and payout is tax free unlike the investment (unless it’s in a retirement account…) When death benefit, tax benefits, etc. are also placed in the picture, the “growth” objection gets much, much narrower.

What’s in it for Me?

This is a reasonable objection. It’s not selfish. There’s limited revenue to spend, and there should be a reasonable benefit for spending it. So, perhaps, a small list of usable features that can be built into a life insurance policy would be useful:

1.      Return of Premium makes 10-30 year fixed Term insurance much, much more attractive, and the price point of a term policy makes it attractive for coverage in the first place;

2.      Waiver of Premium if disabled;

3.      Guaranteed Insurability and Term Conversion Riders to allow a change from a term policy to a permanent product without a medical examination;

4.      Spouse or Child Rider to add insurance on other insureds without changing the policy and with often reduced underwriting requirements;

5.      Borrowing at very favorable rates against cash value is a great way to keep a death benefit and still have access to the funds in the policy;

6.      Long term care riders can be added to allow access to policy funds if institutional care if needed;

7.      Critical Illness Rider in case the insured suffers a serious medical incident;

8.      Accelerated Death Benefit Rider allows access to death benefit when diagnosed with;

9.      Cost of Living Rider which increases the death benefit to keep up with inflation; or a

10.  Family Income Benefit Rider to give the insured’s family a stream of income for a specific period rather than a lump sum; and then

11.  Frankly, you can get peace of mind which is a commodity of inestimable value.

Let a professional guide you.

In conclusion, life insurance isn’t an investment vehicle and if you’re comparing “apples to apples” it is far more flexible than a simple investment or retirement account. Use of appropriate riders can greatly increase the value of a given policy and enable anyone to customize their life insurance contract in very beneficial ways. My final point is this: My spouse and I have over Two Million dollars in life insurance coverage including many of the above riders. We have absolutely no interest in dropping or converting our coverage because of the peace of mind we enjoy…knowing that we are “covered!”

Curry Andrews, Attorney