Have you watched Weeds, the TV series? If not, do yourself a favor and check it out. The general plot surrounds a stay-at-home mother whose husband dies, leaving her to cover the costs of raising her children on her own. Since she does not work and didn’t save enough money to prepare for single parenthood, she resorts to selling drugs in order to sustain herself. This theme of financial fallout is often echoed in other shows to highlight the panic involved in maintaining a certain lifestyle upon the death of your partner. Although this is a great television series, the entire plot would not be applicable if the characters had simply obtained life insurance.
At some point in your life, you should be thinking about life insurance. Most people begin to consider purchasing a life insurance policy when a major life event occurs. Getting married, having a baby, purchasing a house or renting an apartment with a partner can all trigger thoughts about how you or your partner would cover the costs if something were to happen to either of you. Essentially, if you share the costs of living with a partner, friend, or family member and believe the other person would experience hardship if you were not around, it’s worth looking into a life insurance policy for them. It will not be the most enjoyable conversation you’ve ever had, for sure, but it is a necessary one. Do it for love!
Once you’ve reckoned with the concept of insuring your life, you will need to determine which type of policy you want. You can speak to an insurance salesperson, apply online to an insurance company you already deal with, or speak to your financial advisor, if you already have one. There are two types of life insurance policies you can purchase: 1) Permanent life insurance policies (sometimes referred to as whole or universal life insurance), and 2) Term life insurance policies. There are different types of permanent policies that you can discuss with your advisor, but both permanent and term policies can insure your beneficiary (aka, the person who would be left behind) for any amount you choose. Both insurances will pay out if something should happen to you.
The main difference between the two policies is a savings component. Permanent life policies have a significantly higher monthly premium, but a portion of the premium you pay is invested for you. When you decide you no longer need your life insurance policy, you can cash it out and you will receive the savings portions of your premiums in cash. The benefit of having a permanent life policy is that you will continue to secure your life insurance, even in the event of illness or other health concerns that may impact your ability to obtain a new policy later in life. Additionally, if setting money aside does not come easy to you, the automated investment allows you to just “pay another bill” while simultaneously saving money without thinking about it.
On the other hand, term life insurance policies can be obtained for different periods of time. The most common term policies are 10 and 20-year policies. The monthly premiums for these policies are significantly less, but you will have no investment profit to show for the amounts paid at the end of your term. The downside to term policies is that at the end of your 10 or 20-year term, you may not be eligible to obtain a new policy due to health-related issues. Additionally, even if you are able to renew, policy premiums go up significantly with age and health complications.
Now that we’ve covered the basics of each policy type, which one should you choose? To determine the answer to this, I will use the hypothetical example of a 27-year-old female non-smoker with no health issues obtaining a policy worth $300,000.
The permanent life policy premiums will be $94.30 per month. Over a 20-year period, this will add up to $22,632 in premiums paid to keep the account open. If you decide your policy is no longer needed after 20 years and cash the policy out, you will receive a guaranteed $4,200 back from the savings component of the policy. After all is said and done, your 20-year permanent life policy ended up costing you $18,432. On the other hand, the 20-year term life policy (assuming the same scenario above) will cost $21.96 per month. Over the 20-year term this will add up to $5,270, resulting in savings of $17,362 on policy premiums compared to the permanent life policy!
Furthermore, if you’re disciplined and committed to your future, you can calculate the difference between the money you would have spent on permanent life insurance premiums ($94.30 per month) and money you are spending on term life monthly premiums ($21.96 per month)…and invest that difference of money. The difference between the premiums would leave you with $72 a month to invest. Assuming you invest the different in premiums over the 20-year period at a 5% rate of return, you would end up with approximately $29,700. In other words: by choosing the permanent life policy you could lose out on over $25,000!
Investment income is not the only consideration when comparing permanent to term life insurance policies. You also need to consider your health and life circumstances. Will you require life insurance more than 20 years from now? Many people do not feel they require insurance once their children are grown and their mortgage is paid off. You may also want to consider your ability and willingness to save money on your own (for example, the $72/month investment scenario above is not relevant if you just end up spending the additional money, rather than saving and investing it). You can discuss all of the pros and cons of each policy with your advisor. Above all, the most important thing is to start considering and discussing whether obtaining a life insurance policy would benefit your loved ones!
Jodi Paradoski is a full-time accountant and coffee addict who loves animals, taxes, spreadsheets and savings accounts. She recently started her own blog, Economical Girl’s Guide!
Image via Unsplash