“You need to protect yourself and your family
with life insurance that you won’t outlive.” This is one of the common selling points for
whole life or universal life rather than term life insurance. At first glance, it seems
to make a lot of sense. Of course you don’t want to outlive your life insurance. Having
it pay benefits upon your death is the reason you buy it.
This statement, however, misses one essential fact. Many people don’t need to worry about
outliving their life insurance, because they outlive their need for life insurance.
We don’t all need life insurance throughout our entire lives, any more than we do auto
or homeowners’ insurance. If you no longer drive a car, you don’t need auto insurance.
If you no longer own a home, you don’t need homeowners’ insurance.
In circumstances like the following, you may no longer need life insurance: First, when
you and your spouse have accumulated enough assets and income streams to independently
care for yourselves. Second, when your children are self-sufficient adults. Third, when your
estate is too small to owe estate taxes or liquid enough to pay the estate taxes.
The primary purpose of life insurance is to replace the future income of a primary breadwinner.
Two groups most likely to need it are middle-aged couples saving for retirement and parents
of minor children. Ideally, most young families should have over $1 million in life insurance
to provide for the children if either parent should die prematurely. Yet many of them are
unable to afford the higher premiums for this much “permanent” insurance. Their choices
are to underfund their needs with a smaller permanent policy or purchase an affordable
30-year term policy. As we age, the probability of dying becomes
greater. Therefore, a $1 million life policy costs much less for a 25-year-old than a 75-year-old.
It doesn’t matter if the policy is cash value, whole life, universal life, or level term,
the cost of providing the life insurance component increases every year.
Yet most human brains have a psychological aversion to price increases. In order to please
their customers with life insurance premiums that didn’t increase every year, insurance
companies came out with level term policies. Essentially, the premiums are averaged out
by overcharging in the early years of the policy and undercharging in the later years.
Whole life and universal life insurance policies don’t have that same averaging. To be “permanent,”
the premiums must be much higher in order to fund a savings account that grows over
time and is often used to offset a significant portion of the death benefit in the later
years of the insured’s life. Usually, if the insured cancels the policy, a portion of the
premiums will be refunded. A cash value policy may occasionally be a
good estate planning tool, generally for those with substantial wealth. It might be used
to fund an irrevocable life insurance trust upon the second spouse’s death, perhaps to
pay taxes on an illiquid estate like a family farm or other property. It also can be used
for those wanting to leave the bulk of an estate to charity and still provide income
to their children. These strategies rarely apply to those whose primary goal is basic
income replacement for their families. One of the ironies of insurance in general
is that we all know it’s essential and we all hope never to need it. For most people,
life insurance is not really an exception to this. Its primary purpose is not to provide
us with investment income, but to provide our families with income if we aren’t there.