“Fun is like life insurance; the older you get, the more it costs.”
Much of the financial community today seems content with regulating life insurance to the mantra of “buy term and invest the difference”. However, I suggest that this approach is not only seriously short sighted but dangerous and deceptive when it comes to tactical estate planning.
The History of Life Insurance
Back in the late 1800s, America was a young country taking great strides and many of her greatest minds were making unprecedented discoveries (i.e. Franklin, Edison and Graham). During this time, one of the first financial tools of the western world was created and its origins dated back to ancient Rome. This tool would become so ingrained in American culture that making changes to it would become nearly impossible. This asset would save countless families from financial ruin and would become the last place truly protected from greedy investors, untamed government and financial collapse.
Further, this financial fortress would empower some of the greatest entrepreneurs in history such as Ray Kroc and Walt Disney, both of whom borrowed against their whole life policies to finance their historic ventures. During the Great Depression, the stock market would suffer an astonishing 32-year setback and lose 90% of its value from its peak in
September 1929. While banks, businesses and government sectors were closing their doors, one sector of the economy stood unaffected. You guessed it, mutual life insurance companies. In fact, traditional whole life insurance is so stable that many were paid dividends from profits every single year during the Great Depression.
Temporary vs. Permanent Life Insurance
Permanent life insurance refers to a broad category of life insurance that offers permanent benefits. Life insurance that offers permanent benefits is distinguished from temporary life insurance that offers benefits for a set period of time. When suggesting that permanent life insurance offers permanent benefits, we are talking about a permanent death benefit once the policy premium is completely paid for (or paid up) AND some level of accumulation of cash value within the policy. Permanence and accumulation of cash value are the two factors that separate permanent life insurance from term life insurance.
Buying vs. Renting a Death Benefit
Temporary life insurance, more commonly known as term life insurance, does NOT offer a permanent death benefit. Term life insurance offers a specified amount of death benefit for a specified term length, ranging from annual renewable term (ART) which renews every year to 5, 10, 15, 20, 25 and 30 years.
A longer term or higher death benefit (as well as the age and health rating of the individual policy applicant) determines the cost of the insurance. There is no cash accrual or other permanent benefit of any kind. This is why we often refer to term life insurance as “renting a death benefit” and highly recommend purchasing convertible term life insurance if you choose to go this route.
For the above reasons, term life insurance is inexpensive when compared to any type of permanent life insurance. The comparative low cost of term life insurance is why financial entertainers tout opinions like “buy term and invest the difference”. The fact is, term life insurance is NOT “bought” but rather rented for a defined period. This is not me being “cagey” about term life insurance. Rather, it is the simple fact of how term life insurance is packaged.
Different Types of Term Life Insurance
There are different types of term life insurance such as 5, 10 and 20-year level term. These policies offer coverage at a fixed premium for a set period of time. Upon expiration of the term, the premiums for the coverage will typically skyrocket, so that the policy will no longer be practical to maintain and a new term policy may be needed. There is also graduated term insurance which isn’t fixed for a set term of more than a year and offers premiums that increase gradually year after year.
Convertible term life insurance allows the temporary term policy to be converted to a permanent life insurance policy if elected within the policy period. We highly recommend this approach because it preserves the option to convert from temporary to permanent life insurance for any number reasons. For example, if a person’s health declines, he or she may no longer qualify for renewable term and a permanent life insurance may be needed.
Because permanent life insurance can be used for tax advantaged cash value accumulation, it is a good idea to consider convertible term insurance if you’re looking at term insurance. Convertible term will allow you to increase your base of permanent life insurance as your needs and budget increase.
It is important, however, to research the conversion details of your intended policy, such as when you may convert and what policies are allowed. Some policies only allow conversion in the middle of the policy period and only to certain policies…not good. You’re looking for flexibility in timing AND conversion into a favorable policy type to make it worthwhile.
Money doesn’t buy life insurance. Good health buys life insurance. The money just pays for it.