A CPA Talks About Buying Life Insurance
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| A CPA Talks About Buying Life Insurance |
Not everyone needs life insurance. The first
thing to do is make sure you need it. Life insurance is really meant for your
family members or other dependents who rely on your earnings.
<b>Why
You Buy Life Insurance</b>
You buy life insurance so that, if you die,
your dependents can live the same kind of life they live now. Strictly
speaking, then, life insurance is only a means of replacing your earnings in
your absence. If you don’t have dependents (say, because you’re single) or you
don’t have earnings (say, because you’re retired), you don’t need life
insurance. Note that children rarely need life insurance because they almost
never have dependents and other people don’t rely on their earnings.
<b>Life
Insurance Comes in Two Flavors</b>
If you do need life insurance, you should know
that it comes in two basic flavors: term insurance and cash-value insurance
(also called “whole life” insurance). Ninety-nine times out of 100, what you
want is term insurance.
<b>Term
Life is Simple to Buy and Understand</b>
Term life insurance is simple, straightforward
life insurance. You pay an annual premium, and if you die, a lump sum is paid
to your beneficiaries. Term life insurance gets its name because you buy the
insurance for a specific term, such as 5, 10, or 15 years (and sometimes
longer). At the end of the term, you can renew your policy or get a different
one. The big benefits of term insurance are that it’s cheap and it’s simple.
<b>Cash
Value is Trickier</b>
The other flavor of life insurance is
cash-value insurance. Many people are attracted to cash-value insurance because
it supposedly lets them keep some of the premiums they pay over the years.
After all, the reasoning goes, you pay for life insurance for 20, 30, or 40
years, so you might as well get some of the money back. With cash-value
insurance, some of the premium money is kept in an account that is yours to
keep or borrow against.
This sounds great. The only problem is that
cash-value insurance usually isn’t a very good investment, even if you hold the
policy for years and years. And it’s a terrible investment if you keep the
policy for only a year or two. What’s more, to really analyze a cash-value
insurance policy, you need to perform a very sophisticated financial analysis.
And this is, in fact, the major problem with cash-value life insurance.
While perhaps a handful of good cash-value
insurance policies are available, many— perhaps most—are terrible investments.
And to tell the good from the bad, you need a computer and the financial skills
to perform something called discounted cash-flow analysis. If you do think you
need cash-value insurance, it probably makes sense to have a financial planner
perform this analysis for you. Obviously, this financial planner should be a
different person from the insurance agent selling you the policy.
What’s the bottom line? Cash-value insurance is
much too complex a financial product for most people to deal with. Note, too,
that any investment option that’s tax-deductible—such as a 401(k), a 401(b), a
deductible IRA, a SEP/IRA, or a Keogh plan—is always a better investment than
the investment portion of a cash-value policy. For these two reasons, I
strongly encourage you to simplify your financial affairs and increase your net
worth by sticking with tax-deductible investments.
If you do decide to follow my advice and choose
a term life insurance policy, be sure that your policy is non-cancelable and
renewable. You want a policy that cannot be canceled under any circumstances,
including poor health. (You have no way of knowing what your health will be
like ten years from now.) And you want to be able to renew the policy even if
your health deteriorates. (You don’t want to go through a medical review each
time a term is up and you need to renew.)
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| A CPA Talks About Buying Life Insurance |
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